[Senate Hearing 107-1142]
[From the U.S. Government Printing Office]



                                                       S. Hrg. 107-1142
 
    PERSPECTIVES ON IMPROVING CORPORATE RESPONSIBILITY AND CONSUMER 
                              PROTECTIONS

=======================================================================

                                HEARING

                               before the

     SUBCOMMITTEE ON CONSUMER AFFAIRS, FOREIGN COMMERCE AND TOURISM

                                 of the

                         COMMITTEE ON COMMERCE,
                      SCIENCE, AND TRANSPORTATION
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 18, 2002

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation


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       SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

              ERNEST F. HOLLINGS, SOUTH CAROLINA Chairman
DANIEL K. INOUYE, Hawaii             JOHN McCAIN, Arizona
JOHN D. ROCKEFELLER IV, West         TED STEVENS, Alaska
    Virginia                         CONRAD BURNS, Montana
JOHN F. KERRY, Massachusetts         TRENT LOTT, Mississippi
JOHN B. BREAUX, Louisiana            KAY BAILEY HUTCHISON, Texas
BYRON L. DORGAN, North Dakota        OLYMPIA J. SNOWE, Maine
RON WYDEN, Oregon                    SAM BROWNBACK, Kansas
MAX CLELAND, Georgia                 GORDON SMITH, Oregon
BARBARA BOXER, California            PETER G. FITZGERALD, Illinois
JOHN EDWARDS, North Carolina         JOHN ENSIGN, Nevada
JEAN CARNAHAN, Missouri              GEORGE ALLEN, Virginia
BILL NELSON, Florida
               Kevin D. Kayes, Democratic Staff Director
                  Moses Boyd, Democratic Chief Counsel
Jeanne Bumpus, Republican Staff Director and General Counsel...........

     SUBCOMMITTEE ON CONSUMER AFFAIRS, FOREIGN COMMERCE AND TOURISM

                BYRON L. DORGAN, North Dakota, Chairman
JOHN D. ROCKEFELLER IV, West         PETER G. FITZGERALD, Illinois
    Virginia                         CONRAD BURNS, Montana
RON WYDEN, Oregon                    SAM BROWNBACK, Kansas
BARBARA BOXER, California            GORDON SMITH, Oregon
JOHN EDWARDS, North Carolina         JOHN ENSIGN, Nevada
JEAN CARNAHAN, Missouri              GEORGE ALLEN, Virginia
BILL NELSON, Florida


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on July 18, 2002....................................     1
Statement of Senator Boxer.......................................    43
    Prepared statement...........................................    44
Statement of Senator Dorgan......................................     1
Statement of Senator Edwards.....................................    45
Statement of Senator Fitzgerald..................................    46

                               Witnesses

Claybrook, Joan, President, Public Citizen.......................    18
    Prepared statement...........................................    24
    Article, dated July 17, 2002, entitled The Shareholder 
      Lawsuit: A Red Flag for Auditors?..........................    21
    Letters to Hon. Arthur Levitt................................ 39,40
Metzenbaum, Hon. Howard M., (Retired Senator), Chairman, Consumer 
  Federation of America..........................................     2
    Prepared statement...........................................     5
Minow, Nell, Editor, The Corporate Library.......................    48
    Prepared statement...........................................    51
Moore, Hon. Richard, Treasurer for the State of North Carolina...    10
    Prepared statement...........................................    13

                                Appendix

Smith, Hon. Gordon, U.S. Senator from Oregon, prepared statement.    61


    PERSPECTIVES ON IMPROVING CORPORATE RESPONSIBILITY AND CONSUMER 
                              PROTECTIONS

                              ----------                              


                        THURSDAY, JULY 18, 2002

                               U.S. Senate,
Subcommittee on Consumer Affairs, Foreign Commerce, 
                                       and Tourism,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:35 a.m. in 
room SR-253, Russell Senate Office Building, Hon. Byron L. 
Dorgan, Chairman of the Subcommittee, presiding.

          OPENING STATEMENT OF HON. BYRON L. DORGAN, 
                 U.S. SENATOR FROM NORTH DAKOTA

    Senator Dorgan. We call the Subcommittee hearing to order. 
This morning's hearing will be conducted in 2 parts. Beginning 
at 9:30 a.m., we will have the first portion of the hearing 
dealing with the perspectives offered to us by a number of 
organizations and individuals on corporate responsibility, 
consumer protections, and related issues; all of us know that 
we have had a crisis of confidence in this country--in many 
instances, for very good reasons--in the economy and 
corporations.
    Virtually every day, we hear additional news about some of 
America's best-known corporations restating earnings. We have 
news about corporations filing for bankruptcy. We have news of 
companies--such as Xerox, Global Crossing, Qwest, WorldCom, 
Merck, Enron, Tyco--restating earnings going back a quarter, a 
year, 2 years, 3 years, 4 years. It seems to me each and every 
day brings a new revelation about behavior and about practices 
inside the companies, about the actions of accountants and law 
firms that make you just shake your head and say, ``What on 
earth were people thinking about?''
    This is about public trust. The mechanism by which we 
accumulate capital in this country is such that people must be 
able to trust those who are running our companies, those who 
are preparing financial statements, those who are running 
accounting firms, those who are running the law firms. The 
faith in those institutions and those organizations has been 
sorely shaken in recent months.
    We recently passed a piece of legislation in the Senate 
dealing with corporate responsibility. Much more is yet to be 
done, however. That needs to go to conference. There are things 
that are left out of that bill. We will need to have a second 
round on that issue. We thought it was important to continue 
the work that we have done in this Subcommittee, much of it 
focusing on Enron following the announcements with respect to 
the Enron Corporation's scandals, I guess I would call it. The 
more we looked into Enron, I said it was a culture of corporate 
corruption, and I am more convinced of that now than ever. But 
it is not just the Enron Corporation. It goes well beyond that.
    We're going to have a hearing later this morning in which 
we hear about mark-to-market accounting in the State of 
California. Mechanisms by which I believe price fixing occurred 
in the State of California to the tune of billions of dollars. 
Billions of dollars taken out of the pockets of California 
consumers by manipulation of wholesale electricity prices and, 
therefore, the manipulation of retail electricity prices, as 
well. This isn't petty theft. This is wholesale fraud, in my 
judgment. We'll have some discussion about that later this 
morning.
    To give us a perspective from several different points on 
the compass about corporate responsibility, consumer protection 
and related issues--as a prelude to other activities this 
Subcommittee will have dealing with WorldCom, Global Crossing, 
Tyco, Xerox, and other companies, as well--we want to hear from 
four witnesses.
    I would ask the four witnesses to step forward and come to 
the table as I call their name--they are the Honorable Richard 
Moore, the State Treasurer for the State of North Carolina, the 
Honorable Howard Metzenbaum, a former colleague of ours; who is 
now Chairman of the Consumer Federation of America. Senator 
Metzenbaum, of course, served many years as a distinguished 
Senator from Ohio here in the U.S. Senate. Ms. Joan Claybrook, 
President of Public Citizen, and Ms. Nell Minow, Editor of The 
Corporate Library. And let me thank all of you for being here 
to testify this morning. My colleagues will be along in a bit.
    We are holding this hearing in two parts this morning. 
After receiving your testimony and asking some questions, we 
will reconvene the hearing at 11 o'clock, to hear from Army 
Secretary White on subjects that relate to the Enron 
Corporation, his former employer.
    Again, let me thank all of you for being here. As a matter 
of courtesy, I'll call on Senator Metzenbaum first. Senator 
Metzenbaum, we miss you here in the U.S. Senate, but we know 
that you are doing great work as Chairman of the Consumer 
Federation of America. Your voice has long been missed since 
your departure. We welcome you this morning and appreciate your 
willingness to offer testimony on behalf of the consumers of 
America.
    Senator Metzenbaum, please proceed.

   STATEMENT OF HON. HOWARD M. METZENBAUM (RETIRED SENATOR), 
            CHAIRMAN, CONSUMER FEDERATION OF AMERICA

    Senator Metzenbaum. Thank you, Mr. Chairman, and I miss 
being in the U.S. Senate, miss the opportunity to work with 
you, and I appreciate your invitation to offer my comments on 
this very important issue.
    I am particularly pleased to appear before you, Senator 
Dorgan, because you personally have done so much to highlight 
corporate abuses and to propose real reform.
    I spent my career in the U.S. Senate working to prevent 
corporations from running roughshod over the rights of 
consumers and workers. I have to tell you that I have never 
seen a more appalling example of the heartless, unfettered 
corporate greed than that revealed by the present widespread 
accounting scandals. Companies like Enron and WorldCom lied to 
their investors, lied to their employees, hid crucial 
information about their finances, and, in some cases, actually 
tried to influence, improperly, government officials. The 
executives behind what appears to have been a massive fraud--
massive frauds on a grand scale should be brought to justice 
quickly.
    This country finds itself in the midst of a corporate crime 
wave. It's astounding. It's incredible. It's unbelievable. And 
while the average citizens ponder their diminishing retirement 
accounts and wonder whether they will be next to lose their 
jobs, a debate rages in Washington over whether this is the 
product of a few bad apples or evidence of a systemic 
breakdown. The outcome will determine whether Congress and the 
Administration adopt an effective policy response.
    Back in the early 1940s, the number of corporate 
restatements used to run at a pretty predictable 45 or so a 
year. But around the middle of the last decade, it just took 
off. From 1997 through 2001, there were 1,089 restatements, 
including well known companies like Waste Management, Sunbeam, 
Cendant, Rite-Aid, and, of course, Enron. Today, we are fast 
approaching the point where 1 in 10 Americans--1 in 10 of 
America's public companies will have recently been forced to 
restate its earnings. That's more than the few bad apples the 
President claims have a problem.
    Our system of investor protections was ostensibly designed 
with these many bad apples in mind. It was designed to work, 
not just when corporate executives are honest and forthcoming 
and aboveboard, but also when they are greedy, unethical, and 
deceptive. That's why we have standardized disclosure rules and 
SEC oversight and ratings agencies and corporate board audit 
committees. And, above all, it is why we require an outside, 
independent auditor to review and approve a company's financial 
statements.
    In the recent rash of accounting frauds and failures, all 
of those safeguards failed. The accounting rules failed to 
produce an accurate picture of company finances. Corporate 
boards failed to ask tough questions, challenge questionable 
practices, or require more transparent disclosures. Auditors 
signed off on financial statements that clearly presented a 
misleading picture of companies' finances or missed altogether 
Mount Everest-sized reporting errors. In many cases, years had 
passed since the SEC last reviewed the company and questioned 
its financial statements.
    At the end of the day, one conclusion is inevitable. The 
system of corporate governance that we have long and rightly 
touted as the world's best is just not adequate to ensure that 
investors receive accurate information about the companies in 
which they invest. And that has led to the current crisis of 
investor confidence. Although most investors instinctively 
understand that not all companies are corrupt, they also know 
that they can't, on their own, reliably tell the difference 
between those whose finances toe the mark and those with 
troubling secrets hidden in the footnotes or kept out of the 
financial statements altogether. And they have experienced 
firsthand how quickly the bottom can drop out of a once high-
flying stock when questions about its accounting emerge.
    If we want average Americans to continue to view our 
financial markets as a place where they can entrust their long-
term savings, then we need to provide them with a reasonable 
assurance that our system of investor protections is once again 
functioning as it should, and that will require comprehensive 
reforms. Not just a little--not ``reforms,'' comprehensive 
reform. Not just a little reform; comprehensive reforms.
    While a strong civil and criminal enforcement program is a 
crucial element of such a plan, the President's plan just does 
not go far enough. First, he's given no indication that he's 
willing to fund the increased enforcement he's highlighting. 
His recent speech said nothing about new funding for the 
Department of Justice, which is already struggling with massive 
new responsibilities from the war on terror. And the added 
hundred-million dollars he has proposed for the SEC is like 
throwing a drowning man a toothpick when what he needs is a 
lifeboat.
    The House bill is even worse, much worse. It does nothing 
to enhance auditor independence beyond what the major firms 
have said they would do on their own. The bill's supposedly 
independent oversight board for auditors would have a majority 
of accountant representatives. How can you possibly stand up 
and support such legislation? It is sham reform that 
perpetuates the current system of self-regulation.
    Nor does the Senate's accounting reform bill do the job, 
although it is far superior to the President's proposal and the 
House-passed bill. It would be far better, for example, if it 
included your amendment, Senator Dorgan, to open up the 
proceedings of the Accounting Oversight Board to the public. 
It's a shame that that was not included. Or amendments offered 
by you and Senator McCain to ensure that the SEC imposes a 
broad ban on consulting services by accounting firms when they 
are also auditing a particular company. Or Barbara Boxer's 
amendment to prevent an accounting industry takeover of the 
oversight board.
    But the Senate bill does take a number of meaningful steps 
forward to strengthen oversight of the accounting industry. It 
is the minimum bill needed to improve investor confidence in 
the reliability of corporate disclosures. I believe the House 
should just accept the bill in the conference committee, 
because there is virtually nothing--and I mean nothing in the 
House bill worth keeping.
    If the House refuses, then, at the very least, Senators 
should insist that all conference negotiations are held in 
public. That would minimize the danger that opponents of reform 
would try to sneak in anti-investor proposals behind closed 
doors.
    In my written testimony, I mention a number of additional 
reforms that should be enacted. I will not talk at length about 
these measures now, but they include requiring corporations to 
list stock options as an expense. They are and they should be 
listed as an expense. Also requiring corporate boards to 
improve their oversight of company management and eliminating 
unwarranted restrictions in current law on private securities 
lawsuits.
    In closing, let me say that I am nervous--very nervous, Mr. 
Chairman--and uncomfortable that the current SEC will be 
overseeing the new accounting board when it is enacted into 
law, whether in the House or the Senate version. Unfortunately, 
the Chairman's ties to the accounting industry and his 
disappointing showing so far in addressing these issues 
undermines his credibility as the right man to fulfill this 
role. It is time for him to prove conclusively that he's 
protecting the public interest, not special interests, or step 
aside so that--for someone who will. Frankly speaking, the 
President never should have appointed him, who had represented 
so many of the accounting firms, in the position to which he 
had been named.
    To be specific, the Chairman needs to get off the sidelines 
and push the House to adopt the Senate bill. He needs to 
develop a real plan to restore independence to the so-called 
independent audit, and he needs to, and we need to, see to it 
that members appointed to the new oversight board will 
represent investors' interests, not the accounting industry, if 
the Senate bill becomes law.
    It would be good if the Chairman were to make his 
intentions known now. If the Chairman doesn't take these steps 
as soon as possible--he could move on the first two items 
immediately, for example--it is time for new leadership at the 
SEC. I want to repeat that. If he doesn't move immediately with 
respect to the first two items I mentioned, then it is time for 
new leadership at the SEC.
    Thank you, Mr. Chairman, for the opportunity to offer my 
comments. It's a privilege to appear with these other----
    Senator Dorgan. Senator Metzenbaum, thank you very much.
    You haven't changed very much since you've left the Senate. 
I must say, having listened to your testimony.
    Senator Metzenbaum. I'm sorry that I soft-pedaled it, Mr. 
Chairman.
    [Laughter.]
    [The prepared statement of Senator Metzenbaum follows:]

  Prepared Statement of Hon. Howard M. Metzenbaum, (Retired Senator), 
                Chairman, Consumer Federation of America

    Good morning, Chairman Dorgan, Senator Fitzgerald and Members of 
the Subcommittee. My name is Howard M. Metzenbaum and I now serve as 
Chairman of the Consumer Federation of America (CFA). CFA is a non-
profit association of some 300 pro-consumer organizations with a 
combined membership of over 50 million Americans. Ensuring adequate 
protections for the growing number of Americans who rely on financial 
markets to save for retirement and other life goals is one of CFA's top 
priorities.
    I appreciate your invitation to offer my comments on the very 
important issue of corporate responsibility. I am especially pleased to 
appear before you, Senator Dorgan, because you have done so much to 
highlight corporate abuses of late and to propose real reform.
    I spent my career in the U.S. Senate working to prevent 
corporations from running roughshod over the rights of consumers and 
workers. I have to tell you that I have never seen a more appalling 
example of heartless, unfettered corporate greed than that revealed by 
the recent, widespread accounting scandals. Companies like Enron and 
WorldCom lied to their investors, lied to their employees, hid crucial 
information about their finances and, in some cases, tried to 
improperly influence government officials. The executives behind what 
appears to have been massive frauds on a grand scale should be brought 
to justice quickly. This includes officers at companies like WorldCom, 
if they are found to have committed fraud, as well as the individuals 
at accounting firms who should have known when their clients were 
cooking the books.
    The truth is this country finds itself in the midst of a corporate 
crime wave. And while average citizens ponder their diminishing 
retirement accounts and wonder whether they will be next to lose their 
jobs, a debate rages in Washington over whether this is the product of 
a few bad apples or evidence of a systemic break-down. While that may 
seem to be an arcane argument in the face of so much real world pain, 
the implications of this debate are significant because the outcome 
will determine whether Congress and the administration adopt an 
effective policy response.
    The administration has been cynically arguing the ``bad apple'' 
theory. They have used this theory to justify a policy that allows them 
to talk tough about sending corporate crooks to jail without forcing 
them to impose real reforms on the corporate interests that so 
generously fund their campaigns. Now most of us can agree that 
corporate crooks should spend some time behind bars, but this argument 
misses on two counts. First, what we are looking at here is more than a 
few bad apples. Secondly, what we have is a system of investor 
protections specifically designed to eliminate the bad apples; a system 
that clearly is not working.
    One measure of the scope of the problem is the recent dramatic rise 
in companies forced to restate their earnings. Back in the early 1990s, 
that number used to run at a predictable 45 or so a year, but around 
the middle of the last decade, it took off. From 1997 through 2001, 
there were 1,089 restatements, according to a recent study by the Huron 
Consulting Group. The number grew every year over that five-year 
period, from 116 in 1997 to 270 in 2001. The companies involved include 
such well-known examples as Waste Management, Sunbeam, Cendant, Rite 
Aid, and, of course, Enron--accounting failures that together cost 
investors hundreds of billions of dollars in lost market 
capitalization. But, they do not include Adelphia or Xerox or WorldCom 
or any of the other companies whose actions have promised to make 2002 
another record-breaking year. Today, we are fast approaching the point 
where one in ten of America's public companies will have recently been 
forced to restate its earnings. That is a lot of bad apples.
    Furthermore, the companies involved are not unknown fly-by-night 
operations, but the very symbols, in many cases, of innovative American 
capitalism--Enron, WorldCom, Qwest, and Xerox--a company that, as one 
writer put it is ``so established that its name has become both noun 
and verb.'' Even if you were to accept the argument that we are dealing 
with isolated cases of wrong-doing, when they involve the nation's 
leading companies, does that not tell you the system is fundamentally 
broken?
    But the real point is that our system of investor protections was 
ostensibly designed with the bad apples in mind. It was designed to 
work, not just when corporate executives are honest, forthcoming and 
aboveboard, but also when they are greedy, unethical, and deceptive. 
First and foremost, it is why we require an outside, independent 
auditor to review and approve a company's financial statements. It is 
why we have standardized rules that govern what companies have to 
disclose and how. It is why the SEC reviews financial disclosures for 
accuracy, completeness, and compliance with appropriate accounting 
rules. It is why rating agencies pore over massive amounts of 
information to determine the creditworthiness of companies that issue 
debt. It is why corporate boards have audit committees, made up 
primarily of board members who are supposed to be ``independent,'' to 
supervise the audit.
    In the recent rash of accounting frauds and failures, all of those 
safeguards failed. The accounting rules failed to produce an accurate 
picture of company finances. Corporate boards failed to ask tough 
questions, challenge questionable practices, or require disclosure that 
is more transparent. Auditors signed off on financial statements that 
clearly presented a misleading picture of company finances--or missed 
altogether Mt. Everest sized reporting errors. In many cases, years had 
passed since the SEC last reviewed the company in question's financial 
statements.
    At the end of the day, one conclusion is inevitable. The system of 
corporate governance that we have long, and rightly, touted as the 
world's best is not adequate to ensure that investors receive accurate 
information about the companies in which they invest. And that has led 
to the current crisis of investor confidence. Although most investors 
instinctively understand that not all companies are corrupt, they also 
know that they can not--on their own--reliably tell the difference 
between those whose finances toe the mark and those with troubling 
secrets hidden in the footnotes or kept out of the financial statements 
altogether. They have experienced first-hand how quickly the bottom can 
drop out of a once high-flying stock when questions about its 
accounting emerge.
    Another aspect of the current debate swirls around the question of 
whether this recent explosion of corporate greed is something new or 
not. The latter argument is based on the theory that the recent 
revelations of corruption in the boardroom are simply the inevitable 
hangover from the market boom--that this is simply how markets 
``correct'' themselves, and we should simply get out of the way and let 
the market do its work.
    This argument also ignores an important point--that our markets are 
no longer simply a place where the rich get richer. Increasingly, the 
financial markets are where average, middle class Americans put their 
money to save for retirement, to buy a home, or to send their children 
to college. Since the time when the first President Bush took office, 
the number of Americans investing in our markets has grown by roughly 
60 percent. Today, approximately half of all households have money 
invested either directly or indirectly in the stock of American 
companies. It is this massive new influx of capital from average 
Americans that provided the fuel for our recent period of unprecedented 
economic growth.
    When the bottom drops out, what these middle class families have at 
risk is not whether they can vacation in Tuscany this year, or if they 
will have to stay a little closer to home. It is not whether they have 
to give up the private jet, or delay their plans to build a vacation 
home in Aspen. What is at risk is whether they will be able to retire 
in reasonable comfort, or even retire at all. What is at risk is 
whether their children will be able to attend the college of their 
choice, settle for a less expensive alternative, or miss out on college 
altogether. What is at risk is whether they will have to delay 
indefinitely their ability to participate in the American dream of 
owning their own home. So, what is new is not just that the investor 
losses from the recent spate of accounting failures are unprecedented 
in their size, but that families who are far less able than the 
investing class of the past to absorb such losses are feeling them.
    If we want average Americans to continue to view our financial 
markets as a place where they can entrust their long-term savings, then 
we need to provide them with reasonable assurance that our system of 
investor protections is once again functioning as it should. That will 
require comprehensive reforms. While a strong civil and criminal 
enforcement program is a crucial element of such a plan, the 
President's plan does not go far enough. He has given no indication 
that he is willing to fund the increased enforcement he is 
highlighting. His recent speech said nothing about new funding for the 
Department of Justice, which is already struggling with massive new 
responsibilities from the war on terror. The added $100 million he has 
proposed for the SEC is like throwing a drowning man a toothpick when 
what he needs is a lifeboat.
    The House bill is a disaster. It does nothing to enhance auditor 
independence beyond what the major firms have said they would not 
oppose. Its supposedly independent oversight board for auditors would 
allow a super-majority of industry representatives. And the mechanism 
it relies on to create the board--where a board applies for the job--
invites an industry take-over. This is sham reform that, in all but 
name, perpetuates the current system of self-regulation.
    Nor does the Senate accounting reform bill do the job, although it 
is far superior to the President's proposal and the House-passed bill. 
It would be far better, for example, if it included your amendment, 
Senator Dorgan, to open up the proceedings of the Accounting Oversight 
Board to the public or amendments offered by you or your colleague 
Senator McCain to insure that the SEC imposed a broad ban on consulting 
services by accounting firms when they are also auditing a particular 
company. It would be far better with the amendments offered by Senator 
Boxer to enhance the independence of the oversight board.
    Although we were very disappointed that these amendments were never 
voted on and that this important opportunity to improve the bill was 
missed, make no mistake about it. The Senate bill is still by far the 
best reform proposal on the table. It is the only proposal to create a 
strong, effective new oversight board for auditors; to include 
significant provisions to strengthen corporate board oversight of the 
audit and enhance its independence; to lengthen the statute of 
limitations for securities fraud; and to protect the independence of 
the Financial Accounting Standards Board. Like the House, but unlike 
the President's proposal, the Senate bill authorizes a meaningful and 
much needed increase in SEC resources.
    In short, the Senate bill is the minimum needed to justify renewed 
investor confidence in the reliability of corporate disclosures. To 
ensure that the best possible bill is passed as quickly as possible, 
the House should accede to the Senate bill. If it refuses, then at the 
very least, Senators should insist that the conference is held in 
public. That would minimize the danger that the opponents of reform, 
who are nervous about gutting the bill in public, would be bolder in 
behind-closed-doors bargaining sessions.
    But even if the Senate bill is adopted intact, more needs to be 
done. In developing an agenda of additional reforms, policy makers need 
to recognize that one reason the system has run amok is that too many 
of the financial incentives reward doing the wrong thing. If you want 
to bring about a new era of corporate responsibility, you are going to 
have to eliminate those perverse incentives.
Stock Options Should Be Expensed
    The Senate bill would enhance the independence of the Financial 
Accounting Standards Board. Maybe that will give FASB the courage to do 
what it was intimidated to do nearly 10 years ago--require that stock 
options be reflected as an expense on corporate balance sheets.
    Proponents of stock option compensation argue that this practice 
benefits shareholders by aligning the interests of company executives 
with those of company shareholders. But that is clearly not true. As 
Paul Krugman recently wrote in The New York Times, options allow 
executives to ``get a share of investors' gains if things go well,'' 
but don't force them to ``share the losses if things go badly.'' As a 
result, and because of the massive size of many options grants, they 
offer executives massive personal financial incentives to take whatever 
risks necessary to drive up the stock price in the short term.
    Clearly, granting executives shares of company stock, and forcing 
them to hold that stock until after they leave the company, would do a 
far better job of aligning their interests with those of typical 
shareholders. But our accounting rules favor stock option compensation 
over grants of company shares. This is because the grant of company 
shares would have to be reflected immediately as an expense on balance 
sheets, while the stock options can be relegated to the footnotes 
without denting earnings. That makes no sense. As others have pointed 
out--while it may be difficult to pin a precise value on options when 
they are granted, the one thing we do know is that their value is not 
zero.
    If we truly want to align company executives' interests with 
shareholders--a laudable goal--we need to remove this perverse 
incentive in our accounting rules to use stock options rather than 
grants of company shares to provide incentive compensation to 
executives. But, despite the admirable efforts of Senators Levin and 
McCain, this aim was not included in the recent Senate corporate reform 
bill. The bill is incomplete without it.
Improve Corporate Board Oversight of Management
    With all the focus on stock options, it is important to remember 
that personal greed is not the only factor encouraging company 
executives to push share prices ever higher. As Steve Liesman wrote in 
the Wall Street Journal last January, ``stocks have become a vital way 
for companies to run their businesses.'' Companies use stock to make 
acquisitions and to guarantee the debt of off-the-books partnerships. 
They rely on the stock market as a place to raise capital. As a result, 
as Leisman said, ``a high stock price can be the difference between 
failure and success.''
    Clearly, simply fixing the accounting for options will not be 
enough to eliminate the incentive for corporate executives to do 
whatever it takes--including cooking the books--to create the financial 
picture necessary to produce a rising stock price. Corporate boards are 
going to have to do a better job of keeping management on the straight 
and narrow.
    In theory, corporate board members are supposed to represent 
shareholders. But shareholders don't pick board members, CEOs do. 
Recent proposals by the New York Stock Exchange and Nasdaq take a step 
in the right direction by strengthening the independence requirements 
for independent board members and by requiring that all members of the 
audit and compensation committees be independent members. However, they 
are not enough to overcome the influence management has by virtue of 
the fact that it selects the board--and can stack it with cronies and 
``yes'' men or boot those board members they view as trouble makers.
    If we want corporate boards to represent shareholders, we need to 
do a better job of giving shareholders a say in the selection of board 
members. This is an area that we believe deserves additional attention 
in the coming months.
Make the Independent Audit Truly Independent
    Ultimately, however, the ability to ensure reliable disclosures 
comes down to the effectiveness of the independent audit. Nothing else 
can substitute for having a skeptical, independent outsider who 
thoroughly looks over the books. But, here again, auditors faced with 
bogus accounting have overwhelming financial incentives to look the 
other way. Challenging management could cost them the audit engagement. 
Given the decades-long relationships that are typical between auditors 
and their clients, that means losing not just this year's audit fee, or 
next year's audit fee, but decades of expected income. If the client is 
a big one, the incentive to back down is enormous.
    One thing that dramatically ups the ante is the increasingly common 
practice among auditors of also providing consulting services to their 
audit clients. The practice has become all but universal among large 
companies, and the dollar amounts on the table for consulting contracts 
are typically two or three times the audit fees. In some cases, 
however, the imbalance is much greater, with consulting fees in some 
cases bringing in twenty or thirty times the audit fees.
    It is no wonder that expert after expert who testified before House 
and Senate committees said no reform would be complete without a broad 
ban on consulting services and mandatory rotation of audit firms. 
Unfortunately, these central reforms never made the cut. The House bill 
simply does what the major accounting firms said they would not 
oppose--it expands the current ban to include internal audits and 
financial system design and implementation. The Senate bill expands the 
list a little further. But neither bill requires the rotation of audit 
firms.
    Where the Senate bill stands head and shoulders above the rest in 
this area is with its requirement that board audit committees, made up 
exclusively of independent board members, pre-approve any decision to 
hire the auditor to perform non-audit services. Also key is the Senate 
bill's provision making audit committees directly responsible for 
hiring and compensating the auditor and for overseeing the audit and 
giving the audit committee the tools it needs to do that job 
effectively.
    While we respect the efforts the Senate has made to improve the 
oversight of the audit, we do not believe reform will be complete until 
auditors are forced to be truly independent from their audit clients. 
That means the kind of broad ban on consulting services that has been 
proposed by Senators Nelson, Carnahan, and McCain and mandatory 
rotation, as included in the Nelson-Carnahan bill.
Improve Audit Standards
    Because they lack those broad auditor independence reforms, the 
House and Senate bills rely heavily on the new auditor oversight board 
to ensure quality audits. But only the Senate bill gives its new board 
the standard-setting authority that is key to its effectiveness. The 
House bill leaves authority for setting standards with the accounting 
profession. Even under pressure from recent scandals, the accounting 
profession uses its authority to write audit standards that are full of 
suggestions rather than mandates--standards that are more geared toward 
minimizing accounting firms' liability than ensuring high quality 
audits.
    The Senate bill provides ample opportunity for industry 
participation in this process, but it charges the oversight board with 
final responsibility. That should ensure that those whose job it is to 
protect the public interest, not the special interests, make decisions. 
Of course, even if the House bill gave its regulatory board the 
necessary authority, it would not matter. That is because, as we 
mentioned earlier, the House bill is custom designed to ensure maximum 
industry influence over its new ``regulator.'' It is essential that the 
Senate oversight board structure and authority be adopted in the final 
bill.
Increase Deterrence
    The Senate bill includes an impressive package of criminal and 
civil penalties for corporate crimes. These should send the same 
powerful message to white collar crooks that we have sent to street 
criminals--don't do the crime if you can't do the time. The Senate and 
House have also authorized dramatically increased funding to put more 
cops on the beat at the SEC. You know as well as I do, however, that 
authorizing funding and appropriating it are two very different things. 
Particularly in light of the lack of administration support, members 
will need to be vigilant to ensure that this promise of increased 
resources is realized.
    We also continue to believe that private lawsuits form an essential 
supplement to regulatory enforcement efforts, particularly if you are 
unwilling to adequately fund enforcement, as the President appears to 
be. Unfortunately, the deterrent effect of such lawsuits is limited by 
a number of factors, including the unreasonably high pleading standards 
plaintiffs must satisfy before getting access to discovery, the 
unreasonably short statute of limitations that governs such suits, and 
the lack of aiding and abetting liability.
    The Senate bill would address one of those problems, lengthening 
the statute of limitations to 2 years from discovery, but no more than 
5 years from the wrongdoing. This will make it more difficult for those 
who commit fraud to escape liability simply by keeping their fraud 
hidden for a short time. It will also make it less likely that suits 
against secondary defendants are dismissed because the statute of 
limitations has run while the motion to dismiss was pending, blocking 
access to discovery.
    Senator Shelby was prepared to offer another important amendment, 
to restore aiding and abetting liability under the securities laws. 
Unfortunately, like so many other important amendments that we have 
discussed today, he was prevented from offering that amendment. This 
reform is highly relevant to the current crisis since the lack of 
aiding and abetting liability has been used by defendant after 
defendant in the Enron lawsuits to argue that they cannot be held 
accountable for assisting the fraud.
    If you cannot fix this glaring shortcoming in our laws now under 
the current environment, it is hard to imagine when that will be 
possible. But perhaps when these lawsuits have worked their way through 
the court system and we find that the victims have recovered only a 
pittance, if anything, of their losses, perhaps then will certain 
members be willing to abandon their phony rhetoric about frivolous 
lawsuits and recognize that our legal system stands in the way of full 
and fair redress in even the most meritorious of cases.
Conclusion
    The recent corporate crime wave has delivered a wake-up call. The 
system of corporate governance that we have grown accustomed to touting 
is broken. The Senate has started down the road to reform. But our 
system will remain vulnerable until we tackle the fundamental 
incentives that encourage our corporate executives to do the wrong 
thing and our auditors to turn a blind eye.
    We have been given a wake-up call.

