[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
SARBANES-OXLEY: TWO YEARS OF
MARKET AND INVESTOR RECOVERY
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
JULY 22, 2004
__________
Printed for the use of the Committee on Financial Services
Serial No. 108-106
U.S. GOVERNMENT PRINTING OFFICE
96-550 WASHINGTON : 2004
____________________________________________________________________________
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio GREGORY W. MEEKS, New York
JIM RYUN, Kansas BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio JAY INSLEE, Washington
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, Jr., North MICHAEL E. CAPUANO, Massachusetts
Carolina HAROLD E. FORD, Jr., Tennessee
DOUG OSE, California RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois KEN LUCAS, Kentucky
MARK GREEN, Wisconsin JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania WM. LACY CLAY, Missouri
CHRISTOPHER SHAYS, Connecticut STEVE ISRAEL, New York
JOHN B. SHADEGG, Arizona MIKE ROSS, Arkansas
VITO FOSSELLA, New York CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
MELISSA A. HART, Pennsylvania JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia STEPHEN F. LYNCH, Massachusetts
PATRICK J. TIBERI, Ohio BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota RAHM EMANUEL, Illinois
TOM FEENEY, Florida DAVID SCOTT, Georgia
JEB HENSARLING, Texas ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey CHRIS BELL, Texas
TIM MURPHY, Pennsylvania
GINNY BROWN-WAITE, Florida BERNARD SANDERS, Vermont
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
Robert U. Foster, III, Staff Director
C O N T E N T S
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Page
Hearing held on:
July 22, 2004................................................ 1
Appendix:
July 22, 2004................................................ 43
WITNESSES
Thursday, July 22, 2004
Caplan, Mitchell H., Chief Executive Officer, E*TRADE Financial.. 4
Del Raso, Joseph V., Partner, Pepper Hamilton LLP................ 8
Hills, Hon. Roderick M., former SEC Chairman and White House
Counsel........................................................ 6
Quigley, James H., Chief Executive Officer, Deloitte & Touche.... 2
Trumka, Richard L., Secretary-Treasurer, AFL-CIO................. 12
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 44
Gillmor, Hon. Paul E......................................... 46
Hinojosa, Hon. Ruben......................................... 48
Caplan, Mitchell H........................................... 49
Del Raso, Joseph V........................................... 61
Hills, Hon. Roderick M....................................... 67
Quigley, James H............................................. 111
Trumka, Richard L............................................ 137
Additional Material Submitted for the Record
Maloney, Hon. Carolyn B.:
"Not an Option'', article, The Wall Street Journal, July 22,
2004....................................................... 144
Quigley, James H.:
Written response to questions from Hon. Richard Baker........ 146
SARBANES-OXLEY: TWO YEARS OF
MARKET AND INVESTOR RECOVERY
----------
Thursday, July 22, 2004
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to call, at 10:04 a.m., in Room
2128, Rayburn House Office Building, Hon. Michael Oxley
[chairman of the committee] presiding.
Present: Representatives Oxley, Baker, Bachus, Castle,
Kelly, Ryun, Biggert, Fosella, Capito, Tiberi, Feeney,
Hensarling, Waters, Maloney, Velazquez, Watt, Hooley, Lee,
Inslee, Hinojosa, Lucas of Kentucky, Clay, Matheson, Miller of
North Carolina, Davis, and Bell.
The Chairman. [Presiding.] The committee will come to
order.
It has been 2 years since the Congress passed and President
Bush signed the most sweeping corporate reform law in our
nation's history. The Sarbanes-Oxley Act of 2002 was designed
to curb accounting fraud, make financial statements more
transparent and understandable, and hold company executives and
directors accountable. I am pleased to say that the early
returns are in and they are positive.
We all know that no law will stop certain determined bad
actors from violating the trust of shareholders. Indeed, if
that were shareholders we would have passed such legislation a
long time ago. But Congress can establish incentives and
disincentives for certain behavior. It does have the ability
and the obligation to establish a baseline of professional
conduct for American business. If these minimum standards are
not met, Congress can help ensure that there will be swift,
certain and severe punishment.
Sarbanes-Oxley was passed during a period in which a
majority of Americans had lost faith in the pillars of
corporate life: company executives, public accountants,
investment bankers, stock and bond analysts, and attorneys.
This mistrust, I would point out, was well founded. Too many
failed to act ethically. Indeed, we have learned that many
violated criminal laws and will serve time in prison. Sadly, it
was more than a few bad apples.
That is the climate in which Sarbanes-Oxley was debated and
passed. Remarkably, considering the overheated political
environment at the time, it is measured and responsible
legislation. Many of its provisions require companies to do
things that they were already doing or should have been doing.
As companies find that certain mandates like the internal
control standard are particularly costly, maybe that is because
they were deficient in that particular area.
Numerous parts of the act appear to be working extremely
well. Certifications of company financials by chief executives
and finance chiefs, independent and empowered audit committees,
officer and director bars, and the FAIR fund have all had a
very powerful and positive impact, to cite just a few
provisions.