    Senator Dorgan. Next, let me ask for testimony from the 
Honorable Richard Moore, State Treasurer for the State of North 
Carolina. Mr. Moore, you may proceed, and we will include your 
entire statement in the record, so you may summarize.

  STATEMENT OF HON. RICHARD MOORE, TREASURER FOR THE STATE OF 
                         NORTH CAROLINA

    Mr. Moore. Thank you very much, Senators. Thank you for 
this opportunity.
    I come before you today as North Carolina's elected 
guardian of the State Treasury and as the sole trustee of $62 
billion in public money, most of which is the pension funds for 
the 600,000 active and retired public workers of our great 
state--the teachers, fire and rescue workers, nurses, police 
officers, sanitation workers, and state and local government 
employees of North Carolina.
    I come here today as an owner who needs help exercising the 
full rights of ownership--nothing more, nothing less. Now, in 
my prepared remarks, I have some quotations that go back and 
show that, since Alexander Hamilton's day and George 
Washington's first address to this body, we've always 
understood that the power of the marketplace needs to be 
regulated for the good of us all.
    We can go back through the Great Depression. I wanted to 
point out that the deep corruption of our public markets 
brought about the passage of the Securities Acts of 1933 and 
1934 and the passage of the Glass-Steagal Act. I am extremely 
proud that my grandfather, as a member of this body, played a 
significant role in drafting and championing many pieces of 
these necessary reforms. And we find ourselves, 70 years later, 
right back in very, very similar situations. Those reforms 
produced a fair and stable marketplace that's been the envy of 
the world for almost 70 years.
    And I give you this historical background to make what 
ought to be an obvious point. It is important to remember that 
we are addressing regulations that apply only to public 
companies and that no one forces a company to become public. 
The choice to do so means that its corporate leaders 
voluntarily give up some of their autonomy and agree to be 
regulated.
    The tradeoff, which has been significant over the past 20 
years, is that those companies may access capital at a severely 
discounted rate to traditional sources. Even today, most 
businesses and most of the folks I talk to in my home state are 
not regulated, the businesses on Main Street across America. 
And when they need additional capital, they pay a premium for 
it.
    Publicly traded companies have been and must always be 
regulated to make sure that the individual investor can 
properly value his or her risk before an ownership decision is 
made. This obvious point has been overlooked by many who are 
afraid that additional government regulation will foul the 
market.
    Today, more than 80 million Americans have decided to take 
part in these public marketplaces, either through mutual funds 
or pension plans. This, in itself, is remarkable. They have 
been enticed--and I want to repeat that--they have been 
enticed, through tax policy and professional advice, to 
participate and share in this part of the American dream. It is 
not your job, nor is it the job of corporate America, to ensure 
that this dream comes true. However, it is your job to make 
sure that the marketplace is fair to all so that some don't 
profit while others lose from the exact same investment.
    Our markets today contain about $12 trillion in assets. 
More than $2 trillion of that is held by pension funds, like 
the one that I run in North Carolina. Approximately--but here's 
the point that a lot of people don't understand--while $8 
trillion is controlled by mutual funds, most of the large 
mutual funds' largest clients are pension funds like myself. So 
we have tremendous clout in the marketplace, clout that I don't 
think we have fully utilized or understood how to wield.
    Institutional ownership has evolved over the last 30 years, 
and I think that's one of the reasons we're not prepared. As a 
result, we find ourselves, collectively, the largest 
shareholders in virtually every major company in America. The 
founder or the founder's descendants, at the same time, in many 
instances, are no longer seated at the board table advocating, 
out of self-interest, the interest for the shareholders. It is 
truly a setting very much like government, where people are 
spending other people's money.
    Therefore, we, as institutions, must act like the owners 
that we are. However, we cannot do it alone. We need Congress 
and the Administration to help make sure we can properly 
exercise our prerogatives of ownership. We need your help to 
make sure that we can tell whether the interests of management 
and shareholders are properly aligned. We need your help in 
making sure that we, as investors, can properly price risk. We 
need your help to make sure that the cops on this particular 
beat have the resources and tools to do their job effectively. 
We need your help now more than ever. And I won't recap all of 
the events that happened.
    I firmly believe that the vast majority of today's 
corporate managers are smart and honest, but it is 
disconcerting to see so many of them unmasked, not as captains 
of industry, but as captains of greed, with callous disregard 
for the welfare of the people whose money grows their company. 
Simply put, where I come from, we know that the fox cannot 
guard the hen house. No matter how well-meaning, at some point 
the temptation to gorge will prevail.
    Without proper regulation, history has proven that 
hardworking Americans always pick up the tab--the Great 
Depression, the savings and loan debacle, during which I was a 
white-collar federal prosecutor, with nowhere near the 
resources to do the job properly, 12 years ago; and, most 
recently, as the Chairman has referred to, the power shortage 
in California.
    In carrying out my fiduciary duty to 600,000 beneficiaries, 
we have begun to more actively exercise our ownership rights. 
Last month, I was joined by the Comptroller of New York--he and 
I are the two largest sole trustees in America--the Treasurer 
of the State of California, Phillip Angelides, and the Attorney 
General of New York, Elliott Spitzer, to announce important 
investment protection principles. These proposals embody 
simple, common sense, market-based solutions to some of the 
problems that we face.
    We, as owners, are exercising our ownership rights when we 
put new terms on the table. If you want our money, this is what 
we need from you. We're demanding that broker/dealers and money 
managers eliminate actual and potential conflicts of interest 
from the way they pay their analysts and conduct their affairs, 
and we appreciate your help in this. We are asking that the 
managers that we utilize look closer into the areas of 
financial transparency and corporate conduct. As fiduciaries, 
we must and will become more assertive in our ownership role.
    Now, in closing, I would like to say that, as investors, we 
cannot properly price our risk without getting fair and 
accurate information regarding financial transparency and 
corporate conduct. We must be able to assess accurate earnings 
and the future impact of corporate initiatives on those 
earnings. You have already signaled your willingness to help in 
that area. And for that, I thank you.
    In some areas, we need specific prohibitions. And Senator 
Metzenbaum has hit on many of those. In other areas, this may 
be unwise. I ask that in the areas that you feel outright 
prohibition is unwarranted or unnecessary at this point, do 
make disclosure standards tougher. Just as you have done in 
food labeling and countless other areas, it is prudent and 
appropriate to require that certain financial information be 
prominently displayed in plain language in proxy statements and 
annual reports. If you will help the large and small investor 
alike learn how to find the information to properly price 
``option overhangs'' and ``option run rates,'' the market will 
go a long way in ridding itself of the truly abusive practices.
    I would also ask--remind Congress that this situation has 
shown that the defined benefit plans, in many ways, are far 
more secure and better than defined contribution plans, as 
someone who runs both of them. My defined contribution 
investors--I had a lady stop me yesterday. Her money--they had 
put $300,000 away as a public investor. Today she has only 
$120,000 in that account, and she's grateful that my funds were 
properly diversified and we haven't taken that kind of hit. So 
I encourage you to look at those roles again.
    The importance of the task before us cannot be overstated. 
We must restore investor confidence. It is the pillar upon 
which one of the great institutions of our society rests, the 
open and fair marketplace.
    Thank you.
    [The prepared statement of Mr. Moore follows:]

 Prepared Statement of Hon. Richard Moore, Treasurer for the State of 
                             North Carolina

    I come before you as North Carolina's elected guardian of the state 
treasury, and as the sole trustee of $62 billion in public money, most 
of which is the pension funds for the 600,000 active and retired public 
workers of our great state--the teachers, fire and rescue workers, 
nurses, police officers, sanitation workers, and state and local 
government employees of North Carolina. And, I have come here today as 
an owner who needs help exercising the full rights of ownership--
nothing more, nothing less.
    As a student of history, I recognize that capitalism has never been 
totally unrestrained in this country. Those leaders who have championed 
capitalism and the building of economic markets have understood that 
unregulated and unchecked, a pure laissez-faire marketplace is a 
dangerous thing. In arguing that markets could never regulate 
themselves, Alexander Hamilton wrote in his 7th Federalist paper that 
``the spirit of enterprise'' when ``unbridled,'' leads to ``outrages, 
and these to reprisals and wars.'' He later stated that we Americans 
had ``a certain fermentation of mind, a certain activity of speculation 
and enterprise which if properly directed may be made subservient to 
useful purposes; but which if left entirely to itself may be attended 
with pernicious effects.''
    This mindset put forth by the founders of our nation has always 
been understood by our nation's leaders. Agreeing with President 
Theodore Roosevelt, President Woodrow Wilson felt that without ``the 
watchful interference, the resolute interference of the government, 
there can be no fair play between individuals and such powerful 
institutions as [corporations].''
    The Hamiltonian views were again embraced after the Great 
Depression. The deep corruption of our public markets brought about the 
passage of the securities acts of 1933 and 1934 and the passage of the 
Glass Steagell Act. I am extremely proud that my grandfather, Frank W. 
Hancock, Jr., as a business-oriented member of the House Banking 
Committee, played a significant role in drafting and championing many 
pieces of these necessary reforms.
    The result of these and other reforms produced a stable and fair 
public marketplace that has been the envy of the world for almost 70 
years.
    It is important to remember that we are addressing regulations that 
apply only to public companies, and that no one forces a company to 
become public. The choice to do so means that its corporate leaders 
voluntarily give up some of their autonomy and agree to be regulated. 
The trade off, which has been a significant advantage over the last 20 
years, is that those companies may access additional capital at a 
discount to traditional sources. Even today, most businesses in this 
country--those located on main streets across America--are not publicly 
regulated, and when they need additional capital, they must pay a 
premium for it.
    Publicly traded companies have been and must be regulated to make 
sure that the individual investor can properly value his/her risk 
before an ownership decision is made. This obvious point has been 
overlooked by some who fret that additional government regulation will 
foul the market.
    Today, more than 80 million Americans have decided to take part in 
these public markets. Either directly or indirectly through mutual 
funds and other pension plans, they have placed their hard earned 
savings in these marketplaces. This in itself is remarkable. They have 
been enticed through tax policy and professional advice to participate 
and share in the American dream. It is not your job, nor is it the job 
of corporate America, to insure that this dream comes true. However, it 
is your job to make sure that the marketplace is fair to all so that 
this dream does not turn into the nightmare of losing the family nest 
egg.
    Our markets today contain approximately $12 trillion in assets. 
More than $2 trillion of that is held by pension funds like the one 
that I run in North Carolina. Approximately $8 trillion of this 
marketplace is controlled by mutual funds. Many of the largest 
investors in mutual funds are pension funds, so we institutional 
investors have tremendous market clout--clout that I do not think we 
have yet fully utilized to bring about positive change.
    Institutional ownership has evolved over the last 30 years. As a 
result, we find ourselves collectively as the largest stockholders in 
virtually every major company in America. The founder, or the founder's 
descendents, in many instances are no longer seated at the board table 
advocating--out of self-interest--for the interest of shareholders. It 
truly is often a setting where people spend other people's money.
    We must act like the ``owners'' that we are. However, we cannot do 
it alone. We need Congress and the Administration to help make sure we 
can properly exercise our prerogatives of ownership. We need your help 
to make sure that we can tell whether the interest of management and 
shareholders are properly aligned. We need your help in making sure 
that we, as investors, can properly price risk. We need your help to 
make sure the cop on this particular beat has the resources and tools 
needed to do their job effectively.
    We need your help now more than ever. The events of the last few 
months have shown that our system is currently missing effective and 
necessary checks and balances to insure that the fine line between 
proper incentive and destructive greed is not crossed. I firmly believe 
that the vast majority of today's corporate managers are smart and 
honest, but it is disconcerting to see so many unmasked not as captains 
of industry, but as captains of greed, with callous disregard for the 
welfare of the people whose money grows their company.
    Simply put, we know that the fox, no matter how well meaning, 
cannot guard the hen house. At some point, temptation prevails. Without 
proper regulation, history has proven that hard working Americans 
always pick up the tab--the Great Depression, the savings and loan 
debacle, and most recently, the power shortage in California.
    In carrying out my fiduciary duty to my 600,000 beneficiaries, we 
have begun to more actively exercise our rights of ownership. Last 
month, I was joined by the Comptroller of New York, H. Carl McCall, the 
Treasurer of California, Philip Angelides, and the Attorney General of 
New York, Eliot Spitzer, to announce important investment protection 
principles. These proposals embody simple, common sense, market-based 
solutions to some of the problems that we face. We, as owners 
exercising our ownership rights, have put new terms on the table--if 
you want our money, this is what we need from you. We are demanding 
that broker/dealers and money managers eliminate actual and potential 
conflict of interest from the way they pay analysts and conduct their 
affairs. We are asking the money managers we utilize to look closer 
into the areas of financial transparency and corporate conduct. As 
fiduciaries, we must and will become more assertive in our ownership 
role.
    To date, we have been joined by several other large funds in our 
initiative, with more who will likely follow.
    As investors, we cannot properly price our risk without getting 
fair and accurate information regarding financial transparency and 
corporate conduct. We must be able to assess accurate earnings and the 
future impact of corporate incentives on those earnings. You have 
already signaled your intent to help us in these areas, and for that I 
thank you.
    In some area, we need specific prohibitions. In other areas, this 
may be unwise. I ask that in areas where you feel outright prohibition 
is unwarranted, do make disclosure standards tougher. Just as Congress 
has done in food labeling and other areas, it is prudent and 
appropriate to require that certain financial information be 
prominently displayed in plain language in proxy statements and annual 
reports. If you will help the large and small investor alike learn how 
to find the information needed to properly price ``option overhangs'' 
and ``option run rates,'' the market will then go a long ways in 
ridding itself of truly abusive practices.
    In the past 25 years, retirement savings have been systematically 
shifted from defined benefit to defined contribution plans. While this 
shift has been highly profitable to the mutual fund industry and 
corporations, it has not strengthened overall retirement savings. The 
401(k), IRA and Roth IRA are excellent supplementary savings plans. 
However, they are insufficient, as has been evident in the past 2 
years, for many Americans attempting to prepare for a comfortable 
retirement.
    Moreover, defined contribution plans leave matters of corporate 
governance and transparency in the hands of individuals who have little 
time or money to study these issues. In 401(k) plans, these issues are 
left in the hands of trustees who have little incentive to press mutual 
fund managers or the underlying companies. Ownership in equities is a 
proven way to build retirement wealth. However, it requires careful 
attention to the demands of ownership.
    I urge Congress to enact legislation promoting the expansion and 
establishment of defined benefit plans. These plans are the foundation 
of retirement security, and without them, I fear many hard working 
Americans will face difficult retirement years. These plans should be 
portable. We must recognize that lifetime employment is no longer 
feasible or practical in our modern economy. These plans need to run on 
assumptions that are realistic and fair.
    The importance of the tasks before us cannot be overstated. We must 
restore investor confidence. It is the pillar on which one of the great 
institutions of our society rests--the open and fair marketplace.
 July 1, 2002--State Treasurer Richard Moore Announces Landmark Public 
                   Pension Fund Investment Initiative
    RALEIGH--As North Carolina's State Treasurer, Richard Moore manages 
the 10th largest public pension fund in the United States and the 24th 
largest in the world. Add to that the funds managed by Moore's 
counterpart New York State Comptroller H. Carl McCall, and you have a 
total investment portfolio of nearly $170 billion. When that much money 
talks, Wall Street takes notice.
    That's why Treasurer Moore and Comptroller McCall have teamed up 
with New York State Attorney General Eliot Spitzer to launch a major 
initiative to establish stronger corporate disclosure standards for 
investments made with public pension funds, the money that pays the 
retirement of public workers. Under this initiative, which Moore and 
McCall as sole trustees have implemented for their respective pension 
fund investment portfolios effective immediately, the North Carolina 
Public Employees' Retirement Systems and the New York State Common 
Retirement System will require the following of investment banking and 
money management firms that do business with the two pension funds:

   Investment banking firms must adopt the conflict of interest 
        principles set forth in the agreement that New York Attorney 
        General Spitzer reached with Merrill Lynch in May of 2002 
        (referred to as the ``Spitzer Principles.'')

   Money management firms must make disclosures regarding 
        portfolio manager and analyst compensation, the use of any 
        broker dealers that have not adopted the Spitzer Principles, 
        and any potential conflicts of interest arising from client and 
        corporate parent relationships.

   Money management firms must adopt safeguards to ensure that 
        there are no potential conflicts of interest as a result of the 
        method compensation is provided to analysts that could 
        influence investment decisions made on behalf of the pension 
        funds.

   Money management firms must scrutinize more closely the 
        auditing and corporate governance practices of companies in 
        which pension fund monies are invested.

    ``Recent conflict of interest and insufficient corporate governance 
stories coming out of Wall Street firms have shaken the confidence of 
investors, big and small,'' said Treasurer Moore. ``On behalf of the 
hard-working public employees and retirees whose pension funds 
Comptroller McCall and I manage, we are using our clout as large public 
fund investors to set a higher standard. Because people are counting on 
us to ensure their pension funds are secure, we must be able to know 
the information we use to make sound, prudent investment decisions is 
reliable.''
    ``I have been working for months on common sense, market-driven 
solutions that will ensure that our funds are invested safely. I am 
grateful for Attorney General Spitzer's guidance and to Comptroller 
McCall for joining this effort.''
    California Treasurer Philip Angelides today also pledged his 
support for these measures, and will attempt to get them adopted by 
CalPERS and CalSTRS (both $100 billion plus California public employee 
pension funds).
    ``I am today sending out a letter to other pension fund managers 
encouraging them to adopt similar measures, and will also be reaching 
out to other large investors. Public pension funds also have assets of 
about $2.3 trillion. I am, therefore, confident that we can build 
enough support to bring about significant change, with or without 
Congressional or administration action.''
    The North Carolina and New York pension funds contract with dozens 
of investment banking firms, and requiring those firms to adhere to the 
Spitzer Principles will benefit all investors, not just pension funds. 
In addition, public confidence in the stock market has a great impact 
on the future growth of the pension funds. Adoption of these principles 
should help restore confidence in the marketplace, which will have a 
positive impact on both pension fund beneficiaries and individual 
investors.
    A copy of the Public Pension Fund Investment Protection Principles 
adopted by North Carolina and New York is attached.
State and Public Pension Fund Investment Protection Principles
    A. Effective July 1, 2002, every financial organization that 
provides investment banking services and is retained or utilized by the 
State Treasurer of North Carolina, the Comptroller of the State of New 
York, or the State Treasurer of California (hereinafter ``the State 
Investment Officers''), including but not limited to organizations 
retained by the North Carolina Public Employees Retirement Systems and 
the New York State Common Retirement Fund (hereinafter ``the Pension 
Funds''), should adopt the terms of the agreement between Merrill Lynch 
& Co., Inc. and New York State Attorney General Eliot Spitzer dated May 
21, 2002 (hereinafter ``the Investment Protection Principles''). In 
retaining and evaluating any such financial organization, the State 
Investment Officers will give significant consideration to whether such 
organization has adopted the Investment Protection Principles.
    The Investment Protection Principles are as follows:

   sever the link between compensation for analysts and 
        investment banking;

   prohibit investment banking input into analyst compensation;

   create a review committee to approve all research 
        recommendations;

   require that upon discontinuation of research coverage of a 
        company, firms will disclose the coverage termination and the 
        rationale for such termination; and

   disclose in research reports whether the firm has received 
        or is entitled to receive any compensation from a covered 
        company over the past 12 months.

   establish a monitoring process to ensure compliance with the 
        principles;

    B. Effective July 1, 2002, every money management firm retained by 
a State Investment Officer, as a condition of future retention, must 
abide by the following:

        1. Money management firms must disclose periodically any client 
        relationship, including management of corporate 401(k) plans, 
        where the money management firm could invest State or Pension 
        Fund moneys in the securities of the client.

        2. Money management firms must disclose annually the manner in 
        which their portfolio managers and research analysts are 
        compensated, including but not limited to any compensation 
        resulting from the solicitation or acquisition of new clients 
        or the retention of existing clients.

        3. Money management firms shall report quarterly the amount of 
        commissions paid to broker-dealers, and the percentage of 
        commissions paid to broker-dealers that have publicly announced 
        that they have adopted the Investment Protection Principles.

        4. Money management firms affiliated with banks, investment 
        banks, insurance companies or other financial services 
        corporations shall adopt safeguards to ensure that client 
        relationships of any affiliate company do not influence 
        investment decisions of the money management firm. Each money 
        management firm shall provide the State Investment Officers 
        with a copy of the safeguards plan and shall certify annually 
        to the State Investment Officers that such plan is being fully 
        enforced.

        5. In making investment decisions, money management firms must 
        consider the quality and integrity of the subject company's 
        accounting and financial data, including its 10-K, 10-Q and 
        other public filings and statements, as well as whether the 
        company's outside auditors also provide consulting or other 
        services to the company.

        6. In deciding whether to invest State or Pension Fund moneys 
        in a company, money management firms must consider the 
        corporate governance policies and practices of the subject 
        company.

        7. The principles set forth in paragraphs 5 and 6 are designed 
        to assure that in making investment decisions, the money 
        management firms give specific consideration to the subject 
        information and are not intended to preclude or require 
        investment in any particular company.
                                 ______
                                 
              North Carolina, Department of State Treasurer
                                          Raleigh, NC, July 1, 2002
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<<Company>>
<<Address1>>
<<City>>, <<State>> <<Postal Code>>

    Dear <<Salutation>>:

    Recently, I joined New York Attorney General Eliot Spitzer and the 
Comptroller of New York State, H. Carl McCall, to announce public 
pension fund investment protection principles that we are asking 
broker/dealers and money management firms to adopt as a condition of 
future retention by our pension funds. A copy of those principles is 
enclosed for your review.
    In light of the many incidents on Wall Street over the last nine 
months, I feel these principles are necessary to ensure that the firms 
managing the pension funds of North Carolina's hard-working employees 
and retirees are doing business the right way. As two of the largest 
pension funds in the marketplace, I believe North Carolina and New York 
will be able to have some positive effect on the market. It is 
important to publicly spell out what we, as fiduciaries of these 
pension funds, expect firms to do if they want to keep us as customers.
    I would like to ask for your feedback regarding the enclosed 
principles, and would be interested in hearing if you have considered 
similar measures. As you will see, in addition to requiring the use of 
the Spitzer/Merrill Lynch conflict of interest principles, I hope to 
institutionalize the reporting and benchmarking of accounting practices 
and corporate conduct. I hope you will consider joining in our efforts 
to add additional safeguards to the management of our funds. I believe 
this measure will not only benefit institutional investors, but also 
the effects will reach down to the average citizen who invests his or 
her money, as well.
    I thank you for your assistance and input in this matter, and look 
forward to working with you in the future.
        Sincerely,
                                           Richard H. Moore
                                 ______
                                 
Contacts for Top 25 Public Pension Funds
    California Public Employees' Retirement System
    James E. Burton, Chief Executive Officer
    Mark J.P. Anson, Chief Investment Officer
    400 P Street
    Suite 3340
    Sacramento, CA 95814

    California State Teachers' Retirement System
    Jack Ehnes, CEO
    Chris Ailman, Chief Investment Officer
    P.O. Box 15275
    Sacramento, CA 95851

    Florida State Board of Administration
    Tom Herndon, Executive Director
    1801 Hermitage Blvd.
    Tallahassee, Florida 32317-3300

    Teacher Retirement System of Texas
    Charles L. Dunlap, Executive Director
    John Peavy, Chief Investment Officer
    1000 Red River
    Austin, TX 78701-2698

    New York State Teachers Retirement System
    George M. Phillip, Executive Director
    10 Corporate Woods Drive
    Albany, NY 12211-2395

    New Jersey Public Employees' Retirement System
    Steven Kornrumpf, Director, Division of Investment
    Thomas J. Bryan, Director, Division of Pensions & Benefits
    50 W. State Street
    Trenton, NJ 08625-0295

    Wisconsin Investment Board
    Patricia Lipton, Executive Director
    P.O. Box 7842
    Madison, WI 53707-7842

    New York City Employees Retirement System
    John J. Murphy, Executive Director
    335 Adams Street
    Suite 2300
    Brooklyn, NY 11201-3751

    Public Employees Retirement System of Ohio
    Neil Toth, Investment Director
    Laurie Fiori Hacking, Executive Director
    277 East Town Road
    Columbus, OH 43215

    Michigan Department of Treasury
    Alan H. Noord, Chief Investment Officer
    Lansing, MI 48922

    Pennsylvania Public School Employees' Retirement System
    Dale Everhart, Executive Director
    James H. Grossman, Jr., Chief Investment Officer
    P.O. Box 125
    Harrisburg, PA 17108

    State Teachers Retirement System of Ohio
    Herb Dyer, Executive Director
    Robert A. Slater, Deputy Executive Director--Investments
    275 East Broad Street
    Columbus, OH 43215-3771

    University of California Retirement Plan
    P.O. Box 24570
    Oakland, CA 94623-1570

    Washington State Investment Board
    2424 Heritage Court
    Olympia, WA 98504-0916

    Teachers' Retirement System of the City of New York
    40 Worth Street
    NewYork, NY 10013

    Minnesota State Board of Investment
    Howard Bicker, Executive Director
    60 Empire Drive
    Suite 355
    Saint Paul, MN 55105-3555

    Teachers' Retirement System of Georgia
    Jeff Ezell, Executive Director
    Two Northside 75
    Suite 400
    Atlanta, GA 30318

    Oregon Public Employees Retirement System
    Jim Voytko, Executive Director
    11410 SW 68th Parkway
    Tigard, OR 97281

    Retirement Systems of Alabama
    David Bronner, CEO
    135 South Union Street
    Montgomery, AL 36104

    Public Employees' Retirement Association of Colorado
    Meredith Williams, Executive Director
    1300 Logan Street
    Denver, CO 80203

    Massachusetts Pension Reserves Investment Management Board
    James B.G. Hearty, Executive Director
    84 State Street
    Suite 250
    Boston, MA 02109

    State Retirement Agency of Maryland
    Peter Vaughn, Executive Director
    Carol Boykin, Chief Investment Officer
    120 East Baltimore Street
    16th Floor
    Baltimore, MD 21202

    Senator Dorgan. Mr. Moore, thank you very much for your 
excellent testimony.
    Next, we will hear from Joan Claybrook, President of Public 
Citizen.
    Ms. Claybrook.

            STATEMENT OF JOAN CLAYBROOK, PRESIDENT, 
                         PUBLIC CITIZEN

    Ms. Claybrook. Good morning, Mr. Chairman. Thank you very 
much.
    The epic crime wave with pervasive wrongdoing that has 
unfolded in recent months is no accident, and it's not limited 
to a few bad apples. It's the predictable result of a 
coordinated campaign with tons of campaign money over the last 
quarter century to remove government oversight and regulation 
of business practices and reduce or eliminate the 
accountability of corporations and their officers to the 
investors and the public.
    This attack--it has covered not only financial, but health, 
safety, environmental, investor, telecommunications, energy, 
and consumer safeguards, as well as the civil justice system--
has now come home to roost, and it has devastated families 
across America. It is time to restore accountability to 
corporate America.
    President Bush has talked tough about corporate crime, but 
his proposals are meager and would make little change. He 
should start by relieving Army Secretary Thomas White of his 
duties. Mr. White headed a subsidiary of Enron that bilked 
families and the State Treasury of California by cruelly and 
fraudulently manipulating the deregulated energy markets. His 
division, Enron Energy Services, colluded with other Enron 
divisions to deceive the operators of California's electricity 
grid into believing that transmission capacity was full, 
triggering rolling blackouts and payments to Enron to ease 
congestion on transmission lines, which was false.
    In the first 3 months of the year 2001, at the height of 
the California energy crisis, Mr. White's division traded more 
than 11 million megawatts of electricity in the California 
market, making nearly 98 percent of those trades with other 
Enron units at astronomical prices. In addition to this 
profiteering at the expense of California consumers and 
taxpayers, Enron Energy Services participated in the accounting 
trickery that artificially boosted stock prices and ultimately 
led to Enron's collapse, causing many investors and employees 
to lose their life savings.
    Enron is under investigation for multiple criminal 
violations. Mr. White was an intimate part of Enron's criminal 
conduct. In 2001, he was paid $5.5 million, and he sold $12 
million in Enron stock just before the company collapsed last 
December. If Mr. White is not accountable for his company's 
actions, why was he paid all this money? That's crony 
capitalism at its worst. White has millions in assets from 
Enron days in addition. He and his colleagues should be 
required to restore and provide restitution, just like any 
other criminal or thief, for his ill-gotten gains.
    But until President Bush purges corporate malefactors from 
his own Administration, it will be difficult to convince the 
public that he is up to the task of reforming corporate 
America. And what kind of example is this for our children, who 
are told to obey the law and not to lie?
    Turning to specific reforms, Public Citizen applauds the 
Senate passage of the Sarbanes' bill. This is a remarkable 
turnaround for the Senate on regulatory matters, one I hope 
heralds a new mind set when it comes to government's proper 
role in protecting consumers and workers and the environment 
from the consequences of misdeeds wrought by greedy and 
unethical corporate executives. But more is needed.
    Congress should correct the way that corporate stock 
options are treated in the corporate books. The common thread 
in the recent scandals is the fact that corporate boards lavish 
millions of dollars in stock options on top executives, giving 
them a strong incentive to cook the books to cause short-term 
spikes in stock prices so they could cash in. Enron CEO Ken Lay 
exercised $180 million in stock options from 1998 to 2000. And 
Jeffrey Skilling cashed in $117 million in options. Even though 
these options dilute shareholder value, they are not counted 
against profits and losses, and this is a scam on investors 
that must be stopped.
    One of the ways of measuring the extent to which a company 
is involved in the option business is something called the 
``run rate,'' which compares the number of options to the 
number of shares, and generally it's conceded it should not 
exceed 1 percent. The 200 largest corporations in America have 
2.6 percent; whereas, in 1990, it was 1.08.
    The Sarbanes' bill rightly curtails the widespread practice 
of accounting firms providing non-auditing consulting services 
at the same time they are auditing a company's books, but it 
does not have an outright ban to this blatant conflict of 
interest, and it should.
    In my full testimony today, which I ask to be in the 
record, the Public Citizen is releasing an analysis of 
accounting and consulting fees paid to the top 20 companies in 
the United States, and another 29 companies that are embroiled 
in accounting scandals, and comparing the two. We found there 
was a very close parallel between the two groups in terms of 
the percentage of total accounting fees that went to non-
auditing consulting.
    In 2001, the top 20 of the Fortune 500 paid a total of $880 
million to accounting firms. That's $880 million, and 72 
percent of that went for consulting services. Compare that to 
Enron, where it was about 50 percent. So the top 20 companies 
in the United States, in 2001, paid 72 percent to their 
auditors in consulting amounts.
    The 29 companies in trouble paid 75 percent, very close to 
that. In other words, the incentive to falsify earnings is in 
place in the top 20 corporations, as well as the ones in 
trouble. And that's very close to the numbers for the year 
2001.
    Haliburton Company would have been in this group, except 
that in the year 2001 it was reduced. But in the year 2000, the 
last year of Vice President Dick Cheney's tenure as Haliburton 
CEO--Haliburton paid--86 percent of its fees went to consulting 
or non-audit services.
    While legislation pending in Congress rightly addresses 
abuses in accounting, the one thing it does nothing for is the 
investor. It does nothing to help the investor recover the 
losses experienced because of fraud. Teachers, firefighters, 
police, factory workers, mail carriers, secretaries, small 
businesses--these are the people who do the work of America. 
These are the people who have lost the most in the stock 
market, in terms of their pensions and other investments for 
the future and their college savings.
    Congress should reexamine three laws and one Supreme Court 
decision, the Central Bank case, that passed in the 1990s that 
seriously have undermined corporate accountability by making it 
exceedingly difficult for individual investors to recover 
damages for securities fraud. These actions helped create the 
climate of ``anything goes'' arrogance in the corporate 
boardrooms.
    And I would point out that there was an article yesterday 
in The Washington Post that I would like to submit for the 
record, which indicated that when these shareholders' lawsuits 
are filed, it's a hint to the auditors that something is awry. 
The headline is ``The Shareholder Lawsuit: A Red Flag for 
Auditors?''
    [The article mentioned follows:]

               [From the Washington Post, July 17, 2002]

           The Shareholder Lawsuit: A Red Flag for Auditors?

            (By Jonathan Krim, Washington Post Staff Writer)

    Corporate directors and auditing firms serious about preventing 
future accounting scandals might find clues in a place they typically 
revile: shareholder lawsuits.
    Suits alleging financial improprieties preceded scandalous 
revelations at several companies, including WorldCom Inc., Tyco 
International Ltd. and Rite Aid Corp. Although the suits did not 
pinpoint the precise irregularities that have made recent headlines, 
accounting and legal experts say they can be valuable harbingers of lax 
financial standards.
    Instead, shareholder suits often are treated as nuisance actions 
filed by predatory trial attorneys seeking to capitalize on a company's 
financial troubles, these experts contend.
    They argue that as Congress and regulators grapple with an array of 
proposals for restoring public faith in corporate America's books, 
simply increasing the attention paid to the issues raised in such 
suits--even if they are unlikely to be successful in court--could help 
companies head off festering financial problems before they damage 
corporations, employees and investors.
    ``What usually happens is that the suits go to the legal 
department, and when they are mentioned if at all at board meetings, 
it's like swatting a fly or a gnat,'' said Ralph Estes, emeritus 
professor of accounting at American University and longtime advocate of 
more accountable corporate governance.
    Estes and others say word of such suits should spur board members 
and outside auditors to inquire more aggressively and seek deeper 
financial reviews.
    ``Now, especially, boards need to ask more questions,'' said Peter 
Gleason, chief operating officer of the National Association of 
Corporate Directors. ``How did this issue make its way to a lawsuit?''
    Rick Antle, an accounting professor at Yale University, said that 
auditors ``should not just balance the checkbook, and audit the company 
from a business point of view.''
    Shareholder suits grew in popularity with the onset of the 
technology bubble in the mid-1990s and its reversal of fortune in early 
2000. When a company announced unexpectedly bad news, or its stock 
price dropped after earnings failed to meet market expectations, 
attorneys for shareholders would jump in to examine whether management 
had misled investors before the news surfaced. Lawsuits quickly 
followed.
    Companies, especially technology firms whose stocks were volatile, 
fought back in Congress, arguing that the suits often were without 
merit and mere harassment. Industry won changes to the law that made 
suits more difficult to bring, after Congress overrode a veto by 
President Clinton.
    But suits continue to be filed regularly. According to the 
Securities Class Action Clearinghouse at Stanford University Law 
School, 485 suits were filed in 2001 and 127 so far this year.
    In WorldCom's case, shareholders filed suit last summer alleging a 
variety of fraudulent accounting practices, including failure to write 
off accounts that were unlikely to ever be paid and deliberately 
understating expenses overall. The suit was dismissed in March.
    Last month, the company announced that it had improperly 
reclassified $3.9 billion in operating expenses as capital 
expenditures, enabling the firm to bolster its bottom line by spreading 
costs over several years.
    One person familiar with the matter said that when the suit was 
raised at a WorldCom board meeting, it was not clearly presented as 
being focused on accounting issues.
    Late last month, the former chief executive of the Rite Aid Corp. 
drugstore chain was indicted on charges of inflating the company's 
earnings, destroying evidence, witness tampering and moving company 
funds into a personal real estate business. Three other executives also 
were charged. The actions took place between May 1997 and May 1999, 
during which time several executives also received large bonuses from 
the firm.
    Rite Aid was sued by shareholders in March 1999, when the company 
restated earnings and erased $1.6 billion in profit. The company paid 
out $193 million in claims.
    ``The indictments of Rite Aid management late in June 2002, which 
include charges of lying to and misleading the auditors, and the 
actions brought by the Securities and Exchange Commission at that time, 
affirm our position that Rite Aid represents a clear example of an 
auditing firm being victimized by company management,'' said KPMG 
spokesman Robert Zeitlinger.
    At Tyco International, shareholders charged in late 1999 that the 
company issued materially false and misleading statements about key 
acquisitions. The suit also alleged that during the period, certain 
officers of the company sold Tyco shares at artificially inflated 
prices, for proceeds of at least $270 million.
    Early last month, Tyco chief executive L. Dennis Kozlowski 
resigned, a day before he was indicted by a New York state grand jury 
on charges of evading more than $1 million in sales taxes on $13.2 
million in rare paintings. Investigators also are looking at whether 
Tyco improperly paid for an $18 million Manhattan apartment and a $2.5 
million home in Boca Raton, Fla., that belonged to a British nobleman 
who joined Tyco's board in 1997.
    ``Whenever there is a shareholder lawsuit, we look into the 
allegations carefully and defend ourselves where appropriate,'' said 
Tyco spokesman Gary Holmes.
    Representatives of the major accounting firms said that they, too, 
respond to shareholder suits.
    ``If the auditors become aware of information that they think may 
have an impact on the financial statements . . . they are required to 
determine if the information is accurate and reliable,'' said Chuck 
Landis, head of auditing standards for the American Institute of 
Certified Public Accountants, a trade group. ``Maybe that's going to 
management, unless the suit alleges fraud by management . . . then it 
might be going to the audit committee.''
    Landis said shareholder allegations, and the response from 
management, should be treated by the auditor with ``professional 
skepticism.''
    A former audit manager for Arthur Andersen, which approved 
WorldCom's books during the time of its improper accounting, testified 
before Congress that he was aware of the suit against WorldCom, and 
claimed he took it into account.
    ``Any time when Andersen or any auditor does an audit, there is an 
examination and review of litigation filed against a client,'' said 
Andersen spokesman Patrick Dorton. ``It's a component of generally 
accepted auditing standards and Arthur Andersen policy and audit 
methodology.''
    A spokesman for Ernst & Young declined to comment.
    Attorneys for shareholders, many of whom were federal securities 
prosecutors, say that what happens in practice is different.
    ``From the time I was a criminal prosecutor . . . I would say, `Why 
didn't you guys do anything with the class-action lawsuit?' '' said 
Kenneth Vianale, a partner of the class-action law firm of Milberg 
Weiss Bershad Hynes & Lerach, which has pending cases against nearly 75 
companies. ``The answer was `That's just a class-action lawsuit . . . 
we don't pay any attention to that.' ''
    Vianale, a former U.S. attorney in New York who prosecuted 
securities cases, said he is amazed at the number of companies that are 
sued by shareholders, pay out claims and then end up being sued again 
for similar problems.
    He cited the case of Sensormatic Electronics Corp., which late last 
year was bought by Tyco. The Florida-based manufacturer of security 
systems was sued by shareholders in 1995 for improper accounting 
practices. It ultimately settled for $53 million.
    The company has now been sued again by shareholders who charge 
company officials with making false statements about the company's 
sales.
    Auditing firms also have been the targets of lawsuits, or are named 
as co-defendants. Last year, Arthur Andersen paid part of a $229 
million settlement with shareholders of Waste Management Inc.
    Landis of the auditing institute said that in such cases, ``the 
auditors must ask themselves . . . whether by being named in a suit 
puts them in a position where they may no longer be objective'' to 
conduct further audits.