Are there increased costs? Yes. Do the benefits of improved
financial reporting, more active and engaged boards and trusted
markets outweigh these added costs? I believe yes. But do not
take my word for it. Recent surveys indicate that a majority of
corporate directors believe the act has had a positive impact
on their companies and boards. That is not to say that this is
a perfect statute. It certainly is not. No legislation ever is,
or at least none have been in my two decades here in
Washington. But it does appear to be working quite well and for
that we should be very proud.
I look forward to hearing from our distinguished panel
today. We have heard from many of you before and we obviously
like what we have heard because we have invited you back.
Welcome.
I now look to other members for an opening statement. Are
there other members seeking an opening statement? The gentleman
from Alabama.
[The prepared statement of Hon. Michael G. Oxley can be
found on page 44 in the appendix.]
Mr. Bachus. Mr. Chairman, I do not have an opening
statement.
The Chairman. We will turn then to our distinguished panel.
Let me introduce them, from my left to right: Mr. James H.
Quigley, chief executive officer of Deloitte & Touche; Mr.
Mitchell H. Caplan, chief executive officer of E*TRADE
Financial Corporation; the Honorable Roderick M. Hills, former
SEC Chairman and White House Counsel, welcome back; Mr. Joseph
V. Del Raso, partner of Pepper Hamilton, LLP; and Mr. Richard
L. Trumka, secretary-treasurer, AFL-CIO.
Gentleman, to all of you we are in your debt for appearing
today and giving us a good review 2 years later of the
Sarbanes-Oxley legislation. Mr. Quigley, we will begin with
you.
STATEMENT OF JAMES H. QUIGLEY, CEO, DELOITTE & TOUCHE
Mr. Quigley. Thank you, Mr. Chairman and members of the
House Committee on Financial Services.
I am pleased with the opportunity to appear before you on
behalf of the partners of Deloitte. Deloitte has 30,000 people
in the U.S. and we audit more than 20 percent of the Fortune
1000 companies. I have served in several roles in our audit
practice and have first-hand experience on many levels,
including as a lead audit partner responsible for signing the
firm's name.
As the CEO, I interact with our largest clients and attend
approximately 40 audit committee meetings per year, including
two this week. I will provide my perspective and insight from
the frontline. Sarbanes-Oxley is having a positive impact on
the financial reporting process at public companies. I believe
the risk of fraudulent financial reporting has been reduced.
The effectiveness of financial reporting requires
management, audit committees and auditors each to perform their
essential role. The requirements in the act are directed to
each participant. Management has strengthened their process in
part to support the certifications by CEOs and CFOs of the
financial disclosures. In addition, disclosure committees have
been put in place and they are working effectively each quarter
to improve the transparency and completeness of the financial
disclosures. And the internal control documentation and related
processes which have attracted significant attention when
discussions of cost occur is also having a positive impact. It
has led to broader acceptance of the responsibility for
controls. Line management no longer defers solely to the
controller or the internal audit department with respect to
controls. This is progress.
Audit committee effectiveness has also improved
dramatically. We have seen many well-intentioned efforts to
improve audit committee performance, 15 years ago, the Treadway
Commission report and more recently the Blue Ribbon Panel. But
I observed many audit committees viewed those best practices as
good ideas for someone else. The force of law through Sarbanes-
Oxley has made it different this time. I see and feel the
difference.
The number of meetings is up by 50 percent. The duration of
the meetings has also increased by 50 percent, fundamentally
doubling the amount of time that audit committees are spending
in overseeing the financial reporting process. Members are
better informed. They are better prepared and they better
understand their essential role. They ask focused, probing
questions. Prior to the act, the audit committee chairman would
rarely call the lead audit partner in between meetings or in
preparation for an upcoming meeting. Since the act over the
past 2 years, this has become a very common practice.
Auditors are also stepping up. They have embraced both the
letter and the spirit of this new law. We are working more
effectively with audit committees and our new regulator the
PCAOB. We have built our capacity to handle the Section 404
attestation requirements. At Deloitte, the number of internal
control and systems assurance specialists in our firm have been
increased by 20 percent and we have provided extensive training
to each of our assurance professionals.
With respect to cost-benefits, some are honestly
questioning whether the benefits exceed the costs. Most
questions point at the Section 404 requirements. I believe we
need to work through a full cycle of implementation before we
revisit the standards, the law or the regulations related to
Sarbanes-Oxley and then, after we have made our way through
that first full cycle of implementation and have all of those
learnings under our belt, we can again revisit and ask if
changes are needed.
I believe in the cost-benefit question we need to view this
in the spirit of the market cap of each of the registrants.
Based on a recent survey by FEI that indicates the average cost
of compliance, both costs that will be incurred by the
registrant as well as costs that they will pay to the auditor,
will average about $5 million per member of the S&P 500. When
you view that cost in relation to the market capitalization of
that group of companies, it is a very, very, very tiny fraction
of 1 percent, .03 of 1 percent of the market cap. When we think
about the opportunity that we have to reduce the risk of
fraudulent financial reporting, I believe that is a cost that
is well paid.