    It is a red flag for auditors. And yet in three statutes 
passed by the Congress in the 1990s, every effort was made to 
cut back on the capacity of the individual investor to regulate 
the corporations that are misbehaving by filing lawsuits for 
their own protection and recovery.
    The Private Securities Litigation Reform Act that was 
approved over President Clinton's veto in 1995 radically 
diluted laws against making false earnings projections, which 
we've certainly heard a lot about recently, and prevented fraud 
victims from obtaining the evidence they needed to survive a 
defendant's motion to dismiss. A securities fraud case against 
WorldCom, for example, was dismissed earlier this year, 
because, among other things, the Court found that the plaintiff 
's complaint did not attain the heightened pleading standard 
requirements for this type of case under the 1995 law.
    Again, the corporate lobby came roaring back to further cut 
investors' rights after they passed the 1995 law. In 1996, 
Congress enacted the National Securities Markets Improvements 
Act which preempted much state regulation of securities 
transactions. And in 1998, they came back again, with Congress 
passing the Securities Litigation Uniform Standards Act, which 
forced virtually all securities fraud class-action lawsuits to 
be tried in the federal courts under weakened federal 
standards, taking away stronger protection for small investors 
under tougher state class-action laws, such as longer statute 
of limitations, aiding and abetting liability, and joint and 
several liability. The consumer who invests has been really 
harmed by the Congress' actions in the 1990s, and it has freed 
up these megacorporations to misbehave again and again.
    After the disastrous manipulations of the California energy 
market, I am astounded that the Senate voted to repeal the 
Public Utility Holding Company Act of 1935 (PUHCA), one of the 
most basic protections that consumers have against rapacious 
energy companies. This is included in the energy bill passed by 
the Senate, not in the House bill.
    Enron was able to manipulate markets and build a vast, 
impenetrable network of subsidiaries primarily because of 
loopholes that were created in PUHCA, and the law was not 
properly enforced. We must keep this important law on the books 
and ensure that the regulators enforce it, and we must see that 
these loopholes are closed.
    One interesting report that was released yesterday on NBC 
Evening News was about the fees to the SEC. Each year, about 
$2.1 billion in fees are paid by investors for their 
transactions, but only $412 million of this goes to the SEC. 
Since 1991, $11.7 billion in fees have been paid, and only $3 
billion have gone to the SEC. In other words, over $7 billion 
that the SEC could have had from the fees that are paid have 
been taken by the Treasury and not been given to the SEC.
    In conclusion, Ms. Chairman and Mr. Chairman, let me say 
that corporate America loves Uncle Sugar. Uncle Sugar supplies 
subsidies, tax breaks, and all the other goodies that 
corporations love. But they don't like Uncle Sam. And Uncle Sam 
is now, it seems to me, beginning to take back the driver's 
seat. We urge that the Congress pass not only the Sarbanes' 
bill, but additional laws as I have recommended in a long list 
of remedies in my testimony so that the consumer and the 
investor is properly protected for the future.
    Thank you very much, Mr. Chairman.
    [The prepared statement of Ms. Claybrook follows:]
    Prepared Statement of Joan Claybrook, President, Public Citizen
    The financial horror show that the American public has watched 
unfold across the corporate landscape over the past few months is 
nothing less than a corporate crime wave of epic proportions. We have 
seen the rise and fall of a new generation of robber barons, bearing 
striking resemblance--at least in greed and arrogance--to the Gilded 
Age executives of a century ago and to the corporate titans of the 
1920s, when corruption in the boardrooms helped usher in the Great 
Depression. And to think it has been only a decade or so since 
taxpayers lost billions to the high-living thieves who raped the 
nation's savings-and-loan industry and drove it into the ground. How 
soon we forget.
    We should not fall victim to the corporate apologists who would 
have us believe that this is the inevitable and natural consequence of 
the economic boom of the 1990s and that there are only a few bad apples 
involved. In fact, it is the opposite. We now are finding out that this 
speculative bubble grew larger and larger precisely because corporate 
executives were defrauding investors through accounting measures that 
hid the true nature of their profits and losses. And they had plenty of 
incentives to do so, because cozy board members, many with insider 
deals, granted them stock options and cheap loans that encouraged CEOs 
to cheat in order to run up stock prices in the short term so they 
could cash in.
    These are not victimless crimes. The victims are policemen and 
firefighters, teachers, assembly line workers, mail carriers, 
secretaries and, yes, honest business men and women--the people who do 
the work of America, who live paycheck to paycheck and who fuel this 
economy with their work and their spending. The victims are the 
children whose college funds have evaporated, and the elderly, whose 
savings have been stolen.
    The American people are angry. And they should be. Since March 
2000, when the stock markets peaked, investors have seen $7 trillion 
evaporate into thin air. That's an unfathomable number for most of us. 
But it means real pain for millions of Americans who have been 
encouraged to invest their savings. Spurred on by corporate and 
government policies that have reduced and in many cases eliminated the 
old system of guaranteed pensions--and even facing the possibility that 
Social Security as we know it will be phased out--Americans have 
entrusted their retirement savings to the stock market. And now they 
find out the game has been rigged, and that they go broke while the 
crooks, who pay protection money to politicians, walk away with 
millions.
    This corporate crime wave is no accident. It is the result of a 
well-focused political drive over the past quarter century to remove 
government oversight of business practices and reduce or eliminate the 
accountability of corporations and their officers to investors and the 
public. Corporate America has campaigned with a full-scale attack on 
regulation of the financial securities markets and energy markets as 
well as the health, safety and environmental regulations that are 
designed to protect the public from death, injury and disease and 
ensure healthy, sustainable ecosystems, fisheries and wildlife.
    Following the impressive citizen gains of the late 1960s and early 
1970s--when Congress enacted a raft of new health, safety, 
environmental, consumer and civil rights protections--corporate America 
launched a cynical campaign to limit the government's power. This 
coordinated attack on citizen safeguards has been propelled by 
literally billions of dollars of shareholder money for political 
contributions, right-wing think tanks, lobbyists, smear campaigns, TV 
advertising and fake grassroots organizations. Both major political 
parties have seen a dramatic increase in contributions from big 
companies. Corporations have accounted for nearly 90 percent of all 
soft money contributions to the parties since 1995, according to the 
Center for Responsive Politics. Corporate soft money grew from $209 
million in the 1996 cycle to $383 million in 2000. The corporate 
leaders who give shareholder money to politicians demand--and usually 
get--something in return for this political investment.
    Corporate America's campaign of deceit portrays government 
regulation as inherently evil, as an unwarrranted intrusion into the 
free market system and as a drain on capital investment, profitability 
and U.S. competitiveness. It also mocks and denigrates the judicial 
system, which punishes wrongdoing, imposes discipline on corporations 
when regulations fail, and allows injured parties to recover damages. 
According to corporate America's mythology, free markets can solve all 
our problems and government should just, as former President Reagan 
said, ``get off our backs.'' Privatization of schools, Social Security, 
Medicare, water supplies and other commons are sought. This free market 
ideology, of course, does not extend to corporate welfare. The very 
corporations that sponsor this hypocritical campaign continue to feed 
at the public trough, using their political connections to obtain tax 
breaks, subsidies, inflated contracts and other government largess. 
This ideology is useful, it seems, only when it lines the pockets of 
those preaching it.
    This campaign by big business has severely distorted government's 
purpose and its functions. Enforcement budgets have been slashed. 
Health, safety and environmental protection rules have been sacrificed 
to the altar of self-regulation and an unfounded trust in corporate 
leaders. Congress and state legislatures across the country have 
erected new barriers to prevent injured consumers from obtaining 
justice in the courts. We now have a government that responds more to 
the greed motive of corporate leaders than to the legitimate needs of 
people. The system is rigged in favor of the business elite. And the 
public is mad.
    I am amazed by the breadth and depth of the corporate corruption 
now being unraveled. But I am not surprised. Unfortunately, the weak 
financial regulatory system that has failed the American people is only 
one piece of deregulation. We have also seen politicians of both 
parties rush to assuage their campaign contributors by whittling away 
vital health, safety and environmental protections at the behest of 
powerful corporate entities that fill their campaign coffers.
    Corporate leaders remind me of Chicken Little. The sky is always 
falling. Seldom is there a new regulatory proposal that does not elicit 
howls of protests, typically characterized by complaints that new 
consumer safeguards will harm the economy or U.S. competitiveness. 
These complaints typically prove fallacious.
    We should remember that government regulations do not just drop 
from the sky without warning. They are almost universally based on real 
societal needs, as demonstrated by deaths and injuries from faulty 
products and workplace hazards, devastated ecosystems, polluted 
groundwater, unhealthy air, and rivers laden with PCBs and other toxic 
chemicals. Years of research, analysis and public debate precedes the 
final implementation of most rules. In the 1960s, for example, we 
lobbied for the first regulations to cover the safety of automobiles. 
The automobile companies fought back furiously. Today, as a direct 
result of improving automobile designs, cars and trucks are vastly 
safer. In 1966, there were 5.5 fatalities for every hundred million 
miles traveled by the American public. By 2000, that ratio had dropped 
to 1.5--a remarkable difference. Despite their dire warnings, the 
automobile companies are still in business and still making lots of 
money.
    There are many, many more examples. So many, in fact, that 
Americans now take these safeguards for granted. They know the air is 
healthier than it was in the 1960s. They know rivers, lakes and bays 
are cleaner. They know that many unsafe pharmaceutical drugs and other 
products have been taken off the market, yet corporate America 
continues to peddle its siren's song--that government regulation is the 
enemy of free enterprise and profits. And their revolving-door 
lobbyists are able to make headway because the road is paved with the 
gold of massive campaign contributions.
    This campaign money buys more than access. It buys policy. How else 
can one explain the incredible deference paid by this Congress to the 
pharmaceutical industry? This industry, in the current election cycle 
alone, has given more than $10 million in unregulated soft money to 
politicians of both major parties. This industry spent obscene amounts 
of money on lobbying in 2001--$78 million--according to a recent Public 
Citizen report, and employed 623 lobbyists--more than one for every 
member of Congress. This money has stymied efforts to enact a 
meaningful prescription drug plan under the Medicare program.
    Another example is the nuclear industry, which just won passage of 
legislation to build a massive nuclear waste dump at Yucca Mountain, 
Nevada, requiring the transportation of 77,000 tons of high-level 
nuclear waste through major population centers by truck, train and 
barge over 30 years. Since 1997, the nuclear industry has contributed 
more than $30 million in individual, PAC and soft money donations to 
federal candidates and parties, 68 percent of which went to 
Republicans. Why do they give this money if not to influence policy? 
And how can anyone justify making government decisions based on 
campaign money?
    The point is that corporate America exercises far too much control 
over what passes--or doesn't pass--through the Congress. It is time for 
corporate rule to end. We must restore integrity to our business 
entities and to the political process. To do that, the Congress and the 
White House must stand up to the corporate lobbyists and start 
legislating and governing on behalf of the American people. We need 
strong regulation of corporations--standards that will prevent 
wrongdoing and then punish executives who violate the public trust.
Army Secretary Thomas White
    President Bush, who recruited his top government officials 
liberally from the corporate boardrooms, is talking tough about 
accountability for corporate leaders. But does he mean it? I would like 
to read a quotation about corporate accountability for CEOs from 
Treasury Secretary Paul O'Neill, from the July 11 edition of USA Today: 
``Whatever happens in your organization, you're responsible for it. 
There aren't any excuses for you to say, `I didn't know. I didn't 
understand.' ''
    I agree wholeheartedly with Secretary O'Neill. To meet this 
standard of conduct, and to begin restoring his credibility on this 
issue with the American public, President Bush should immediately 
relieve Army Secretary Thomas White of his duties. Mr. White is the 
poster boy for corporate abuse. But instead of being held accountable, 
he now has his hand on the Army's massive budget.
    Before being appointed to his position, Mr. White headed a 
subsidiary of the infamous Enron Corp. that blatantly manipulated the 
energy market in California to cause an artificial shortage of 
electricity, lied to state officials and cheated hard-working consumers 
out of literally millions upon millions of dollars with intricate 
schemes designed to rig the energy-trading markets and unfairly inflate 
company profits. According to numerous sources, his division also 
employed the same type of questionable accounting measures that have 
defrauded investors and enriched corporate insiders at other companies.
    Let me review the publicly available facts surrounding Mr. White's 
tenure at Enron. Up until the day he was nominated by President Bush 
and confirmed by the Senate in May 2001 to serve as Secretary of the 
Army, Thomas White was a high-ranking executive at Enron, where he had 
worked for 11 years. Since 1998, Mr. White served as vice chairman of 
Enron Energy Services, a retail services and wholesale energy trading 
subsidiary of Enron. As vice chairman, Mr. White shared oversight of 
the division's responsibilities with Lou Pai.
    As vice chairman, he was in charge of negotiating many of Enron's 
retail energy contracts. During his tenure, Enron Energy Services 
became one of Enron's fastest-growing subsidiaries through the use of 
questionable accounting practices. Enron Energy Services' revenues 
climbed 330 percent to more than $4.6 billion in 2000--up from $1 
billion when Mr. White became vice chairman in 1998. Much of this 
revenue increase is attributable to aggressive accounting techniques, 
including so-called ``mark-to-market'' bookkeeping, under which Enron 
booked much of the long-term retail contracts' revenue immediately--
providing the company with inflated revenues.
    For example, in February 2001, Mr. White played a role in the high-
profile signing of a retail energy services contract with Eli Lily. 
Enron claimed it was a 15-year deal worth $1.3 billion, but the details 
of the contract show that Enron paid Eli Lily $50 million up front as 
an enticement to sign the deal. Former employees of the division allege 
Mr. White's division used questionable accounting practices to create 
illusory earnings. Using ``mark-to-market'' accounting, Enron Energy 
Services would, for example, estimate that the price of electricity 
would fall over the life of a contract, and the unit would book an 
immediate profit on the contract.
    Glenn Dickson, an Enron Energy Services director laid off in 
December, claimed that both Mr. White and Mr. Pai ``are definitely 
responsible for the fact that we sold huge contracts with little 
thought as to how we were going to manage the risk or deliver the 
service.''
    While Enron Energy Services' reputation on Wall Street was as a 
retail supplier of energy, the division also was one of Enron's four 
registered power marketers, trading substantial amounts of energy in 
deregulated wholesale markets during Mr. White's tenure. According to 
internal Enron memos obtained by the Federal Energy Regulatory 
Commission and released in May, Mr. White's division played a key role 
in manipulating the West Coast energy market from May 2000 until the 
day he left in June 2001. Enron Energy Services colluded with other 
Enron divisions to deceive operators of California's energy grid into 
believing that transmission capacity was full. In the first three 
months of 2001--at the height of skyrocketing prices and rolling 
blackouts--this division traded more than 11 million megawatts of 
electricity in the California market alone, making nearly 98 percent of 
these trades with other Enron divisions at astronomical prices up to 
$2,500 per megawatt hour.
    This type of manipulation scheme was damaging because it led 
California officials to believe that transmission lines were clogged, 
and so power was intentionally shut off to millions of Californians. 
Meanwhile, Enron was able to profit by getting the state to pay Enron 
for relieving congestion on transmission lines. This naked profiteering 
and fraudulent activity by Enron caused a massive disruption in the 
economy of California and the lives of citizens there. Electricity 
rates soared. Small businesses suffered. Rolling blackouts cut power to 
millions. Pacific Gas and Electric, California's largest investor-owned 
utility, was victimized by exorbitant wholesale rates that it could not 
recover and sought bankruptcy protection in April 2001. California 
Edison also went deeply into debt, but has not filed for bankruptcy. 
The state of California was forced in January 2001 to begin spending 
billions of dollars to purchase power for its residents.
    Regulators found it difficult to trace Enron's trades because the 
company had four separate divisions interacting in the wholesale and 
retail markets, and with each other, with little transparency. These 
practices also allowed various Enron units to overstate revenues and 
contributed to the accounting gimmickry that artificially inflated the 
company's share prices.
    While it is unclear as to whether or not Mr. White personally knew 
all of the details of these fraudulent trading practices, it is very 
clear that he profited from them.
    When President Bush nominated Mr. White for the post, he cited his 
experience as a top Enron executive as a primary qualification. Mr. 
White made tens of millions of dollars during his tenure at Enron. In 
2001 alone, he was paid $5.5 million in performance-based salary and he 
sold $12.1 million in Enron stock just before the company collapsed in 
December 2001. Last year Mr. White owned three opulent homes and 
condos, with a total value of more than $16 million.
    And just like President Bush, Mr. White had a problem reporting 
some of these stock sales to the Securities and Exchange Commission, as 
required by law. Here is an excerpt from page 29 of a Schedule 14a 
filed by Enron with the SEC on March 27, 1995: ``Section 16(a) of the 
Securities Exchange Act of 1934 requires Enron's executive officers and 
directors, and persons who own more than 10 percent of a registered 
class of Enron's equity securities, to file reports of ownership and 
changes in ownership with the SEC and the New York Stock Exchange. 
Based solely on its review of the copies of such reports received by 
it, or written representations from certain reporting persons that no 
Forms 5 were required for those persons, Enron believes that during 
1994, its executive officers, directors and greater than 10 percent 
stockholders [sic] complied with all applicable filing requirements, 
except that Thomas E. White failed to timely file one report for one 
transaction.''
    In addition, Mr. White has been habitually late in reporting to 
Senators when asked to disclose his Enron holdings after being named 
Army Secretary. He agreed to divest all of his Enron holdings within 90 
days. He subsequently received at least two extensions from the Senate 
Armed Services Committee. But he was reprimanded by the leadership of 
the Committee when members learned that he continued to hold a large 
chunk of Enron stock options into January 2001 and had failed to inform 
them that he had accepted a pension partly paid by Enron.
    Mr. White's ethical lapses continued, when in March 2002, he flew 
on an Army jet with his wife at taxpayer expense to Aspen, Colorado, to 
sign the papers on the sale of a $6.5 million estate.
    While at Enron, Mr. White became a very wealthy man. What was the 
purpose of his compensation? If he is not accountable for what went on 
in his company, then why was he paid these millions? Was it because of 
his business acumen? Was it because of his connections to the Defense 
Department at a time when Enron was trying to win military contracts? 
The bottom line is that if Mr. White knew what was going on with Enron 
Energy Services, he has no business running the Army. If he did not 
know, he is an incompetent manager and therefore should resign his 
post.
    President Bush has appointed many others from the corporate 
boardrooms, giving Americans the sense that the foxes are indeed 
guarding the henhouse. No wonder the stock market has been plunging 
since the president gave a tepid speech on Wall Street last week. The 
former lawyer and chief lobbyist for the Big Five accounting firms, who 
opposes the Sarbanes bill's independent accounting standards board, now 
heads the Securities and Exchange Commission. And Deputy Attorney 
General Larry D. Thompson, the president's choice to lead his new 
corporate fraud task force, used to sit on the board of Providian 
Financial Corp., a credit card company that paid more than $400 million 
to settle allegations of consumer and securities fraud. Mr. Thompson, 
according to the Washington Post, sold stock worth nearly $5 million 
just a few months before Providian began to disclose business problems 
that led to a collapse in the company's stock price. That is the same 
pattern that we have seen with other corporate scandals. President Bush 
himself, as well as Vice President Dick Cheney, also have been 
implicated in possible accounting irregularities and stock sales that 
preceded sharp drops in stock prices.
    We are not inspired by President Bush's recent call for $100 
million to be added to the SEC's budget, after he earlier sought to 
slash the agency's budget. Under Bush's recommendation, the SEC would 
have a budget of $513 million, a pittance compared to the Drug 
Enforcement Agency's budget of $1.8 billion. Much more is needed. And 
we should examine the penalties meted out to white-collar criminals. 
The average sentence for white-collar criminals is less than 36 months. 
By comparison, non-violent, first-time federal drug offenders get an 
average sentence of more than 64 months.
    We hope that President Bush is serious about putting corporate 
criminals in jail. But the government's record over the past 10 years 
is not good. The SEC has referred 609 offenders to the Justice 
Department for criminal prosecution. Of those, 187 faced criminal 
charges, and only 87 went to jail.
Incentives to Cook the Books
    Fortunately, the Senate on July 15 passed legislation to begin 
addressing these corporate abuses. Most unfortunately, the measure, the 
Sarbanes bill does nothing to help defrauded investors. But Public 
Citizen strongly endorses it as an important step because it: (1) 
begins to put an end to the failed self-regulation of the accounting 
industry by establishing an independent Public Company Accounting 
Oversight Board to monitor the accounting industry; (2) forbids some--
but not all--non-auditing services performed by accounting firms that 
are simultaneously providing auditing services (although the Senate 
bill allows for case-by-case exemptions); (3) promotes a ``fresh pair 
of eyes'' by forcing accounting firms to rotate the lead accounting 
partners (but not accounting firms) on audits after five years; (4) 
addresses revolving-door conflicts of interest by prohibiting 
accounting firms from auditing companies whose top executives worked 
for the firm during the year before the audit; (5) strengthens the 
Financial Standards Accounting Board and gives it more independence 
from the industry; (6) requires CEOs and CFOs of public companies to 
personally vouch for the accuracy of financial reporting; (7) requires 
disclosure of insider stock trading within two days; (8) prevents 
executives from selling stock during employee stock sale blackout 
periods; (9) financially penalizes executives for earnings 
restatements; (10) restricts loans to executives; and (11) makes 
securities fraud a criminal offense and increases prison sentences for 
fraud.
    It is unfortunate that the bill does not address one of the major 
underlying incentives that have prompted crooked executives and 
accountants to cook the books--the practice of granting stock options. 
The common thread woven through virtually all of the ongoing corporate 
scandals is the fact that executives were granted exorbitant stock 
options. Corporate boards have handed out stock options like candy, and 
they are not required to count them as an expense on their balance 
sheet, even though they dilute shareholder equity as surely as if the 
payments were made in cash. Because corporations do not have to account 
for these expenses, they have become an insider scheme to enrich 
executives. Though they were once believed to align the interests of 
management with shareholders, perversely, the opposite has occurred. As 
we've learned from Enron and other companies like Global Crossing, 
WorldCom and Qwest, the allure of stock options can drive executives to 
intentionally distort the numbers to create temporary run-ups in stock 
prices so they can cash out quickly, while investors are left to soak 
up the losses.
    Research shows that more and more corporations are turning larger 
shares of their earnings over to insiders by increasing the number of 
stock options issued to executives and directors. At Enron, for 
example, Ken Lay exercised $180.3 million in stock options from 1998 to 
2000, and Jeffrey Skilling cashed in $111.7 million in options.
    ``Stock option overhang'' is a measure of the number of stock 
options granted to employees and directors (both the number already 
issued and the number of options promised in the near future) compared 
to the total number of shares held by investors and employees. This 
measure can estimate the potential of investors' shares to be diluted 
by stock options policy. Many institutional investors, such as large 
pension funds, don't want a stock option overhang to exceed 10 percent 
of shares outstanding. A February 2002 survey by the Investor 
Responsibility Research Center showed that the stock option overhang 
for the S&P 500 was 14.3 percent. And 13 of the 50 largest U.S. 
corporations had a stock option overhang that exceeded 14.3 percent. 
J.P Morgan Chase, for example, had an option overhang of more than 20 
percent. Morgan Stanley was one of the highest at 36 percent.
    Another way to measure the potential negative impact of stock 
options is the ``stock option run rate.'' This adds up the stock 
options granted over the past three years, divides by three, and then 
divides by the total number of shares held by all investors and 
employees. Many experts agree that a stock option run rate exceeding 1 
percent is excessively diluting investors' equity. Two hundred of the 
largest U.S. companies have stock option run rates of 2.6 percent, more 
than double the rate of a decade ago (1.08 percent in 1991), according 
to compensation consultants Pearl Meyer & Partners. Although a stock 
option run rate of 3 percent may look small at first glance, if these 
current scandals return the market to its historical 10 percent annual 
rate of return, that would mean a company with a stock option run rate 
of 3 percent would see one-third of the company's value siphoned off by 
the time the stock options expire in 10 years.
    It's also important to note the share of all stock options enjoyed 
by the top executive. A CEO holding more than 5 percent of all stock 
options should be considered excessive. So what to think about the CEO 
of Freddie Mac (10.9 percent), American International Group (10.6 
percent), Fannie Mae (7.4 percent) and Wells Fargo (5.6 percent)?
    This is a scam on investors. Companies are currently allowed to 
deduct these stock options as an expense in figuring their tax 
liabilities--but are not required to do so in reporting profits or 
losses to shareholders. Companies would not be so free in handing out 
so many options if they were counted as an expense. Plus, there should 
be requirements for executives to hold stock options for the long-
term--not cash in during stock price spikes or shortly before the 
company announces bad news.
    On July 16, the International Accounting Standards Board announced 
a unanimous decision to require that executive stock options be counted 
as a business expense by 2005 in the EU and Australia. The U.S. 
legislation should be identical.
    Another common thread in the scandals is the practice by accounting 
firms of providing consulting services at the same time they are 
auditing the finances of corporations. Accounting firms that collect 
large consulting fees from the corporations they audit have a strong 
incentive to look the other way when corporations cook the books. In 
essence, the auditors are in part auditing their own company's work. 
The big accounting firms, which are supposed to audit the books of 
public corporations and certify to the board, public and investors that 
they accurately portray a company's financial status, have been seduced 
and corrupted by multimillion-dollar consulting services that they also 
provide to the same companies they are auditing. This creates an 
enormous and unconscionable conflict of interest that leads to the type 
of abuses we have seen in Enron, WorldCom, Tyco, Halliburton, Global 
Crossing, Adelphia, Xerox and others. The previous head of the SEC, 
Arthur Levitt, sought to end this conflict, but in the deregulatory 
climate of the 1990s, his proposal was quashed. And now working 
Americans are paying a severe price.
    While S. 2673, the Public Company Accounting Reform and Investor 
Protection Act of 2002, does address these conflicts of interest by 
banning certain types of consulting contracts, it still allows many 
damaging consulting services--such as providing tax shelter advice--to 
be performed by companies that are in charge of audits.
    Submitted with my testimony today is a new study by Public Citizen 
of these fees (see Appendix A and B). Public Citizen found that the 20 
largest companies in the United States all had consulting relationships 
with their accounting firms in 2000 and 2001 that, at the very least, 
created incentives for cheating. In the aggregate, 72 percent of the 
$880 million in fees paid by these Fortune 500 companies to their 
accountants in 2001 were for consulting services--meaning that at the 
same time accounting companies were supposed to be looking out for 
shareholders, they were also helping their clients develop accounting 
schemes to hide income from taxation, or conceal debt and revenues from 
regulators and investors.
    Some examples from the year 2001: AT&T paid $78 million to 
PricewaterhouseCoopers, 86 percent of which went for non-audit 
services. ExxonMobil paid $87 million to PricewaterhouseCoopers, 80 
percent for non-audit services. General Motors paid $102 million to 
Deloitte & Touche, 79 percent for non-audit services. Chevron paid $64 
million to PricewaterhouseCoopers, 83 percent for non-audit services. 
Duke Energy paid $15 million to Deloitte & Touche, 78 percent for non-
audit services. Bank of America paid $74 million to 
PricewaterhouseCoopers, 81 percent for non-audit services.
    We also looked at corporations whose practices have come under 
recent scrutiny. Enron was one of the best. It paid $52 million to 
Arthur Anderson in 2000, a mere 52 percent for non-audit services. The 
highest percentage we found was for BristolMyersSquibb, which in 2001 
paid $41 million to PricewaterhouseCoopers, 93 percent for non-audit 
services. Halliburton in 2001 paid $27 million to Arthur Anderson, 73 
percent for non-audit services. The year before, Halliburton paid $52 
million to the company, 86 percent for non-audit services. Global 
Crossing in 2000 paid $14 million to Arthur Anderson, 84 percent for 
non-audit services. Tyco paid $35 million in 2001 to 
PricewaterhouseCoopers, 62 percent for non-audit services. WorldCom 
paid $17 million to Arthur Anderson in 2001, 74 percent for non-audit 
services.
    How can this possibly be justified? Unless accountants are 
completely banned from providing both auditing and consulting services 
simultaneously to the same client, these conflicts of interest will 
continue to plague the industry.
    In addition to these regulatory failures dealing with stock options 
and accounting rules, the rights of investors to protect themselves and 
recover for losses due to fraud have been severely curtailed by 
Congress and the U.S. Supreme Court. This has allowed corporate 
criminals to swindle investors with the knowledge that there was little 
they could do in return.
Laws Protecting Investors' Rights are Weakened
    In the 1980s, a key target of this business attack on laws 
punishing financial fraud was the civil RICO (Racketeer Influenced and 
Corrupt Organizations Act) law. Amazingly, this onslaught was initiated 
in the midst of the revelations of self-dealing, insider trading and 
fraud by the savings-and-loan thieves. The scandal put a public face on 
this arcane but potent law. For a number of years, Public Citizen 
fought tooth-and-nail against the accounting industry lobbyists, who 
liberally lathered both Democratic and Republican Members of Congress 
with campaign money to obliterate this very effective law prohibiting 
conspiracy to defraud with its important attorney fees and treble 
damages for the victims. Without the determination and persistence of 
Senator Howard Metzenbaum, we would not have succeeded in stopping this 
corporate juggernaut. Without civil RICO, the bondholders in the 
Charles Keating S&L fraud would not have been fully compensated. The 
S&Ls and accounting firms paid out some $1.4 billion in damages for 
their fraudulent practices.
    In the 1990s, two key Supreme Court cases were decided by 5-to-4 
votes, and after the Republicans took over the Congress in 1995, three 
key pieces of legislation were enacted, the first one over President 
Clinton's veto, that, together, have taken the federal, state and 
investor cops off the corporate crime beat and have left many 
securities fraud victims without a remedy. At the same time, the 
funding of the Securities and Exchange Commission was not increased as 
the financial markets grew exponentially. Predictably, a business 
ethics gap matured into full flower, and we are now experiencing a 
corporate crime wave of untold proportions that is undermining public 
trust in our markets and robbing citizens of their pensions and life 
savings and kids of their college tuition nest eggs. Not surprisingly, 
the accounting industry gave liberally to Members of Congress from both 
parties. From 1990 to 2002, this industry gave almost $57 million 
dollars in campaign money, $24 million to Democrats and $33 million to 
Republicans.
    In 1991, the U.S. Supreme Court in Lampf, Pleva limited the federal 
statute of limitations to one year from the discovery of securities 
fraud or three years from the violation, whichever is earlier, 
shortening the time that was allowed under federal law previously, when 
courts borrowed the generally longer state law limitation periods. In 
1994, in the Central Bank case, the Court came down with a strict 
construction decision, holding that those engaged in ``aiding and 
abetting'' are not liable in consumer or investor federal securities 
fraud cases because these words are not specifically in the statute. 
Aiding and abetting had been universally recognized as a federal 
violation for 60 years since the enactment of the federal securities 
laws and was accepted in every federal circuit. The S&L scandal could 
not have been perpetrated without the active and knowing assistance of 
numerous professionals, particularly lawyers and accountants. By 
allowing these professionals to escape liability, this decision 
undercut recovery by the victims and diminished the incentive to 
exercise due care and prevent reckless or knowing misconduct in 
assisting in the perpetration of a fraud in violation of federal 
securities laws. Needless to say, Vinson & Elkins and Kirkland & 
Ellis--Enron's lawyers--have cited Central Bank in recent motions to 
dismiss shareholder litigation. We all know the power of corrupt 
lawyers and accountants. They are the engines that drives corporate 
fraud. They must be held accountable.
    In 1995, following a massive lobbying campaign, Congress passed the 
Private Securities Litigation Reform Act over President Clinton's veto. 
It was promoted as necessary to stop so-called ``frivolous'' lawsuits, 
even though investor lawsuits had barely increased in the seven years 
prior to its enactment. But it was a nuclear bomb used to quash an ant 
hill. The act for the first time radically diluted laws against making 
false earnings projections (sound familiar today?). By rejecting an 
amendment to overrule the Central Bank decision, it also gave 
protection to accounting firms that approved false earnings statements, 
such as those issued by Arthur Andersen for Enron's massive deception. 
It granted companies and their accountants ``safe harbor'' protections, 
which Public Citizen criticized at the time. Thus accountants who 
failed to spot or disclose fraud could be given immunity from private 
lawsuits, as were companies issuing false earnings projections, even if 
they lied.
    The act also forced defrauded investors to meet a high pleading 
standard with respect to a corporate officer's state of mind (generally 
only required in criminal cases); stayed discovery proceedings until 
the defendant's motion to dismiss is decided, thus preventing fraud 
victims from obtaining the very evidence needed to defeat the motion; 
for the first time limited liability of auditors and other conspirators 
from full accountability under ``joint and several liability''; failed 
to extend the statute of limitations imposed by the Supreme Court; 
eliminated treble damages as punishment for deliberate fraud under 
civil RICO; failed to restore private liability for aiding and abetting 
securities fraud; and for the first time required plaintiffs to divulge 
in the complaint any confidential sources, thus preventing fraud 
victims from gathering key evidence from confidential informants such 
as whistleblowers, employees, ex-employees, competitors and media.
    The absence of these protections is directly related to the 
corporate fraud and failures we have been witnessing with dismay day 
after day. A securities fraud case against MCI WorldCom was dismissed 
earlier this year because, among other things, the court found that the 
plaintiff's complaint ``does not attain the heightened pleading 
standard requirements for this type of case'' under the 1995 law. The 
case alleged that the company and its top executives had ``cooked the 
books'' and fraudulently misled investors by artificially inflating the 
financial condition of the company, but the court found that there were 
not enough facts showing CEO Bernard Ebbers had acted with ``actual 
knowledge or conscious misbehavior.''
    Also, a 1999 securities fraud case against Tyco International Ltd. 
was thrown out because of the 1995 law. It was filed after reports of 
spectacular earnings increases and huge stock sales by executives and 
directors, including Chairman and CEO Dennis Kozlowski, who sold $187 
million in stock, Director Michael Ashcroft, who sold $37.4 million, 
and General Counsel Mark Belnick, who sold $7.6 million. There was a 
total of $252.8 in insider stock sales. Tyco then ``restated'' its 
financial statements after a limited SEC review. After two years of 
attempting to meet the harsh pleading standards of the 1995 law, the 
investors' action was dismissed by the court. Today, top executives are 
fired, indicted or under investigation, and many walked away with 
millions of dollars. The investors have not recovered their losses and 
the shortened statute of limitations has run. As the Washington Post 
headlined on July 17, 2002, ``The Shareholder Lawsuit: A Red Flag for 
Auditors,'' these lawsuits serve a multitude of purposes--compensation 
for victims, deterrence and notice to auditors, the board and 
government enforcers.
    Not satisfied with these cutbacks severely limiting the possibility 
of recovery by victims of securities fraud, the Congress in 1996 
enacted the National Securities Markets Improvements Act, which 
preempted much state regulation of securities transactions. Again in 
1998, the Congress cut back investor protection. It passed the 
Securities Litigation Uniform Standards Act, which forced virtually all 
securities fraud class action lawsuits to be tried in federal courts 
under the weakened federal law, taking away stronger protection for 
small investors under tougher state class action laws, such as longer 
statute of limitations, aiding and abetting liability, and joint and 
several liability.
    At the same time, the independent Securities and Exchange 
Commission under Chairman Arthur Levitt was trying to change SEC rules 
to eliminate conflicts in the accounting companies by separating 
auditing and consulting services. The number of financial fraud cases, 
in Levitt's words, ``absolutely exploded.'' Three big accounting 
firms--Arthur Andersen, Deloitte and KPMG--said, in Levitt's words, 
``We're going to war with you. This will kill our business. We're going 
to fight you tooth and nail. And we'll fight you in the Congress and 
we'll fight you in the courts.''
    Sure enough, Levitt shortly thereafter received a demand letter 
from three top chairmen on the House Commerce Committee: Tom Bliley, 
Mike Oxley and Billy Tauzin, making 16 demands for extensive 
information that tied the agency up for weeks and in Levitt's words 
``intended to really stand in the way of the rulemaking we had in 
mind.'' Levitt has described how the heat was kept up with ``telephone 
calls, congressional hearings, and ultimately by threatening the 
funding of the agency . . . threatening its very existence.'' He was 
also threatened with a rider on his appropriations bill if he 
proceeded. Another letter came from Senate Banking Committee members 
Rod Grams, Evan Bayh, Phil Gramm, Charles Schumer, Mike Crapo, Rick 
Santorum, Chuck Hagel, Jim Bunning, Wayne Allard and Robert Bennett, 
opposing auditor independence rulemaking. After being urged again by 
many Members of Congress to make peace with the audit companies, Levitt 
agreed to a compromise rule that just called for corporations to bring 
to their Boards' audit committees any consulting contracts that they 
had made with their auditor. At Enron, Wendy Gramm, former chair of the 
Commodity Futures Trading Commission, sat on the audit committee.
    As if these laws and court decisions had not harmed investors 
enough, now securities firms are using mandatory arbitration agreements 
to force aggrieved investors into a company's own, costly private 
judicial system, where there is limited discovery, limited recovery and 
where arbitrators must depend on the defendants for repeat business.
    I recently received a letter from a member of Public Citizen who 
wrote that he opened an investment account with Payne Webber and was 
required to sign a statement agreeing to arbitration in the event of a 
dispute with the company. He did this only after researching virtually 
every stock broker in the country and finding that he could not buy 
stocks without agreeing to arbitration. ``This is a tragedy,'' he 
wrote.
    One more way that corporate America has put the screws to the 
people without whom it could not survive.
Public Utility Holding Company Act
    Particularly relevant to the fraudulent dealing and manipulation at 
Enron in which Army Secretary Thomas White participated is deregulation 
as it applies to energy policy. Despite the California electricity 
scandals, the unraveling of the stock market and almost daily 
revelations of new corporate abuses, we continue to see a drive to 
deregulate business--even in the energy sector. There is a provision in 
the recently passed energy legislation that will have a devastating 
impact on consumers and lead to more Enron-style abuses. On April 25, 
the Senate voted to repeal the Public Utility Holding Company Act 
(PUHCA). This vote to repeal PUHCA comes at a time when courts are 
finally using the law to rescue consumers. At a time when the Enron 
disaster and the failure of electricity deregulation across the country 
(a dozen states have repealed or delayed their deregulation laws) 
illustrate how vulnerable consumers and investors are to impenetrable 
corporate structures and unaccountable markets, PUHCA's protections are 
needed now more than ever.
    PUHCA was enacted in 1935 in response to the United States' first 
Enron-style energy crisis in the 1920s. A handful of energy companies, 
employing business strategies strikingly similar to Enron's, held 
consumers hostage with complex, multi-state pyramiding schemes. These 
holding companies purchased financial, fuel and construction businesses 
through a complex web of subsidiaries. Not only did consumers pay 
inflated prices for energy to fuel the acquisition and operations of 
businesses unrelated to the core energy concerns, but investors were 
robbed because the holding company's assets were artificially inflated. 
These pyramiding schemes finally collapsed, ringing in the stock market 
crash of 1929 and the Great Depression.
    The Securities and Exchange Commission is supposed to enforce 
PUHCA, which protects consumers by ensuring that multi-state utility 
companies re-invest ratepayer money into providing affordable and 
reliable electricity. A corporation must register as a ``holding 
company'' if it owns at least 10 percent of the stock of an electric or 
natural gas utility. Consumers benefit from PUHCA's requirements that 
holding companies invest only in ``integrated systems''--utilities that 
are ``physically interconnected''--thereby maximizing economies of 
scale by operating a single, coordinated system. PUHCA has historically 
prohibited holding companies from investing ratepayers' money in areas 
that will not directly contribute to low bills and reliable service, 
such as out-of-region power plants or non-electricity industries such 
as water and telecommunications.
    PUHCA is the most important protection the federal government 
provides for electricity consumers. But the law's potency has been 
eroded over the past decade. Enron, with help from regulators and 
Congress, helped undermine the act's effectiveness by creating new 
loopholes. Incredibly, rather than proposing to close these Enron 
exemptions to prevent other energy companies from abusing consumers and 
investors, the response by the Bush Administration and Congress 
(including the Senate Democrat energy bill) is to repeal the entire 
law. Repealing PUHCA will lead to a rash of mergers, further 
threatening consumers.
    PUHCA has lost much of its teeth as a result of deregulation, 
Enron's lobbying, and decisions by the SEC to simply ignore the law. 
First, Congress undermined PUHCA by passing the 1992 Energy Policy Act, 
permitting holding companies to invest ratepayer money in foreign power 
projects and divert resources away from American consumers. Second, 
Enron pushed a gaping hole in SEC regulation when the SEC, in response 
to a petition by the company, exempted power marketers like Enron from 
PUHCA on Jan. 5, 1994. As a result, power marketers--creatures of 
deregulation that don't own power plants but rather speculate on and 
trade electricity contracts--can trade free from government oversight 
in deregulated markets across the country. Finally, the SEC has refused 
to enforce the investment provisions of PUHCA, instead rubber-stamping 
mergers that are in direct violation of PUHCA's consumer protections--
including the foreign acquisition of several U.S. utilities.
    These loopholes have already resulted in a significant increase in 
utility consolidation. In 1992 (prior to the passage of the loophole-
creating Energy Policy Act) the 10 largest utilities owned one-third of 
the national generating capacity. By 2000, the top 10 owned half of all 
capacity, while the top 20 owned 75 percent. These numbers will become 
more concentrated if PUHCA is repealed, inevitably resulting in 
monopoly pricing.
    Although proponents of repealing PUHCA claim that the law's 
ownership restrictions hinder adequate investment, corporate leaders 
appear to be more interested in repealing PUHCA to satisfy their 
craving for Enron-style accounting freedom and convergence. If PUHCA is 
repealed, a flurry of mergers will bury our electricity markets, 
rendering states incapable of regulating sprawling multi-state holding 
companies. The already overwhelmed Federal Energy Regulatory Commission 
(FERC) will face a daunting task in trying to regulate all energy 
markets. Both Democrats and Republicans propose replacing PUHCA's 
consumer protections with weaker ones that would be under the 
jurisdiction of FERC, which the GAO recently concluded was deficient in 
handling its current responsibilities. But these huge holding companies 
will have incentive to cover their tracks with Enron-esque accounting, 
and no state or federal agency will be able to verify the accuracy of 
the bookkeeping.
    Enron's collapse exposed consumers and investors to the dangers of 
inadequate government oversight inherent in electricity deregulation. 
The combination of deregulated state wholesale electricity markets, 
federal deregulation of commodity exchanges and the creation of 
loopholes in PUHCA removed accountability and transparency from the 
energy sector. Had PUHCA's loopholes been closed and the law properly 
enforced, Enron's fraud against shareholders and consumers never could 
have occurred! PUHCA's ownership limits would have prevented the 
company from hiding revenues and debts in offshore tax havens and 
failed foreign projects, such as Enron's Dabhol power plant in India.
    The solution is to strengthen PUHCA rather than repeal it. First, 
Congress must require the SEC to strictly enforce the act, and beef up 
funding and staff for the SEC. Second, the harmful loopholes pushed 
through by Enron and other energy companies must be closed. Holding 
companies must no longer be allowed to divert funds secured from 
consumers for this essential commodity to invest in foreign countries, 
and power marketers must be subject to PUHCA. Third, Congress can 
improve PUHCA by using it to address issues of market power. For 
example, Congress should grant federal and state regulators the 
authority to order holding companies to divest assets, expand anti-
trust investigations and enforcement, and create non-profit, consumer-
owned regional transmission councils to ensure non-discriminatory 
access to the grid.
    It is important to note a recent court decision that could require 
the SEC to enforce PUHCA. In January 2002, the U.S. Court of Appeals 
for the District of Columbia ordered the SEC to revisit its decision to 
approve a merger between American Electric Power (AEP) and Central & 
South West (CSW). Public Citizen had maintained that the SEC's earlier 
decision to approve this merger between Ohio-based AEP and Texas-based 
CSW violated PUHCA's requirements that holding companies have 
interconnected systems. The SEC had ruled that because the two 
utilities are connected by a lone, 250-mile transmission line owned by 
an unrelated company that the merger satisfied PUHCA! The judge's 
decision illustrates that the court has finally noticed that the SEC 
has refused to enforce the law and will force the review of other 
recently approved mergers that clearly violate PUHCA (Progress Energy, 
a union between Florida Progress and Carolina Power & Light; Exelon, a 
product of PECO Energy and Unicom; Xcel, a merger between Northern 
States Power and Public Service Co., and the foreign acquisition of 
Oregon-based Pacificorp by Scottish Power).
Remedies
    The public is paying a dear price for the follies of the 1990s. The 
dreams and hopes of tens of millions of families across America are 
being dashed by the misbehavior of unethical companies spurred by 
greed. The Congress has permitted this disaster, and we are pleased to 
see it taking some corrective action. We support the new corporate 
accountability requirements contained in the Sarbanes bill but believe 
Congress must go further to protect consumers, investors and employees 
of corporations. We applaud the criminal penalties it contains. They 
should apply as well to knowingly selling defective products that kill 
or injure.
    One critical ingredient that is still missing is the ability of 
investors to recover damages when regulators fail to prevent harm. We 
all know that regulations alone are not sufficient to deter wrongdoing. 
Federal agencies are often underfunded and are sometimes poorly 
managed. Congress and several court decisions have undercut the ability 
of citizens to seek proper justice in the courts. These rights must be 
restored.
    In addition, there are key consumer protections contained in the 
Public Utility Holding Company Act, which is repealed in the Senate's 
energy legislation. This law has been weakened in piecemeal fashion by 
a lack of enforcement and Congressional actions. It should remain on 
the books, be improved and be enforced vigorously. Finally, even with 
the Sarbanes bill, there remain problems with corporate governance and 
possible conflicts of interest in the accounting industry.
    The following are Public Citizen's specific recommendations:
Investor Recovery for Fraud
    The two Supreme Court decisions and the three statutes cutting back 
liability to investors for corporate fraud must be changed, as I have 
testified. Professionals, including accountants and attorneys, must be 
liable for aiding and abetting. And the statutes of limitation must be 
longer, as provided in the Sarbanes bill, given the difficulty of 
learning the truth about fraudulent activity.
    The Private Securities Litigation Reform Act must be largely 
repealed to give investors a level playing field in their efforts to 
recover against corporate giants who control all the information about 
any financial misbehavior. And federal laws should not limit state 
regulation or state courts from protecting investors merely because 
some states have more progressive laws than the existing federal law. 
Further, securities firms should not be allowed to impose their own 
private legal system of mandatory predispute arbitration that prohibits 
court adjudication of disputes. If companies know there is a strong 
likelihood of federal or state government or private enforcement, they 
will be far more likely to behave.
    Gag orders in the settlement of litigation, often demanded by 
corporations, must be prohibited if they would result in covering up 
corporate fraud against investors.
Restoring Strong Regulation to Energy Markets
    Do not repeal the Public Utility Holding Company Act in the pending 
energy bill.
    Re-regulate energy trading. Pass Senator Feinstein's bill, which 
would restore accountability in energy markets by overturning the 1993 
decision to not extend CFTC jurisdiction over energy trading contracts 
and the Commodity Futures Modernization Act of 2000 (which deregulated 
over-the-counter energy trading), allowing companies like Enron to 
operate unregulated power auctions.
    Strengthen the regulatory and enforcement power of the Securities 
and Exchange Commission by extending jurisdiction over power marketers.
    Amend the Federal Power Act, forcing the Federal Energy Regulatory 
Commission to revoke market-based rates and order cost-based pricing in 
all wholesale electricity markets.
Corporate Executive Obligations and Limits
    First and foremost, stock options must be treated as an expense by 
corporations, as Senator McCain has so effectively argued. Overuse of 
options has distorted the financial markets, diluted shareholder value, 
and encouraged greedy executives to manipulate corporate books to drive 
stock prices higher in the short term at the expense of long-term 
stability and financial health. If options are exercised, as Senator 
McCain suggests, the net gain after taxes should be held in company 
stock until 90 days after departure from the company.
    Repricing or swapping of stock options for executives must be 
prohibited (Business Week reports that 200 companies regularly did this 
for the corporate elite).
    Top executives and board members should be prohibited from selling 
company stock while still employed or serving there.
    Company loans to corporate officers or directors must be 
prohibited. (412 of 1,000 U.S. companies lent money to top executives, 
often at low interest rates, from 1991 to 2000--almost double the 
number from the prior decade.)
    Executives must return all compensation, as Senators Dorgan and 
McCain have urged, that is directly derived from proven misconduct. 
While the SEC already has authority to require disgorgement of ill-
gotten gains, in 2002 it has requested it in only four cases out of 
hundreds of ``restatements'' and dozens of investigations of accounting 
failures.
Auditor Responsibility
    The Sarbanes bill properly requires auditors to report to the Board 
(which is supposed to represent shareholders, not be handmaidens to 
management). The bill limits auditors from providing many consulting 
services and requires preapproval by the Board audit committee where 
allowed. Consulting services by auditors should be completely 
prohibited.
    The Sarbanes bill requires the audit personnel to rotate every five 
years but does not require a new audit company. A new audit company is 
needed to take a fresh look at the company's books.
Corporate Governance
    The corporate compensation committee must be composed of board 
members with no personal relationship with management or special 
relationship with the company. The compensation, audit and nominating 
committees should be made up of only independent members.
    No more that two board members should be insiders.
    Directors should not serve on more than three boards.
    If shareholder resolutions pass by a majority of votes cast for 
three consecutive years they should be considered adopted.
    Shareholder meetings should be held in locations where the largest 
number of shareholders reside, not in remote locations where most 
cannot attend.
Securities and Exchange Commission
    In addition to increasing staffing and funding for the SEC, the SEC 
must ensure transparency of its actions and of reporting by companies 
in formats that enhance the ability of shareholders to evaluate this 
complex information.
Pension Reform
    Limit the percentage of a company's stock that can go into a 
pension fund;
    Allow employees to move investments in pension plans from company 
stock to other securities (a right denied to Enron's unfortunate 
employees).
    Require employees to have equal representation on the 401(k) boards 
that oversee pension systems.
    Require investment advisers to be independent, without ties to the 
company.
    There are five attachments to my testimony: (A) a Public Citizen 
compilation of spending for accounting services--auditing versus non-
auditing services--by corporations that have recently been implicated 
for questionable accounting, for the years 2000 and 2001; (B) a Public 
Citizen compilation of spending by the nation's 20 largest corporations 
on accounting services in 2000 and 2001--auditing versus non-auditing 
services; (C) a copy of the April 17, 2000, letter from the leadership 
of the House Commerce Committee to then-SEC Chairman Arthur Levitt, 
referenced in my testimony; (D) a copy of a Sept. 20, 2000, letter from 
Enron CEO Ken Lay to then-SEC Chairman Arthur Levitt, commenting on the 
SEC's proposed rulemaking regarding auditor independence; and (E) a 
list of 50 thoughtful recommendations for stemming corporate abuses, 
taken from ``Corporate Crime and Violence,'' a 1988 book written by 
Russell Mokhiber, who is the editor of the weekly newsletter Corporate 
Crime Reporter.
    I would like to finish with a quote from the May 6, 2002, edition 
of Business Week. It says that ``the challenge in coming years will be 
to create corporate cultures that encourage and reward integrity as 
much as creativity and entrepreneurship. To do that, executives need to 
start at the top, becoming not only exemplary managers but also the 
moral compass for the company. CEOs must set the tone by publicly 
embracing the organization's values. How? They need to be forthright in 
taking responsibility for shortcomings, whether an earnings shortfall, 
product failure, or a flawed strategy and show zero tolerance for those 
who fail to do the same.''
    Thank you very much.


                   Appendix A.--Corporations Embroiled in Scandal and Fees Paid to Accountants
----------------------------------------------------------------------------------------------------------------
                                 Percent of            Percent of
 Fees in millions ($)    2000     fees for     2001     fees for           Accountant           Scandal in Brief
                                 consulting            consulting
----------------------------------------------------------------------------------------------------------------
Adelphia                  $3.5          62       n/a         n/a   Deloitte & Touche           Investigations by
 Communications                                                                                 the SEC and 2
                                                                                                grand juries.
  auditing                 1.3                   n/a
  non-audit and            2.2                   n/a
   consulting
Bristol Myers Squibb      25.7          89      41.3          93   PricewaterhouseCoopers      Under
                                                                                                investigation by
                                                                                                the SEC.
  auditing                 2.8                   2.7
  non-audit and           22.9                  38.6
   consulting
Cendant Corp.             27.9          80      32.4          79   Deloitte & Touche           Former Chairman
                                                                                                indicted for
                                                                                                accounting
                                                                                                scheme.
  auditing                 5.6                   6.9
  non-audit and           22.3                  25.5
   consulting
CMS Energy                 3.9          60       5.6          71   Arthur Andersen             Embroiled in
                                                                                                energy trading/
                                                                                                accounting
                                                                                                scandal.
  auditing                 1.6                   1.6
  non-audit and            2.3                   3.9
   consulting
Computer Associates        2.9          42       n/a         n/a   KPMG                        Paid fine to
 International                                                                                  Justice Dept.,
                                                                                                under
                                                                                                investigation by
                                                                                                SEC.
  auditing                 1.7                   n/a
  non-audit and            1.2                   n/a
   consulting
Dollar General Corp.       1.4           7       1.3           8   Ernst & Young
  auditing                 1.3                   1.2
  non-audit and            0.1                   0.1
   consulting
                           0.7          67      n/a*               Deloitte & Touche           Settled a class-
                                                                                                action lawsuit
                                                                                                for $162 million
                                                                                                for accounting
                                                                                                problems.
  auditing                 0.2
  non-audit and            0.5
   consulting
Duke Energy               15.2          78        15          78   Deloitte & Touche           Investigations by
                                                                                                the SEC, CFTC
                                                                                                over trading and
                                                                                                accounting
                                                                                                problems.
  auditing                 3.4                   3.3
  non-audit and           11.8                  11.7
   consulting
Dynegy                     7.3          56       8.0          59   Arthur Andersen             Investigations by
                                                                                                the SEC, CFTC
                                                                                                over trading and
                                                                                                accounting
                                                                                                problems.
  auditing                 3.2                   3.2
  non-audit and            4.1                   4.7
   consulting
El Paso                    5.9          68      12.3          65   PricewaterhouseCoopers      Embroiled in
                                                                                                energy trading/
                                                                                                accounting
                                                                                                scandal.
  auditing                 1.9                   4.3
  non-audit and            4.0                   8.0
   consulting
Enron                     52.0          52       n/a         n/a   Arthur Andersen             Took advantage of
                                                                                                lax regulations
                                                                                                to defraud
                                                                                                consumers &
                                                                                                investors.
  auditing                25.0                   n/a
  non-audit and           27.0                   n/a
   consulting
Global Crossing           14.2          84       n/a         n/a   Arthur Andersen             Under
                                                                                                investigation by
                                                                                                the FBI and SEC
                                                                                                for accounting
                                                                                                fraud.
  auditing                 2.3                   n/a
  non-audit and           12.0                   n/a
   consulting
Halliburton               51.5          86      26.5          73   Arthur Andersen             In May the SEC
                                                                                                began
                                                                                                investigating
                                                                                                Dick Cheney's
                                                                                                role
  auditing                 7.4                   7.2
  non-audit and           44.1                  19.3
   consulting
IMClone Systems            0.2          63       0.4          58   KPMG                        CEO arrested for
                                                                                                insider trading,
                                                                                                Martha Stewart
                                                                                                also under
                                                                                                investigation.
  auditing                 0.1                   0.2
  non-audit and            0.1                   0.2
   consulting
Kmart                     12.8          91     n/a**               PricewaterhouseCoopers      Under
                                                                                                investigation by
                                                                                                the SEC for
                                                                                                accounting
                                                                                                fraud.
  auditing                 1.1
  non-audit and           11.7
   consulting
Lucent Technologies        n/a                  62.6          88   PricewaterhouseCoopers      Under
                                                                                                investigation by
                                                                                                the SEC for
                                                                                                accounting
                                                                                                fraud.
  auditing                                       7.6
  non-audit and                                 55.0
   consulting
Martha Stewart Living      1.0          69       0.8          64   Arthur Andersen             Martha Stewart is
 Omnimedia                                                                                      under
                                                                                                investigation by
                                                                                                the SEC for
                                                                                                insider trading.
  auditing                 0.3                   0.3
  non-audit and            0.7                   0.5
   consulting
Merck & Co                 6.3          33       6.5          34   Arthur Andersen             Shareholder
                                                                                                lawsuits
                                                                                                concerning
                                                                                                accounting
                                                                                                problems.
  auditing                 4.2                   4.3
  non-audit and            2.1                   2.2
   consulting
MicroStrategy              2.1          62       1.4          36   PricewaterhouseCoopers      Settled a suit
                                                                                                brought by the
                                                                                                SEC for
                                                                                                accounting
                                                                                                fraud.
  auditing                 0.8                   0.9
  non-audit and            1.3                   0.5
   consulting
Mirant                    13.5          84      13.1          77   Arthur Andersen             Embroiled in
                                                                                                energy trading/
                                                                                                accounting
                                                                                                scandal.
  auditing                 2.2                   3.0
  non-audit and           11.3                  10.1
   consulting
Network Associates         5.0          71       4.0          61   PricewaterhouseCoopers      Under
                                                                                                investigation by
                                                                                                the SEC for
                                                                                                accounting
                                                                                                fraud.
  auditing                 1.5                   1.6
  non-audit and            3.5                   2.4
   consulting
Peregrine Systems          1.0          82       n/a         n/a   Arthur Andersen             Under
                                                                                                investigation by
                                                                                                the SEC for
                                                                                                accounting
                                                                                                fraud.
  auditing                 0.2                   n/a
  non-audit and            0.9                   n/a
   consulting
PNC Financial             19.1          85      18.8          79   Ernst & Young               Forced to restate
 Services Group                                                                                 $155 million
                                                                                                after SEC
                                                                                                investigated.
  auditing                 2.9                   3.9
  non-audit and           16.2                  14.9
   consulting
Qwest Communications       7.9          86      11.8          89   Arthur Andersen             Under
                                                                                                investigation by
                                                                                                the SEC for
                                                                                                accounting
                                                                                                fraud.
  auditing                 1.1                   1.4
  non-audit and            6.8                  10.5
   consulting
Reliant Energy            22.1          84      33.2          87   Deloitte & Touche           Embroiled in
                                                                                                energy trading/
                                                                                                accounting
                                                                                                scandal.
  auditing                 3.6                   4.3
  non-audit and           18.5                  28.9
   consulting
Rite Aid                  20.6          50       7.9          37   Deloitte & Touche           Indicted by the
                                                                                                SEC for
                                                                                                accounting
                                                                                                fraud.
  auditing                10.4                   5.0
  non-audit and           10.2                   2.9
   consulting
Tyco                       n/a         n/a      34.9          62   PricewaterhouseCoopers      Under
                                                                                                investigation by
                                                                                                the SEC for
                                                                                                accounting
                                                                                                fraud.
  auditing                 n/a                  13.2
  non-audit and            n/a                  21.7
   consulting
Waste Management          79.0          39      23.3          41   Arthur Andersen             Fined by the SEC
                                                                                                for accounting
                                                                                                fraud.
  auditing                48.0                  13.7
  non-audit and           31.0                   9.6
   consulting
WorldCom                  26.7          86      16.8          74   Arthur Andersen             Under
                                                                                                investigation by
                                                                                                the SEC for
                                                                                                accounting
                                                                                                fraud.
  auditing                 3.8                   4.4
  non-audit and           22.9                  12.4
   consulting
Xerox                     18.8          40       n/a         n/a   KPMG                        Paid a $10
                                                                                                million fine to
                                                                                                the SEC for
                                                                                                accounting
                                                                                                fraud.
  auditing                11.3                   n/a
  non-audit and            7.5                   n/a
   consulting
----------------------------------------------------------------------------------------------------------------
      Totals,           $448.3          67    $377.9          75
   Corporate Scandals
        auditing        $149.1                 $94.2
        non-audit and   $299.1                $283.7
     consulting
----------------------------------------------------------------------------------------------------------------
*Deloitte & Touche was dismissed as the auditor in September 2001.
**Filed for bankruptcy 8 days before they would have been required to disclose for 2001.


             Appendix B.--America's 20 Largest Corporations and Consulting Fees Paid to Accountants
----------------------------------------------------------------------------------------------------------------
                                                         Percent of             Percent of
  Fortune 500       Fees in millions ($)         2000     fees for      2001     fees for        Accountant
     rank                                                consulting             consulting
----------------------------------------------------------------------------------------------------------------
15              AT & T                            56.2          86       78.2          92   PricewaterhouseCoope
                                                                                             rs
                  Auditing                         7.9                    6.6
                  Non-Audit & Consulting          48.4                   71.6
16              Boeing                            34.8          70       28.2          52   Deloitte & Touche
                  Auditing                        10.5                   13.4
                  Non-Audit & Consulting          24.3                   14.8
17              El Paso                            5.9          68       12.3          65   PricewaterhouseCoope
                                                                                             rs
                  Auditing                         1.9                    4.3
                  Non-Audit & Consulting           4.0                    8.0
18              Home Depot                         4.5          78        6.2          81   KPMG
                  Auditing                         1.0                    1.2
                  Non-Audit & Consulting           3.5                    5.0
19              Bank of America                   49.4          73       74.2          81   PricewaterhouseCoope
                                                                                             rs
                  Auditing                        13.2                   14.0
                  Non-Audit & Consulting          36.3                   60.2
21              JP Morgan Chase                  105.5          80       75.0          62   PricewaterhouseCoope
                                                                                             rs
                  Auditing                        21.3                   28.8
                  Non-Audit & Consulting          84.2                   46.2
               -------------------------------------------------------------------------------------------------
                    Total Top 20                $938.6          74     $880.4          72
                 Fortune 500
                      Auditing                 $243.9.                 $244.5
                      Non-Audit &               $694.7                 $635.8
                 Consulting
----------------------------------------------------------------------------------------------------------------
Top 20 Fortune 500 companies as determined by the April 15, 2002 issue of Fortune magazine.
* 2000 ChevronTexaco includes only Chevron corp.
JP Morgan Chase, ranked 21st by Fortune, replaces Fannie Mae, ranked 20th, because Fannie Mae does not file
  Schedule 14a filings.

Source: Company Schedule 14a filed with the Securities and Exchange Commission. Compiled by Public Citizen
  www.citizen.org/cmep

                                 ______
                                 
Introduction of letter to Arthur Levitt, Chairman, Securities and 
        Exchange Commission, from Kenneth L. Lay
    At the height of the debate over auditor independence in 2000, Ken 
Lay sent this eye-opening letter to Arthur Levitt, then Chairman of the 
SEC, urging him to back down on his efforts to eliminate the potential 
conflicts of interest created when accountants provide both auditing 
and consulting services to a single client. The letter argued that 
Levitt was jeopardizing the productive relationship Enron had built 
with Andersen, one in which Andersen had become so deeply intertwined 
with Enron that its staff had moved into the same building, taken over 
much of the internal auditing usually left to Enron employees, and 
expanded rapidly into the highly profitable area of consulting. 
Andersen touted this ``integrated audit'' as a new paradigm in 
corporate accounting.
    Although ostensibly from Lay, the letter was secretly co-authored 
by Andersen partner David Duncan in consultation with the firm's 
lobbyist in Washington as a part of the accounting industry's massive 
lobbying effort against Levitt's reforms. Letters such as this one, 
coupled with enormous pressure from Congress, forced Levitt to back 
down on the issue of auditor independence and eventually to adopt a 
less stringent rule, a move he later called the ``biggest mistake'' of 
his time at the SEC.
                                          Enron Corporation
                                    Houston, TX, September 20, 2000
Hon. Arthur Levitt,
Chairman,
Securities and Exchange Commission,
Washington, DC.

Dear Chairman Levitt:

    I would like to take this opportunity to comment on the Securities 
and Exchange Commission's proposed rulemaking regarding auditor 
independence, on behalf of Enron Corporation. Enron is a diversified 
global energy and broadband company that prides itself on a uniquely 
entrepreneurial business philosophy and on creating knowledge-based 
value in emerging markets.
    For the past several years. Enron has successfully utilized its 
independent audit firm's expertise and professional skepticism to help 
improve the overall control environment within the company. In addition 
to their traditional financial statement related work, the independent 
auditor's procedures at Enron have been extended to include specific 
audits of and reporting on critical control processes. This arrangement 
has resulted in qualitative and comprehensive reporting to management 
and to Enron's audit committee, which has been found to be extremely 
valuable. Also, I believe independent audits of the internal control 
environment are valuable to the investing public, particularly given 
the risks and complexities of Enron's business and the extremely 
dynamic business environment in which Enron and others now operate.
    While the agreement Enron has with its independent auditors 
displaces a significant portion of the activities previously performed 
by internal resources, it is structured to ensure that Enron management 
maintains appropriate audit plan design, results assessment and overall 
monitoring and oversight responsibilities. Enron's management and audit 
committee are committed to assuring that key management personnel 
oversee and are responsible for the design and effectiveness of the 
internal control environment and for monitoring independence.
    The proposed rule would preclude independent financial statement 
auditors from performing ``certain internal audit services.'' The 
description of inappropriate activities included in your current 
proposal is so broad that it could restrict Enron from engaging its 
independent financial statement auditors to report on the company's 
control processes on a recurring basis as the company has now arranged. 
I find this troubling, not only because I believe the independence and 
expertise of the independent auditors enhances this process, but also 
because Enron has found its ``integrated audit'' arrangement to be more 
efficient and cost-effective than the more traditional roles of 
separate internal and external auditing functions. Frankly, I fail to 
understand how extending the scope of what is independently audited can 
be anything but positive.
    The SEC has supported a number of measures to ensure that audit 
committees are informed of auditor's activities and feel the burden of 
determining auditor independence. Enron's audit committee takes those 
responsibilities very seriously. Given the wide-ranging impact of your 
proposed changes, I respectfully urge the Commission to reassess the 
need for such broad regulatory intervention when the business 
environment is more dynamic than ever. I also respectfully suggest the 
SEC give the new measures regarding the enhanced role of audit 
committees in ensuring auditor independence a chance to work before 
regulations of this magnitude are considered.
        Sincerely,
                                             Kenneth L. Lay
                                Chairman and CEO, Enron Corporation
                                 ______
                                 
                             U.S. House of Representatives,
                             Committee on Commerce, April 17, 2000.
Hon. Arthur Levitt,
Chairman,
Securities and Exchange Commission,
Washington, DC

Dear Arthur:

    In connection with its oversight of the securities markets, the 
Committee has a number of questions relating to accounting practice. 
Pursuant to Rules X and XI of the U.S. House of Representatives, please 
respond to the following questions:
    1. What empirical evidence, studies or economic analysis does the 
SEC possess that demonstrates accounting firms having consulting 
relationships with audit clients are less independent than firms that 
do not have such relationships? Are there any specific administrative 
findings that have concluded the provision of consulting services 
resulted in a specific audit failure by the same firm?
    2. What empirical evidence, studies or economic analysis does the 
SEC possess that demonstrates accounting firms providing tax advice to 
audit clients are less independent than those firms that do not provide 
such advice? Are there any specific administrative findings that have 
concluded the provision of tax advice resulted in a specific audit 
failure by the same firm?
    3. What are the investment restrictions to which employees of the 
SEC are subject? How are they different from restrictions placed on 
accountants? What is the rationale for those differences? Is there 
evidence that share ownership by SEC personnel compromises their 
independence or ability to discharge their duties in accordance with 
the public interest? What are the similarities in access to material 
non-public information shared with auditors and with the SEC staff 
reviewing statements filed with the Commission? Estimate the number of 
violations that would exist if the stock restrictions applicable to the 
accounting profession were to be applied to the SEC and its staff on 
January 2, 2000.
    4. You and members of the Commission staff have suggested a new 
regulatory oversight and disciplinary process for the accounting 
process be adopted. Is the SEC developing recommendations on this 
proposal? How would the SEC receive input on its recommendations? Under 
what specific grant of statutory authority would the SEC propose to 
implement these recommendations?
    5. We understand the SEC has expressed its views on the question of 
independence primarily in interpretive guidance or no action letters 
issued by the staff. Have the policies in this interpretive guidance 
ever been subject to rulemaking subject to notice and comment? Identify 
all guidance which was adopted by rulemaking and the date of 
consideration and adoption.
    6. Members of the SEC staff have publicly supported restricting the 
scope of services offered by accounting firms to audit clients beyond 
current restrictions such as the prohibition on audit firms acting in a 
management capacity for audit clients. Are such considerations 
currently under consideration by the SEC or the staff? How would the 
SEC receive input on and implement such changes?
    7. Under Section 3(f) of the Exchange Act and Section 2(b) the 
Securities Act [sic], the SEC is required to consider efficiency, 
competition, and capital formation when engaging in rulemaking under 
the public interest standard. The legislative history accompanying 
these provisions, as well as a plain reading of the statute, makes 
clear a thorough cost benefit analysis performed by the office of the 
Chief Economist must be undertaken prior to any such rulemaking. Has 
the SEC commenced cost benefit analysis of proposed changes to 
limitations on the scope of services offered by accounting firms to 
audit clients? If so, what are the findings of this cost benefit 
analysis?
    8. Regulation S-X provides that the SEC ``will not recognize any 
certified accountant or public accounting who is not in fact 
independent.'' Has the SEC defined the principles by which it 
determines that an accountant is not in fact independent? [sic]
    9. Does the fact that audit firms are compensated for their 
services create an ``appearance of conflict'' problem? If direct 
compensation does not create an unacceptable appearance of conflict 
issue, how are more attenuated relationships between an auditor and its 
clients, such as the ownership of share in an audit client by a spouse, 
child or son or daughter-in-law of an audit partner determined to be 
unacceptable violations of independence?
    10. What is your view on the proper role of the SEC and its chief 
accountant regarding the Financial Accounting Standards Boards's 
(``FASB'') agenda? What is the proper role of the Commission and its 
Chief Accountant regarding FASB's deliberation on new GAAP rules? 
Please identify all no-public meetings between SEC personnel and 
members of the FASB or the FASB staff concerning recent proposals to 
change the accounting treatment of business combinations.
    11. Identify all private sector committees, commissions, boards or 
other groups created at the request of the Commission or yourself 
during your tenure at the SEC. For each group, identify the method and 
criteria by which members of these boards were selected, including the 
role you played in selecting members. What is the legal status of each 
of these commissions or boards? What are the terms of existence of 
these boards and the terms of their constituent members?
    12. In what ways did the SEC seek to influence the actions of the 
NASD and the NYSE as they considered the recommendations of the Blue 
Ribbon Committee on Improving the Effectiveness of Audit Committees? 
Did SEC officials meet with self-regulatory groups charged with 
reviewing the recommendations regarding listing qualifications?
    13. What is the status of SEC consideration of rules issued by the 
Independence Standards Board (ISB) last December relating to 
investments in mutual funds and related entities? Given the 
consideration of these rules would be made under a public interest 
standard, what specific criteria would the SEC use to reject a proposed 
ISB standard?
    14. The SEC Chief Accountant stated the SEC intends to move forward 
with proposals to modify independence rules. Is it the SEC's intention 
to make recommendations to the ISB for action, or to undertake action 
outside the ISB process?
    15. In the area of rules and guidance on auditor independence 
please indicate whether each of the following situations would be a 
violation of auditor independence. For those that are a violation, 
justify why the situation should be grounds for an independence 
violation:
    <bullet> A partner's spouse participates in an employer sponsored 
benefit plan that invests in securities issued by an audit client with 
which the partner has no direct contact or responsibility. The benefit 
plan is the only option offered to the spouse by the employer.
    <bullet> A partner's spouse participates in an investment club that 
owns 100 shares of stock of an audit client of the firm's Detroit 
office. The partner works out of the Seattle office and has no 
involvement with the client. The investment is not material to either 
spouse.
    <bullet> The son-in-law of a partner is the beneficiary of a blind 
trust that has a de minimis investment in an audit client of the firm's 
Boston office. The tax partner works out of the Atlanta office and has 
no involvement with the client.
    <bullet> A partner has a brokerage account with a securities firm 
that is not audited by the accounting firm. Cash in the brokerage 
office is automatically swept into a mutual fund that is audited by the 
firm's New York office. The partner works out of the Denver office, 
provides no services to the mutual fund, and is unaware the mutual fund 
is a client.
    <bullet> The grandparents of a partner's children purchase a share 
of an audit client and hold the share pursuant to the Uniform Gift to 
Minors Act. The partner has no control over the purchase or disposition 
of the stock and does not work for the client.
    For the following situations also indicate what alternatives the 
couples would have to come into compliance with independence 
restrictions.
    <bullet> A partner's spouse is an executive at company A, and 
through the only reasonable employer benefit plan has holdings in the 
company. The partner works for a firm which audits company B, though 
neither the partner's office nor the partner perform any work for 
company B. Companies A and B merge and the spouse retains both holdings 
and employment. The holdings are material to the couple. The firm 
audits the merged company.
    <bullet> The spouse of a partner works in a non-management capacity 
for a non-public company that is an audit client. The spouse has 
holdings in the company which are material to the couple. Neither the 
partner's office nor the partner perform [sic] any work for the 
company. The company goes public.
    <bullet> A manager's spouse is promoted to CFO of an audit client 
company. Neither the manager's office nor the manager perform [sic] any 
work for the company. The manager is promoted to partner.
    <bullet> A partner's spouse works for a company as a non-management 
employee and participates in the stock option and 401(k) program. 
Neither the partner's office nor the partner perform [sic] work for the 
company. Due to fluctuations in stock price, the value of stock in the 
company represents 5.1 percent of the couples [sic] net work on 
particular days.
    16. Accounting independence prohibitions were drafted at a time 
when few women worked outside the home. Given the prevalence of women 
in the workforce, both as accounting partners and as workers, managers 
or executives in public companies, does the SEC agree current 
independence restrictions are outdated and in need of modernization? Do 
the restrictions as they stand discourage wives and daughters from 
participating in the workforce?
    Please respond to these questions 2 weeks from the date of receipt 
of this letter. These responses will help to determine if hearings on 
the SEC's oversight of the accounting profession are warranted.
        Sincerely,
                                                Tom Bliley,
                                                          Chairman.

                                          Michael G. Oxley,
         Chairman, Subcommittee on Finance and Hazardous Materials.

                                     W.J. ``Billy'' Tauzin,
 Chairman, Subcommittee on Telecommunications, Trade, and Consumer 
                                                        Protection.

    Senator Dorgan. Ms. Claybrook, thank you very much for your 
testimony.
    I just received a call from Senator Byrd, the Chairman of 
the Appropriations Committee, and the conference on the 
supplemental appropriations bill is convening at this moment. 
I'm a conferee, so I'm going to briefly go to that conference. 
Senator Boxer will continue to chair the hearing. We, have been 
joined by Senator Edwards, as well.
    Senator Boxer, thank you very much.
    Senator Boxer [presiding]. Thank you. Let me tell you what 
the plan is. I'm going to give a very brief opening statement. 
Then I'm going to call on Senator Edwards. And then we're going 
to go to Ms. Minow, and then we have some questions.

               STATEMENT OF HON. BARBARA BOXER, 
                  U.S. SENATOR FROM CALIFORNIA

    Senator Boxer. I'm going to put my entire statement in the 
record, but I want to just thank my Chairman, who just left, 
for his steadfast adherence to justice. And if it wasn't for 
him, and for Senator Hollings, we wouldn't have been able to 
take a look at Enron and the larger issues that we're beginning 
to look at today. So let me put that on the record.
    Senator Metzenbaum and Joan Claybrook are institutions unto 
themselves, and they both have a long history of fighting for 
consumers. The organizations that they lead, the Consumer 
Federation of America and Public Citizen, and the groups they 
work with provide the invaluable service of, frankly, educating 
lawmakers on the rights and interests of American consumers. 
And sometimes it's a lonely battle for you. And I've been very 
proud to stand with you on many of those battles.
    But I believe if WorldCom and Enron and Tyco and Merrill 
Lynch and the other corporate players, past and present, had 
one-tenth of the ethics of both of you, we wouldn't be in 
trouble today, and I think that's the basic point. Now, we 
can't legislate that, but we can sure say that's the standard 
we want to see, and people will have to pay the price if they 
don't adopt new ethics.
    Decades ago, when I was a stockbroker on Wall Street, it 
was very different--very, very different. Granted, it was, when 
I had a 12-million-share day in those days, it was a big deal. 
There were fewer players. But the fact remains, the system 
could have been gamed, and, of course, once in awhile, it was, 
but really you didn't have what you have today.
    When you had one of the big accounting firms sign off on a 
balance sheet, on a statement, you could take it to the bank. 
And now you take it to bankruptcy. Something is rotten, awful. 
There's no check and balance here, and that's what we need to 
do in Congress today, is to get a check and balance on this 
type of behavior.
    I've watched in horror to see consultants who were auditors 
and analysts, who are supposed to be honest, telling you what 
to buy, being rewarded with inside stock deals, and CEOs who 
don't care about anyone but themselves. It is more than a 
scandal. It's a moral crisis in our country. Corporate 
irresponsibility has turned our nation's free market system 
into a free for all for the privileged few. And when companies 
lie and cheat and steal--and I want to say they're not 
companies; they're people in companies--lie, cheat, and steal, 
it causes a devastating ripple effect to the workers in those 
companies who end up losing their jobs and their dreams and 
their investments and their 401(k)'s and their savings.
    And I'll tell you, I just don't want to see another group 
of people coming up here in tears saying, ``All I wanted to do 
was take my grandchildren to Disneyland or something, and I 
can't even do that,'' or read about people who were ready to 
retire who are now saying, even though they're tired, they have 
to work another 5 years at least, because of what has happened. 
This isn't a theoretical discussion, as you know. This is about 
real people.
    Fifty percent of all Americans invest in the stock market. 
That's way up. It's at historic highs. And they count on those 
investments to send their kids to college. And we don't want 
them to walk away from being able to invest in a healthy 
economy in a healthy stock market. But if you can't believe 
what you read in a corporate statement, you're going to think 
twice. And if you don't, you're making a mistake.
    So what we're doing here I consider to be business-
friendly, because if we can restore confidence in business by 
setting rules and regulations and checks and balances, we will 
go back to having a healthy business climate.
    So I'll put the rest of my statement in the record and say 
that my state has suffered. On WorldCom, alone, pensions in my 
state lost $1.2 billion, just from WorldCom alone. So, again, 
it's very, very serious, and we all have to work together.
    And I agree with the statements you've made. The Sarbanes' 
bill is the best we've got. Yes, I had some amendments I was 
hoping to get, and I'm going to talk about them later. But 
it's, by far, the stronger bill, and I'd like to see the 
President get behind it. I'd like to see the House Republicans 
change their tune and get behind it. The Senate Republicans, 
for the most part, did. I'm very glad of that. So we have some 
opportunities.
    [The prepared statement of Senator Boxer follows:]
 Prepared Statement of Hon. Barbara Boxer, U.S. Senator from California
    Mr. Chairman, thank you for calling this hearing on improving 
corporate responsibility and for inviting such formidable consumer 
advocates to testify before the committee.
    Senator Metzenbaum and Joan Claybrook are both institutions unto 
themselves who both have a long history of fighting for consumers. The 
organizations they lead, the Consumer Federation of America, Public 
Citizen, and the groups they work with provide the invaluable service 
of educating lawmakers on the rights and interests of American 
consumers. That information helps counteract the well-funded efforts of 
high-paid K Street lobbyists working to weaken the government agencies 
and regulations that were created to protect Americans from unethical 
corporate practices.
    WorldCom, Enron, Tyco, Merrill Lynch, and the other corporate 
scandals on today's front pages reflect structural flaws in our system. 
But the Administration would have us believe that these are just a few 
bad apples rather than worms of greed that have infested the corporate 
orchard. The Administration wants to act on a case-by-case basis, only 
grudgingly accepts the need for meaningful reform, and refuses to 
acknowledge that the government has a responsibility to establish and 
enforce rules that really protect workers and investors from abuse.
    When we succeed in passing the legislation and enforcing the 
stronger regulations necessary to improve corporate responsibility, it 
will have been over the decades long objections of the right and in 
spite of, rather than because of, the President.
    Let's examine the record. This Administration refuses to force 
corporate polluters to pay for the harm they inflict on our 
environment. It has designed an energy package gift wrapped for 
corporations while ignoring the needs of consumers or the long-term 
interests of the people and the environment. It has failed to fully 
support the Senate passed reform bill because its corporate friends 
claim the new rules would be too stringent.
    Even with workers losing retirement savings and the elderly 
struggling to pay for prescription drugs, the Administration still 
refuses to support meaningful pension reform or a prescription drug 
program that works for all Americans.
    Americans know who fights for them. For the last two decades, some 
have fought to dismantle the rules and institutions that protect the 
people. Too often, lawmakers have behaved as if they work at the U.S. 
Chamber of Commerce rather than the U.S. Congress. The time to restore 
corporate responsibility is now and the way to do it is for public 
leaders to fight to protect consumers from corruption instead of 
fighting to protect the corrupt from regulators.
    Mr. Chairman, I look forward to hearing the testimony of our 
witnesses and to working with you to move necessary reforms forward. 
Thank you.

    Senator Boxer. With that, I'll call on Senator Edwards and 
then on Senator Fitzgerald, whom I welcome to the hearing.

                STATEMENT OF HON. JOHN EDWARDS, 
                U.S. SENATOR FROM NORTH CAROLINA

    Senator Edwards. Thank you. Thank you very much.
    I first want to just echo what Senator Boxer just said. It 
is so important not just to business and for the investors, but 
for the entire economy, for us to restore some level on 
confidence. I mean, I think there's no question that that's 
playing a major role on what we're seeing both in the stock 
market and Wall Street, but also what we're seeing with our 
economy today. I think we have a responsibility to lead on this 
issue and send a strong signal to the American people that 
we're willing to do what's necessary to protect investors, to 
restore confidence in corporate America, and, as a result, 
restore confidence in the investments that they're making, 
knowing that the information they get they can rely on, that 
it's accurate.
    I also want to say a word about our State Treasurer, who 
we're so glad to have here, Richard Moore, who's an old friend 
of mine. He's a wonderful leader. We're very proud of what 
you're doing, Richard, because you've really taken a lead 
nationwide working with the folks in New York, the Attorney 
General of New York and saying what needs to be said by more 
people, which is, as the manager of the tenth largest public 
pension fund in American, if you don't do right, if you don't 
do what needs to be done to be responsible, we're not going to 
invest with you. And I think if others would follow your lead, 
and I'm hopeful that they will, that it would go a long way 
towards doing what needs to be done, along with the work that's 
being done here with the Senate with Sarbanes' bill here in the 
Congress.
    So welcome. We're glad to have you here, very proud of you. 
We've been watching your leadership on this issue, and we 
couldn't be prouder of the work that you're doing.
    I also want to say just a quick word to my friend Joan 
Claybrook, who's just been such an incredible advocate for 
consumers in this country who need a voice. Lots of other 
powerful interests have voices up here, as she well knows, and 
it's a good thing for there to be at least one loud, strong 
voice for regular folks and for consumers in this country. 
We're proud of what you're doing, and Senator Metzenbaum, who's 
been a great champion for a long time of the little guy. We're 
very proud of you, too, Senator Metzenbaum. We're happy to have 
all the witnesses.
    And, Madam Chairwoman, I thank you for letting me go.
    Senator Boxer. Thank you so much, Senator.
    Senator Fitzgerald.

            STATEMENT OF HON. PETER G. FITZGERALD, 
                   U.S. SENATOR FROM ILLINOIS

    Senator Fitzgerald. Thank you, Madam Chairman, and thank 
all of you for testifying today. I want to welcome you all to 
the Committee.
    And, Nell Minow, I want to especially welcome you. You grew 
up in Illinois, and I consider you on honorary constituent for 
that reason, and I compliment you for your work as editor of 
The Corporate Library. And I know you've been involved in many 
of these issues for years and years.
    I wanted to ask some questions regarding the accounting for 
stock options. I actually believe that the Sarbanes bill was a 
very good bill. It was very well thought out, very well put 
together. I think it does make some incremental improvement. 
But I think both houses of Congress are ignoring a fundamental 
problem here, and that is the lack of expense recognition for 
stock options to corporate management and to employees.
    Back in 1993, the Financial Accounting Standards Board 
wanted to require companies to expense stock option 
compensation. And yet corporate America came to Washington and 
got politicians in Washington to thwart FASB. A resolution was 
introduced in the Senate condemning FASB for having the 
audacity to suggest that stock option compensation be recorded 
on the earnings report, and a separate bill was introduced in 
the Senate that would have eviscerated FASB and put them out of 
business if they didn't back down. So FASB backed down. They 
wanted to stay in existence. And since that time, there has 
been a gargantuan, humongous acceleration in the issuance of 
stock options.
    And you can see why. It's almost irrational, if you can get 
a tax deduction for your stock-option compensation expense, but 
you don't have to record it as an expense on your income 
statement, you'd almost be irrational to pay your employees and 
management in cash. Why not use stock options? You get the tax 
deduction, but you treat it like manna from heaven on your 
earnings report.
    There is an analysts' accounting observer Jack--gosh, 
Ciezelski, I think--is that the proper pronunciation? He has 
just issued a report that indicates that the Standard and Poors 
500 companies, that the lack of expense recognition for stock 
options caused the earnings reports of the S&P 500 companies in 
2001 to be overstated by 31 percent. And there are a number of 
companies that he points out--and they have enough enemies 
already; I won't read these companies out--but there are many 
companies in America that all of their earnings last year were 
delivered to the employees and management via stock options. 
And had they taken an expense for their stock option 
compensation, there would have been no recorded earnings.
    My question to you is----
    Senator Boxer. Well, we're not asking questions yet----
    Senator Fitzgerald. Oh, you're not?
    Senator Boxer.--because we haven't heard from the last 
witness. We'll come back to you----
    Senator Fitzgerald. OK. All right. Well, I'll rephrase 
things. I guess the point I would want to make is, in part, 
what's going on in the market now is that sophisticated 
investors, led by the institutions, have figured out that 
there's no reason to be a shareholder in companies that take 
all of their profits and give it to their management and, in 
some cases, their management employees. They've removed the 
incentive to be a shareholder in one of these companies. And I 
think those companies are getting their comeuppance now on the 
market.
    I am much chagrined that there have been continued attempts 
in Congress to thwart any kind of effort to deal with this 
issue, because I believe that this is the root cause of all the 
earnings restatements and debacles and corporate scandals we've 
seen in recent months. The top 29 managers at Enron cashed out 
$1.1 billion in stock options before the company went bankrupt. 
And there's a recurring pattern at many of the corporations 
that we have seen embroiled in scandal, that management there 
was gorging themselves on stock options, they'd cash out their 
options, many of them would then just leave the company, 
knowing that it was going to hit the wall sooner or later.
    At a certain point, while stock options might be a good, 
healthy incentive that, to some extent, aligns the interests of 
employees and management with the shareholders, at a certain 
point, when there's too heavy an issuance of options, then the 
management gets very short-term incentives, starts thinking 
about keeping their own options in the money. And when they 
start doing that, they're acting adversely to the interests of 
the long-term shareholders.
    And I think that there needs to be some discipline on 
options, and certainly one discipline would be to require the 
expense to be reflected in the earnings report. And I will be 
interested in hearing from the panel on their thoughts on this 
issue.
    I want to thank Senator Boxer for chairing this hearing.
    Senator Boxer. Thank you. Before you came, I want you to 
know that a couple of our people did talk at length about 
options. They agree with you. They--we haven't heard from Ms. 
Minow. We're going to in a moment.
    But I just want to say, in the interest of an interesting 
debate, that I don't think the root cause of the scandals we're 
facing now are stock options. I think the root cause of the 
scandal is thieving corporate leaders. Thieving, breaking laws, 
hiding losses, and also treating expenses as income.
    Now, the stock option is another question, but it isn't 
illegal, what they did. I would certainly like to make it 
illegal to do some of the things that these corporate leaders 
did with their stock options. I want to see them have longer 
holding periods. Maybe they don't get to cash in until they 
leave the company for a few years. Then maybe they'll have, you 
know, the desire to do right by the company, not just to do 
what you correctly stated, which is to phony up the earnings. 
That's no question, but let's keep our eye on the prize here. 
We didn't have any accountants that blew the whistle on these 
other matters.
    And I do want to put on the record the fact that I come 
from a state where stock options have been used by 100 percent 
in some companies. I have letters that I'll put in the record 
from women who are on the bottom of the ladder in the company 
who were able to use their options.
    [Letters are not available.]
    Senator Boxer. So what I want to do with options is not 
something really simple that eliminates them for the little guy 
and keeps them for the big guy and allows the big guy--if you 
just did expensing tomorrow, this is my prediction, because 11 
million people have stock options, the top guys will still get 
them, and they'll still abuse them unless we change the laws 
surrounding what they can do with them.
    So I think it's a very interesting debate, and I'm working 
very hard to make sure that when we do make our move on this 
issue that we move on it in a right fashion so that the little 
guy doesn't get it in the neck again, but the big guy does. And 
it makes a lot more sense.
    So I don't think that there's division in our Senate at 
all. I think the division is exactly what you do about it. But 
everyone sees it as an evil that needs to be addressed, where 
you keep the good side of it, but you get rid of the bad side 
of it.
    But I just would disagree that the cause of the scandal now 
is stock options. They're a real problem. The causes of the 
scandal are illegal acts, and that's why I'm so proud that 
Senator Leahy and Members of the Judiciary Committee on both 
sides were able to put together some stronger penalties.
    But, with that, let's call on Ms. Minow, and we welcome 
you. The whole panel has just been wonderful so far. I'm sure 
you will continue in that tradition. I ought to say that you 
are the editor of The Corporate Library.

               STATEMENT OF NELL MINOW, EDITOR, 
                     THE CORPORATE LIBRARY

    Ms. Minow. Thank you very much, Madam Chairman. And, 
Senator Fitzgerald, I may just have to move back to Illinois so 
I can vote for you. I appreciate what you said very much. Thank 
you.
    I want to begin, again, by thanking you for inviting me to 
appear today. I've been working in this field, corporate 
governance, for 16 years, and it's really been a shock to my 
system not to have to explain to anybody anymore what that is.
    American investors, consumers, and employees have been very 
deeply shaken by the stories of corporate corruption, and it 
has been very gratifying to see the Senate and Congress move so 
quickly to respond. I really want to emphasize that if there 
was ever an issue that required bipartisanship and even 
statesmanship on behalf of the Senate and the Congress in 
accepting responsibility for the causes of this problem and in 
developing a response, this is definitely it. The one thing 
that the Senate and Congress could do that would really create 
more problems of investor confidence is turn this into a 
partisan matter.
    The discussion of investor confidence reminds me of a story 
about my dad, Newton Minow, who is a resident of Illinois. He 
was asked to speak to a group of young lawyers at his firm, and 
he told them that the most important thing that you could do as 
a lawyer was to get the client to trust you. And one of the 
hotshot young lawyers raised his hand, and he said, ``Well, Mr. 
Minow, how do I do that?'' My father said, ``Well, you could 
start by being trustworthy.'' And that is a lesson that our 
corporations must learn. There is nothing that we can do to 
solve that problem for them. We can create more penalties, we 
can remove improper incentives, but they've got to learn that 
themselves.
    In a way, we've all been enablers for bad behavior by 
corporate managers and directors. We've been rewarding them at 
a level unprecedented since they used to pay people their 
weight in gold. Unfortunately, like that thankfully outdated 
form of compensation, ours have not provided optimal 
incentives, and the managers, therefore, have opted for short-
term self-dealing rather than long-term sustainable growth and 
shareholder value.
    It was interesting that Madam Chairman referred to the 
``root cause.'' This really has been like a root going off in a 
lot of different directions. There are many different causes 
here. And the challenge is that there have been so many 
failures by so many different entities that it's difficult to 
provide an effective and coordinated response.
    I'm a big fan of everybody on the panel, but I have to 
disagree. I think that Harvey Pitt is going to do a very good 
job. He's very committed to doing a good job and just needs 
some additional support to do it.
    And I also have to disagree on the Securities Litigation 
Reform Act. It was not a perfect act. Obviously anything could 
be improved, but I personally have filed lawsuits under the 
Reform Act, and the amount of settlements that, not only I 
received, but other people have received have been 
unprecedented. So I think it's actually been a net improvement.
    I do want to talk a little bit about stock options and pay 
disclosure. We have to take some responsibility for the problem 
here. I really appreciate that Senator Fitzgerald mentioned the 
way that Congress interfered with what FASB wanted to do 
previously. I'd like to have Congress get out of the way so 
that FASB will do the right thing now.
    Going back to your point, Madam Chairman, the issue of how 
long the employees must hold the exercised options I think is a 
terribly important one. I'd like to see them not be allowed to 
cash out until 3 years after leaving the company to make sure 
that their perspective is a long-term one.
    I particularly want to point out the fact that the SEC, not 
too long ago, changed the rules to allow a cashless exercise of 
options. I think that that has been insidious. Executives can 
exercise the options and sell them immediately without having 
to put any money down, and I think that that has created a 
terribly perverse set of incentives.
    What Congress should do is revisit the tax code to redefine 
performance-based pay. The last time pay was an issue, Congress 
tried to fix it by setting the million dollar pay cap and then 
giving a get out of jail free card, basically, to performance-
based pay. I've brought a report from The Corporate Library on 
the failure of U.S. stock option plans to tie pay to 
performance. I don't intend to clog up the record here with it, 
but I'm making it available to the staff.
    I think what we need to do is instead of discouraging 
indexed options tied to the performance of the individual 
company, which our tax code right now makes almost impossible, 
we need to encourage them.
    Furthermore, there is this trend in corporate America that 
I call the Leona Helmsley trend, the only ``little people pay 
taxes'' trend, and that is to ``gross up'' CEO pay, meaning 
that not only does the company pay the CEO, the company pays 
the taxes of the CEO. I have to pay my taxes. You have to pay 
your taxes. We should not allow that anymore.
    My second point has to do with the enforcement of existing 
laws. The SEC, under Mr. Pitt's predecessor, in particular, had 
a terrible relationship with the Justice Department. And, 
therefore, there was very little criminal enforcement. I think 
that the Senate should require the SEC and the Justice 
Department to work better to eliminate petty bureaucratic 
differences and present a meaningful plan for enforcing the 
laws already on the books. And it would help if we had a full 
SEC and perhaps fewer people with ties to the accounting world.
    The failures at all of the companies we've listed today are 
not necessarily the failures of the accountants, analysts, or 
regulators. It was really the boards of directors, and we need 
to think carefully about a system that takes capable, 
honorable, experienced people and puts them into a board room 
where there's something about the oxygen that causes them to 
lose half of their IQ points and all of their courage. We need 
to really get out of their way.
    And, in particular, we need to work on the fact that, the 
Federal Government has more of a say in what goes on in your 
local elementary school than it does in a board room because of 
the deference to state law, meaning Delaware. If shareholders 
could pick the state of incorporation, we'd have some 
competition in the states to do better by them.
    I support the New York Stock Exchange's proposals, which I 
think are very constructive, but I worry that the NASDAQ 
proposals are disappointing and make it harder for the New York 
Stock Exchange to uphold the high standard.
    Most important, all of the reform proposals currently focus 
on what I call the supply side of corporate governance, what 
companies, directors, and auditors must do. And none of this 
will work unless we focus on Mr. Moore's side, the demand side, 
what shareholders can and must do. I'm really happy to see 
North Carolina weighing in here. Of course, your state, Madam 
Chairwoman, has been the leader in this field, but what is 
wrong with the other 48 states? Why don't we get the public 
pension funds playing more of a role?
    In the hotly contested Hewlett-Packard merger this year, 
every vote counted. It was closer than Bush-Gore. In the 
equivalent of the butterfly ballot, we had Deutsche Asset 
Management, one of Hewlett-Packard's largest investors, voting 
against the deal, and then getting paid a million dollar fee 
from Hewlett-Packard; and then voting for the deal; and then, 
of course, being upheld by the friendly courts of Delaware. If 
we're going to allow that level of corruption on the 
shareholder side, we will never have any meaningful oversight. 
I draw your attention to the work done in the U.K. by the 
Myners' Commission, which has been very, very worthwhile in 
this area.
    One thing that Senators understand better than anyone else 
is the importance of a system of checks and balances to guide 
the exercise of power and protect citizens from abuse. The 
corporate system of checks and balances has been allowed to all 
but tip over completely. The failures at what I believe are the 
edges of the system have taught us some important lessons about 
the obstacles to market efficiency, what we need to do to make 
sure that the checks and balances are restored, and I hope to 
be a constructive voice in that process.
    Thank you, again. I welcome your questions.
    [The prepared statement of Ms. Minow follows:]
    Prepared Statement of Nell Minow, Editor, The Corporate Library
    Mr. Chairman and members of the committee, I want to begin by 
thanking you for inviting me to appear today. American investors, 
consumers, and employees have been deeply shaken by the stories of 
corporate corruption, and it has been very gratifying to see the Senate 
and Congress move so quickly to respond.
    My father, asked to speak to a group of new young lawyers at his 
firm, told them that the most important goal was to get the client to 
trust you. One young man asked him how to do that, and my father 
responded, ``Well, you can start by being trustworthy.''
    This is a lesson that our corporate leaders must learn. In a way, 
we have all been enablers for bad behavior by corporate managers and 
directors, rewarding them at a level unprecedented since they used to 
give kings their weight in gold. Unfortunately, like that thankfully 
outdated form of compensation, ours have not provided optimal 
incentives, and managers have therefore opted for short-term self-
dealing rather than long-term, sustainable growth in shareholder value.
    The complicating factor here is that there have been so many 
failures by so many different entities that it is a challenge to 
provide an effective and coordinated response.
    I want to speak briefly about five problem areas and the place most 
likely to provide some improvement. The one area I do not plan to 
address is accounts and accounting firms, because I believe that it has 
been thoroughly covered by the pending legislation. I will be happy to 
answer questions about that issue as well as the others I am raising at 
the end of my testimony.
1. Stock Options and Pay Disclosure
    We all have to take a moment to accept some responsibility for the 
problem here. Stock options would not have gotten so out of hand if not 
for our last attempt to address these problems, back when CEO pay was 
grabbing headlines in 1991. The result was a classic lesson in the law 
of unintended consequences. Congress amended the tax code to put a 
ceiling on deductibility of CEO cash compensation at $1 million, but no 
limit on performance-based pay, meaning options. The result: all base 
pay got raised to $1 million and the average option grant went from the 
thousands to the millions. The stock doesn't have to do very well for 2 
million options to be worth a lot of money. Seventy percent of option 
gains are attributable to the overall market, not the performance of an 
individual company, much less the individual recipient of the options. 
And the tax code provides enormous obstacles to the most legitimate 
option grants, indexed options, which would make sure that the 
executives are rewarded only for their company's performance.
    To make things worse, the SEC changed the rules to permit 
``cashless exercise'' of options instead of encouraging or requiring 
executives to hold on to the shares.
    I do not believe Congress should get involved in setting accounting 
standards. In fact, Congress was the problem the last time this came 
up, with an unprecedented interference with FASB's attempt to require 
that option grants be expensed. FASB wants to do the right thing, and 
has additional support from the investor community and the 
International Accounting Standards Board. All we need to do is get out 
of their way and protect FASB from political interference.
    What Congress should do is revisit the tax code to redefine 
performance-based pay. Our recent report compares U.S. option grants, 
which are generally not linked to performance, to those in the UK. Our 
tax code should encourage compensation plans that truly link pay to 
long-term performance and not short-term books-cooking.
    The SEC should rescind its rule and prohibit cashless exercise of 
stock options.
    Finally, the SEC should go back to its original disclosure 
requirement for the top five highest paid executives. That rule was 
changed to apply only to ``officers,'' creating a huge loophole that 
permits companies to evade disclosure of crucial information.
2. Enforcement of Existing Laws
    The SEC under the previous administration and the one before that 
has done a poor job of coordinating with the Justice Department and as 
a result, there have been far too few criminal prosecutions for 
securities fraud. Oversight committees should insist that the SEC and 
DOJ work closely together to eliminate petty bureaucratic differences 
and present to Congress a meaningful plan for enforcing the laws 
already on the books and making it so painful to violate securities 
laws that the bad guys will reconsider and try something a little less 
risky.
    It would help a lot if we had a full set of SEC Commissioners, and 
now would be a good time to put one or two investor advocates on the 
commission, instead of the usual suspects who come from the other side. 
One action has already been thrown out because two of the three sitting 
SEC commissioners had conflicts. Let's get five commissioners on board, 
with backgrounds with enough diversity that we will not have that 
problem again.
3. Boards of Directors
    The greatest failure at Enron, WorldCom, Adelphia, Global Crossing, 
and Tyco was not the failure of the accountants, analysts, or 
regulators. It was the boards of directors. We need to think carefully 
about a system that takes capable, honorable, experienced people and 
puts them into a situation that does not allow them to do a good job. 
What is it about the atmosphere of the boardroom that causes the most 
distinguished people in America to lose half of their IQ points and all 
of their courage?
    Unfortunately, the Federal Government plays more of a role in a 
local elementary school than it does in the boardroom. Our tradition is 
to leave that role to the states, and that means Delaware, which long 
ago won the race to the bottom by providing the most management--and 
director-friendly legislature and court system in the country. Now, of 
course, Bermuda beckons, and I hope Congress will cut off that route 
before any other companies escape American law entirely.
    But if we are to leave it to state law, we must create a race to 
the top by allowing shareholders to choose the state of incorporation. 
Every 5 years, shareholders should be allowed to submit a proposal to 
change the state of incorporation. That would encourage 
experimentation, innovation, and, especially, consideration of 
shareholder rights.
    The SEC should also require additional disclosure, including all 
relationships between directors and officers of the company. And we at 
The Corporate Library are hoping that our new board effectiveness 
rating will someday become as important a part of the risk assessment 
of an investment as the company's credit rating and performance 
history.
4. The Exchanges
    The Self-Regulatory Organization structure has permitted the foxes 
to guard the chicken coop. No wonder the chickens are scared. The 
exchanges usually act as though they work for the issuers. In a rare 
exception, the NYSE has produced a truly outstanding proposal for 
enhancing its listing standards. NASDAQ, on the other hand, has 
produced a proposal most charitably described as disappointing. If the 
NYSE is not going to run the risk of scaring its listed companies over 
to the more forgiving confines of the NASDAQ, the SEC has to have 
authority to require it to match the NYSE's standards.
5. The Shareholders
    All of the reform proposals currently focus on what I call the 
``supply side'' of corporate governance--what companies, directors, and 
auditors must do. None of this will work unless we also focus on the 
``demand side,'' what shareholders can and must do.
    Institutional shareholders manage the largest accumulation of 
investment capital ever assembled. They include pension funds, mutual 
funds, foundations, endowments, and others. There was a lot of 
information about the potential problems at Enron, Global Crossing, 
Adelphia, and WorldCom. Why didn't they act on it?
    In the hotly contested merger at Hewlett Packard and Compaq this 
year, every vote counted. One of HP's largest shareholders, Deutsche 
Asset Management, voted against the merger. Then they got a million 
dollar fee from the company. Then they changed their vote. Then the 
merger passed.
    This was challenged in the Delaware courts. But the Delaware court 
upheld it, partly because, as I said earlier, they cater to management 
because they want to keep that nice, clean income from the companies 
``domiciled'' there. But the other reason was that the challenge was to 
HP, and whether what they did was fair to HP shareholders. Putting that 
issue aside, who is going to challenge it from the Deutsche Asset 
Management side, and ask whether what they did was fair to the people 
whose money they manage, the people who trust them to buy, sell and 
vote stock based on what is right for them, regardless of what fees 
they generate for themselves?
    Where are the SEC and DOL? They both have the right to investigate 
the exercise of proxy votes by institutional fiduciaries. But despite 
extensive evidence of the deepest level of corruption and 
mismanagement, there has never been a single enforcement action brought 
because of the failure to exercise shareholder rights, including proxy 
voting, in the interests of investors or plan participants.
    Both agencies should issue prompt, clear, and unequivocal 
statements to the institutional investors under their jurisdiction 
calling for the strictest possible controls to ensure that proxy votes 
are cast with integrity.
    Institutional investors should have to disclose their proxy voting 
policies and any votes inconsistent with those policies. They should 
log every attempt to get them to change a vote.
    Here is why these issues are suddenly so striking: The rising tide 
lifted all the boats and the boom market hid a multitude of shortcuts 
and fudges. But as the tide went out, boats foundered on the rocks, and 
some of the rocks fell over, revealing some nasty creatures underneath.
    One thing that Senators understand better than anyone else is the 
importance of a system of checks and balances to guide the exercise of 
power and protect the citizens from abuse. The corporate system of 
checks and balances has been allowed to all but tip over completely. 
The failures at what I still believe are the edges of the system have 
taught us some important lessons about the obstacles to market 
efficiency and about what we need to do to make sure that the checks 
and balances are restored. I hope to be a constructive voice in that 
process.
    Thank you again, and I welcome your questions.

    Senator Boxer. Thank you to the whole panel.
    Here's what we're going to do. We have a vote on the Senate 
floor. I'm going to stay here till Senator Fitzgerald comes 
back, then he's got some questions. And at that point, Senator 
Dorgan should be back, so we're just having a little rolling 
chairmanship here.
    Mr. Moore, I also want to commend you for exposing 
conflicts of interest at Merrill Lynch, working with Elliot 
Spitzer, who you probably know we had before us. And I talked a 
little bit about that. And on the Sarbanes' bill, I had an 
amendment which was blocked by Senator Phil Gramm which would 
have said that not only does an analyst have to say that he or 
she owns the stock when they're making a recommendation, but 
that members of the immediate family, that has to be disclosed, 
as well.
    I think that's important information, for two reasons. One, 
you may decide, well, if the guy believes so much in it and he 
has it, maybe it's a good thing; or, maybe it's a way to push 
the stock up. And that's up to you. But at least it's what you 
said; it's disclosure. And I wonder how you felt about my 
amendment, if you thought that was a good idea, because we 
still want to try to make the bill stronger in the conference.
    Mr. Moore. Well, I've never seen a situation where 
disclosure is not a good thing. And I think one of the things--
one of the reasons that I felt so strongly about this over the 
last few months is that the leaders of Wall Street and the 
leaders of corporate America, they're spending other people's 
money, and it struck me as odd--they were much more like you 
and me, who answer to the voters. And I remember the first time 
I signed a bond offering document coming to the public 
marketplace to borrow money for my state, I signed under the 
oath of perjury. I mean, I faced a penalty that the corporate 
executives did not.
    So the more disclosure--we live in a glass bowl spending 
other people's money--the better. And I'm not saying they have 
to publicly disclose, but they should at least disclose to 
their customers like me.
    Senator Boxer, I would support that. I think you will see, 
thanks to your state and your State Treasurer, who is my good 
friend, we have more--as of 2 days ago, we have more than $600 
billion behind the proposals that Elliott Spitzer and I wrote. 
I don't think the market is going to be able to tell us no on 
this, because what we're asking for is reasonable and right and 
they owe us a clear fiduciary duty. So I think we're going to 
get a lot of disclosure.
    Senator Boxer. Good, because if you don't, then you don't 
know who to believe or what to believe. It's sad that--you 
know, we used to count on, as Ms. Minow said and I said before, 
the checks and balances, that if something went through the 
system, that at least the auditor would find it, somebody in 
the corporation would speak up, so on and so forth.
    And what we're seeing is just everybody's in the tank, you 
know, from the--we heard that from Mr. Spitzer, from reading 
his materials, and I'm sure you know this, that there was one 
period of time where Merrill Lynch never issued a sell order. 
They never suggested that a company they recommended be sold, 
because they had all this involvement with them. It's just 
absolutely stunning.
    So, you know, we try to clean that up, but we also want to 
have a layered defense, which is, if you don't trust that 
person, let's get to the disclosure. And I really--I really 
want to thank you.
    I'm going to ask one question.
    Ms. Claybrook. Senator Boxer, could I----
    Senator Boxer. Yes. Please.
    Ms. Claybrook --comment on that?
    Senator Boxer. Please.
    Ms. Claybrook. I got a letter the other day from a member 
of Public Citizen. He's a lawyer. He said he was trying to 
decide what stockbroker to hire, and he looked at the different 
forms that you have to sign when you hire a stockbroker. And he 
said every single one of them required him to agree to 
arbitration and to give up his right to go to court if he 
wanted to challenge something that the company had done.
    And, you know, here we have Merrill Lynch, who happens to 
be my stockbroker, having engaged in these tremendous wrongs. 
And when you sign that form, you have to agree to go to 
arbitration. And the problems with arbitration are you have to 
put the money up front--you, the consumer--in order to have an 
arbitrator. These arbitrators again and again represent the 
business defendants, so they don't want to irritate them too 
much, because they won't be hired in the next arbitration by 
that business defendant. And there's no discovery, there's no 
opportunity for class actions, that is, for a lot of small 
people harmed to joined together.
    And so it seems to me this is an issue that should also be 
addressed here, that this is like a private judicial system 
that's being created, and it protects companies like Merrill 
Lynch and others from ever having to disclose anything. So you 
talk about public disclosure--well, it's one thing to require 
regular disclosure. It's another thing when they misbehave to 
get disclosure. And one of the ways that you get disclosure is 
through lawsuits and discovery. And if you can't file a lawsuit 
and you can't get discovery, the likelihood of your succeeding 
as an individual investor is zilch.
    Senator Boxer. Well, I want to thank you for that point. 
And I think that you're right. And you're absolutely right. If 
people know that there's no price they have to pay at the end 
of their lies and their cheating and their scandalous behavior, 
they'll just continue it. You know that's what we're seeing. 
It's a very sad day in America, but that's what we're seeing.
    And this whole notion, I never thought about arbitrators as 
being perhaps in another conflicted situation, so I think we 
need to take a look at how we can avoid that, because you're 
right, if they want to be hired again, then they ought to come 
down on the side of the business.
    Ms. Claybrook. Well, the key issue here is it's mandatory 
predispute arbitration. I love arbitration. I think arbitration 
is fine. But if I'm required to go to arbitration----
    Senator Boxer. I hear you.
    Ms. Claybrook.--before the harm ever occurs, in order to 
even get a stockbroker. That is where the wrong is. And this 
individual who wrote to me said he checked every major 
stockbroker in America and could not find one that didn't 
insist on arbitration. So there's essentially a collusion among 
the stockbrokers in America to insist that you have arbitration 
so that there's no penetration of the wrongs that they do by 
litigation.
    Senator Boxer. Right. Well, you've raised yet another layer 
of an issue that we have to get to.
    Because I'm going to be late now, I was hoping that Senator 
Fitzgerald would come back, but he should be back shortly, or 
Senator Dorgan, and so I will say adieu for the moment while I 
go vote, and we'll stand adjourned until the next chair 
returns.
    [Recess.]
    Senator Fitzgerald [presiding]. We're going to call this 
meeting back to order. I appreciate your indulgence while we 
had a vote. I voted, and then--now Senator Boxer's voting. And 
at 11 o'clock, actually, we're supposed to go to a second 
hearing on somewhat different matters. And I do want to wrap up 
with some rounds of questioning that will have to be brief by 
necessity, and we apologize for that.
    I know Senator Boxer discussed stock analysts, and I do 
believe, to some extent, we addressed that in the Sarbanes 
bill. But, again, I wanted to follow up on my comments from the 
opening round about the lack of expense recognition of stock-
option compensation expense on earnings reports. And I noted in 
my opening remarks that, according to a recent study, the 
earnings of the Standard and Poors 500 companies in 2001 were 
overstated by over 30 percent.
    And I'd like to start with Ms. Minow. What effect do you 
think this news coming out, that earnings reports are inflated, 
is having on the stock market now? Do you think that is 
inhibiting institutional and other investors because they're 
really not sure that they can rely on the earnings reports of 
companies that are out there?
    Ms. Minow. Senator, I believe that there are a number of 
reasons that investors feel that they can't rely on the 
earnings reports. I had a reporter call me yesterday on this 
issue of expensing stock options, and he said, ``Well, we just 
really don't know how to value them, so how can we value 
them?'' I said, ``Well, right now we are valuing them. We're 
valuing them at zero.'' We're valuing them at a lot more than 
zero when we give them away. But when we tell the shareholders 
what we've done, we're saying that they're not worth anything. 
And if they're not worth anything, then why don't you give them 
to me? I'll take them. So I think that this is one of many 
reasons that investors are feeling very shaky right now.
    Also, ironically, as we are beginning to expense them, as 
Coca Cola and Bank One and a number of companies have announced 
that they're going to expense stock options the formulas are 
based, in part, on past performance of the stock. We may be 
getting overvaluations of these options, because it's unlikely 
that the market will continue to perform as well as it has 
been.
    Senator Fitzgerald. I have a follow-up question on that. 
Some companies, particularly in Silicon Valley, pay ordinary 
expenses--like they have a bill from their law firm, they'll 
pay it in stock options. Do they--does anybody know whether 
they're expensing those bills when they pay them in stock? And 
my understanding is that they do, they have to expense it when 
they're paying anybody but their own employees. What is the 
public policy rationale if you pay an expense to your own 
employees in options for not expensing it, but if you pay it to 
a law firm or pay some ordinary bill in stock options, that you 
do expense it?
    Ms. Minow. Yes. In the go-go years, even landlords were 
asking to have their rents paid in stock options.
    [Laughter.]
    Senator Fitzgerald. That is an expense, right? They do have 
to report that as an expense on their earnings report?
    Ms. Minow. It's an operating expense, absolutely, and 
you've pointed out exactly the logical flaw, the fallacy, and 
the corruption at the heart of this one exemption. Everything 
else that the company pays out in the form of compensation does 
have to be expensed. And this one great big loophole has 
created a very perverse incentive and a distortion of the 
balance sheet.
    Senator Fitzgerald. Now, let me ask you this. When a 
manager has millions of stock options and they could make 
millions of dollars--Ken Lay cashed out, I think, $250 million 
worth of his stock options in Enron. There are many examples of 
corporate executives who just feasted on options and can make a 
lot of money by keeping the stock price of their corporation 
high, and that often depended on keeping the earnings per share 
high. At a certain point, when there's so many options in the 
hands of senior management, doesn't that become somewhat of an 
incentive to goose the earnings to keep the stock price high so 
that the management can profit from their own stock options?
    Ms. Minow. There is no question about it, and there have 
been academic studies documenting corporate announcements and 
developements and relating them to the exercise of options. 
That's why I believe that it's very important that we rescind 
this SEC rule that permits cashless exercise of options and 
require those who exercise options to put the money down and 
hold onto the stock, because that will truly align their 
interests with the interests of the shareholders.
    I want to really emphasize one point here. Seventy percent 
of option gains are attributable to the overall market and have 
nothing to do with the performance of the individual company. 
And the fact that our tax system makes it impossible to give 
out indexed options has also contributed to that same----
    Senator Fitzgerald. Are you saying that's like rewarding 
the weatherman because the weather turns out good?
    Ms. Minow. Except that the weather turns good less often 
than the market does well, so, in fact, it's a better bet.
    Furthermore, just a few years ago, 100,000 options was 
considered to be a very generous grant. They literally 
redefined the term ``mega-grant'' of options, because everybody 
was getting them. And if you have a million options, the stock 
doesn't have to do that well for you to make a million dollars.
    Senator Fitzgerald. There's one famous company, and I won't 
mention its name, but it's my understanding they earned $5 
billion last year; but if they had recorded an expense for 
their stock options, they would have reported zero earnings. 
Now, there are two ways of looking at that. They earned 
nothing--one way of looking at it is they earned nothing, but 
figured out a way to tell the public they earned $5 billion.
    Ms. Minow. Right.
    Senator Fitzgerald. Or another way of looking at it is that 
they earned $5 billion, but they transferred the $5 billion in 
profits to their employees and, to a lesser extent, their 
management, and, to a lesser extent, their rank and file 
employees. My question is, would not an investor be irrational 
to want to hold stock in a corporation where 100 percent of the 
profits are transferred to the employees? Why would someone 
want to hold stock in a company like that?
    Ms. Minow. You're completely right. And they're transferred 
to the employees in a way that's very dilutive to the 
shareholder value, not only to the shares themselves, but to 
the voting rights that go with them. And the answer is, that's 
why companies don't want to expense their options, because if 
they told the truth about it, nobody would want to buy stock.
    Ms. Claybrook. Mr. Chairman, I think it's also the point 
that it's very hard for the investors to figure out how many 
options are being given. This is not an easy type of 
information to find. The calculation you just made, it may be 
irrational, but----
    Senator Fitzgerald. Since it's not reported. But the 
institutions have figured this out. I mean, they're coming into 
my office begging to require expensing of stock options. But, 
unfortunately----
    Ms. Claybrook. It's certainly not something that's readily 
available to the average citizen, and I was just going to say 
that Mr. Moore was talking earlier about transparency and 
availability of information, and certainly we've done a lot of 
research through the SEC files. It's not easy. Most consumers 
could never do this. Most investors could never do this.
    Senator Fitzgerald. So won't they just stay away from the 
market? Figure this is a fool's game?
    Ms. Claybrook. No, no----
    Senator Fitzgerald. You think they'll--you don't--I mean, 
aren't they doing that, to some extent, now?
    Ms. Claybrook. They are now, because there's this huge 
corporate crime wave going on, but, by and large----
    Senator Fitzgerald. What's the motive for goosing the 
earnings, though, if it isn't to cash in on the options?
    Ms. Claybrook. Well, I completely agree that it is. I mean, 
that is absolutely what it is.
    Senator Fitzgerald. So isn't that the root cause, then?
    Ms. Claybrook. Oh, I believe it is one of the root causes 
of it, but when they goosed the earnings, they engaged in a lot 
of illegal acts, and if there's no----
    Senator Fitzgerald. But why goose the earnings unless it's 
to pocket the money that, individually, you can make from your 
own options and then leave the company?
    Ms. Claybrook. That's the incentive, but if there's no 
enforcement for doing it, then they're going to keep on doing 
it.
    Senator Fitzgerald. Well, why don't we remove the incentive 
to goose the earnings. I guess that--Mr. Moore?
    Mr. Moore. And you're hitting on a couple of points, 
Senator First of all, the reason that it's done to begin with, 
the reason that people look at using options, is the tax policy 
in place. You know, if you want to peel that back to root 
cause, and both of you, Senator Boxer and Senator Fitzgerald, 
have both made equally compelling points on this. Instead of 
getting caught up on whether options are good or bad or not, 
examine whether the taxing policy that encourages the use of 
them is something you want to do.
    And I would urge you to look back at another thing. We're 
one of the few nations in the world that double-taxes 
dividends. You know, maybe it wasn't such a bad thing for the 
quality of corporate earnings to pay out dividends. And I've 
been working with a group, with Warren Buffett, who, you know 
how strong his opinions are that the quality of corporate 
earnings are the worst they have ever been. Let's maybe take a 
step backwards in that way.
    Now, I agree with you, Senator Fitzgerald. I think it is 
the root cause. As someone who spent several years of their 
life prosecuting smart, white-collar criminals, there are two 
types of people in the world that do these things--one, the 
people who are criminals the day they enter the business, and 
we're never going to stop them. I mean, the only thing is we 
can prosecute them to the full extent of the law.
    But there is the type of person that, if there is an 
incentive--and I believe you're right; it's tied back to 
options--that if they tell the truth or they lie, next year 
they make $500,000, no matter what. If they tell the truth or 
they lie. Well, which one are they going to do? They're going 
to tell the truth.
    Now, if you change the scenario, and if they lie, they make 
$10 million next year, instead of a half million. Well, that's 
a decision many people don't want to be faced with, and that's 
what options do.
    Senator Fitzgerald. So they're----
    Mr. Moore. But it goes back----
    Senator Fitzgerald.--giving incentives for good people to 
do bad things.
    Mr. Moore. But you didn't, you weren't here during my 
testimony. And I think an appropriate middle ground on this is 
do as you've done in food labeling, do as you've done in so 
many things. If this is a contentious area, make them put it in 
the proxy statements, in the annual reports, in a clear and 
open place----
    Senator Fitzgerald. How about in the earnings statement?
    Mr. Moore.--and the market----
    Senator Fitzgerald. How about the earnings statement?
    Mr. Moore.--will take care of the options that do not align 
management and ownership.
    Senator Fitzgerald. But are you----
    Mr. Moore. Because those are the----
    Senator Fitzgerald. You're in favor of putting it in the 
proxy statement and the annual report. It's already in a 
footnote in the annual report. What I'm suggesting is they 
should expense the expense in their earnings report. Are you in 
favor of expensing stock option compensation on the earnings 
report?
    Mr. Moore. I am in favor of that, but if you, as a body, 
get caught up between the two, what I'm saying, at a minimum, 
please put it in boldface, not in a footnote somewhere, so we 
can value these overhang and run rates. We can do this. The 
institutional investor can do this. And if we kill the stock 
price, then we look after the small investor.
    Senator Fitzgerald. Well, thank you.
    Senator Boxer [presiding]. Let me just disagree. I don't 
think good people do what these people did. So I will disagree. 
Good people don't hide losses and show them as profit. Good 
people don't do that. And so I do believe there are good people 
who don't do that, but I don't believe the people who have done 
this----
    Senator Fitzgerald. Do you believe that it's a temptation 
at all?
    Senator Boxer. I'll be happy to yield to my friend.
    Senator Fitzgerald. Do you believe it's a temptation at 
all?
    Senator Boxer. You know, I guess I'm a person that's kind 
of right and wrong, black and white. It's the kind of family I 
grew up in, it's the way I am. And I was taught, you know, you 
don't take a two-cent lollipop out of that candy store even, if 
it's right out there. Even when I was a little kid, and, boy, 
if I ever did it, that would have been it.
    So I would like to tell you that we need to do something 
about changing the law here, because just note, this scandal, 
the illegalities were not the exercising of the stock options, 
as we've all pointed out; this is the law. So we need to do 
something to change it. Some think if you expense it, you solve 
the problem. I do not. Because I believe what will happen then 
is the little guy gets squeezed out, the big guy will still get 
it and will still be able to manipulate.
    But I want to just put in the record what I think the roots 
of the scandal are. Accountants acting as consultants, OK? 
Analysts making false recommendations because of conflicts of 
interest, Enron and others hiding losses in special-purpose 
entities, executives encouraging their workers to put their 
retirement savings, 100 percent of it, in employer's stock as 
they were unloading--that's wrong--claiming false earnings. And 
the rules of the game allowed them to do this.
    But yet and still there's a lot of illegalities. Insider 
trading, I would add, which I hope we're going to get to later 
today.
    So I just want to thank the panel from my perspective, 
because I think you've given me some great ideas. And, Ms. 
Minow, I want to talk to you a little further about the ideas 
you've put on the table, as far as how we should treat these 
options, because FASB can meet today and do whatever they want.
    And my fear is, you know, it will have unintended 
consequences. We will take these away from the--out of the 11 
million people, 10 or 11 million, we'll take it away from the 
hardworking middle class, lower class folks, and the upper 
class will still get their options and they'll still be able to 
do all these things, these bad people will. And I want to make 
sure that we have a fix here that's much broader than an 
accounting fix, and that's what I'm working on. And I heard you 
talk about that, holding periods and so on and so forth.
    And so I want to thank you all. Mr. Chairman, we've had a 
series of rolling chairs, and we're back to you.
    [Laughter.]
    Senator Dorgan [presiding]. Let us thank the witnesses and 
excuse them. Thank you for your contribution.
    [Whereupon, at 11:15 a.m., the hearing was adjourned.]
                            A P P E N D I X

   Prepared Statement of Hon. Gordon Smith, U.S. Senator from Oregon

    Mr. Chairman, thank you for holding this hearing today on 
the perspective of improving corporate responsibility. So many 
investors in this country have lost hope. They have lost hope 
that honesty and integrity guide the businesses of America. A 
sad state of affairs has led us to create a system of increased 
checks and regulation. I am committed to preventing further 
corruption and dishonesty from entering into corporate America. 
I am proud of the legislation passed unanimously by the Senate 
last week, S. 2673, the Public Company Accounting Reform and 
Investor Protection Act of 2002, and I will continue to fight 
for needed reform.
    In the weeks before this bill was passed, I proposed an 
Investors' Bill of Rights. I worked with colleagues on both 
sides of the aisle to come up with bipartisan goals to prevent 
corporate abuse and protect investors. I feel that there are 
changes that investors should be able to count on coming out of 
the United State Congress. Many changes will be made as a 
result of this bill . . . and in other areas we may have to 
work further.
    I believe that investors must have access to information 
about a company. We should ensure that every investor has 
access to clear and understandable information needed to judge 
a firm's financial performance, condition and risks. The SEC 
will have the power to make sure companies provide investors a 
true and fair picture of themselves. A company should disclose 
information in its control that a reasonable investor would 
find necessary to assess the company's value, without 
compromising competitive secrets.
    I believe that investors should be able to trust the 
auditors. Investors rely on strong, fair and transparent 
auditory procedures and the concept of the Oversight Board in 
the Sarbanes bill is a sound one.
    I believe investors should be able to trust corporate CEOs. 
Unlike shareholders or even directors, corporate officers work 
full-time to promote and protect the well-being of the firm. A 
CEO bears responsibility for informing the firm's shareholders 
of its financial health. I support the concept of withholding 
CEO bonuses and other incentive-based forms of compensation in 
cases of illegal and unethical accounting . . . further I do 
believe that CEOs must vouch for the veracity of public 
disclosures including financial statements.
    I believe that investors should be able to trust stock 
analysts. Investors should be able to trust that 
recommendations made by analysts are not biased by promises of 
profit dependent on ratings. It is only common sense that there 
should be rules of conduct for stock analysts and that there 
must be disclosure requirements that might illuminate conflicts 
of interest.
    Finally I believe that we should be able to rely on the 
Securities and Exchange Commission to protect investors and 
maintain the integrity of the securities market. Current 
funding is inadequate and should be increased to allow for 
greater oversight--ensuring investors' trust in good 
government.
    During the debate on this bill my attention has been called 
to the plight of public pension systems, such as Oregon's 
Public Employment Retirement System--known by the acronym PERS. 
PERS was invested in both Enron and WorldCom stock and has been 
hit hard by the debacles that occurred in each company. The 
PERS system lost about $46 million after Enron self-destructed 
and another $63 million following the WorldCom scandal.
    These losses occurred because false profits were inflated 
and corporate books were doctored. Under the PERS system, an 8 
percent rate of return is guaranteed for the 290,000 Oregon 
active and retired members of PERS. Oregon taxpayers have to 
make up the difference following an ENRON debacle or WorldCom 
scandal--and my state's budget is not prepared for this kind of 
loss.
    Further, I am interested in finding out if there is more we 
can do. I am asking the General Accounting Office, in 
consultation with the Securities and Exchange Commission and 
the Department of Labor, to report to Congress on the extent to 
which federal securities laws have led to declines in the value 
of stock in publicly traded companies and in public and private 
pension plans.
    I believe that a study of this nature is necessary because 
many public and private pension plans continue to rely on the 
continued stock growth in publicly traded companies--much like 
the PERS system. I believe that such a study would provide the 
needed information so public and private pension plans can 
reevaluate future investments in publicly traded companies.
    We cannot stand by and watch our hard working Americans' 
pension systems ruined while corrupt corporate executives take 
advantage of investors. I am proud of the work the Senate has 
done in the last week in creating accountability and 
responsibility in corporate America and look forward to working 
on this issue in a way that will help the investors and 
pensioners in the PERS system in Oregon.
    Thank you Mr. Chairman.

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