Separate from Sarbanes-Oxley, the SEC issued a rule to
shorten the number of days between a company's fiscal year end
and the filing of its annual report, from 90 days in 2002 to 75
days in 2003 and to 60 days for 2004. This plan for accelerated
filing requirements was conceived before section 404 was
enacted. Having to address both these new and significant
requirements in the same year is very challenging and will put
unusual pressure on all parties concerned that could impact the
quality of financial reporting, the audit, and the internal
control assessments. Frankly, it might also increase further
these costs.
Next week, we will recommend in a letter to the SEC that it
delay by 1 year the acceleration to the 60-day filing
requirement, making it applicable for 2005 annual reports. This
would allow companies and auditors an additional 2 weeks this
year to focus on these significant new internal control
requirements of the act.
Let me conclude. We are making progress, and I believe
anytime you assess the impact of a change as sweeping as
Sarbanes-Oxley, it is as important to consider the direction
you are moving, as well as assess where we are. The risk of
fraudulent financial reporting has been reduced by the actions
taken to implement the act by management, by audit committees,
by the PCAOB, by auditors. I believe it is time to absorb this
massive change represented by Sarbanes-Oxley. Let's sustain our
commitment to restore investor confidence and avoid future
legislation, regulation, or scope of services limitations.
Costly, yes, but I believe these are costs that registrants
should be willing to pay in return for the privilege of being
the stewards of the public's money.
Thank you, Mr. Chairman.
[The prepared statement of James H. Quigley can be found on
page 111 in the appendix.]
The Chairman. Thank you, Mr. Quigley.
Mr. Caplan?
STATEMENT OF MITCHELL H. CAPLAN, CEO, E*TRADE FINANCIAL
CORPORATION
Mr. Caplan. Good morning. I am Mitchell Caplan, CEO of
E*TRADE Financial. We are a leading provider of online,
personalized and fully integrated financial services, including
investing, banking, lending, planning and advice. A key tenet
of our business strategy is to use our proprietary technology
and the Internet to deliver an integrated, personalized and
value-added financial services experience to all our customers.
I would like to thank Chairman Oxley and the committee for
inviting us to share our company's experience with the
implementation of the Sarbanes-Oxley Act as your committee
examines the law's effectiveness since its enactment 2 year
ago. Our experience with this law has clearly been a positive
one. At the time this committee was debating the legislation,
which became known as Sarbanes-Oxley, E*TRADE Financial was
confronted with a serious corporate governance issue.
Our former CEO had taken an $80 million pay package amidst
a number of unfolding corporate scandals. This excessive
compensation package was frankly a surprise to many in the
company and revealed flaws in our corporate governance policies
and structure. Trust is especially important for the customers
and shareholders of financial services companies. This breach
of trust for us was a call to action. In 2003, the board of
directors aggressively put in place changes to restore the
confidence of our employees, our customers, our investors and
our analysts. With the resignation of our former CEO, E*TRADE's
board of directors took action to address those issues.
The board first separated the titles of chairman and CEO.
It brought on four new members to our board of directors. We
revamped entirely the audit and compensation committees of the
board. We eliminated interlocking directors. We rationalized
executive pay. We added a chief risk officer to our management
team. We greatly enhanced the internal control processes by
establishing additional checks and balances in compliance with
Sarbanes-Oxley's Section 404, and we rotated our auditors.
When I assumed the role of CEO, we clearly had lost the
confidence of both the investment community and our employees.
While excessive executive compensation was the obvious problem,
it drove the company to recast the composition and structure of
the board and to realign incentives by focusing on rewarding
actions that add value to our shareholders.
Today, after working to adhere to the strict guidelines of
corporate governance, we have restored investor confidence and
investor trust. We have been able to refocus on our core
strength, providing innovative products and technology to self-
directed investors.
Our implementation of Sarbanes-Oxley 404 has progressed
very well, although the process has not been painless. The
value we have received from documentation and testing has
reinforced management's understanding of accountability for
processes and financial reporting across the entire company. It
has helped us identify where those processes were deficient or
inadequate, and we have designed the necessary improvements to
correct those inadequacies.
E*TRADE commends the committee for reviewing the Sarbanes-
Oxley Act. We would urge you to resist any wholesale changes to
the law. No one can fully predict the consequences of a new law
until enough time has passed to determine whether it is working
as Congress intended. Our management team and our board
strongly believe that good corporate governance is a key
contributor to shareholder value. The time and effort our
management and board has taken to comply with Sarbanes-Oxley
has fostered a vigorous, yet healthy internal debate over the
company's direction and how to deliver innovative products to
our customers, further adding value to our shareholders.
The changes we have implemented reflect the company's
transition from a dot com organization into today a mature
financial services business. It allows us to focus once again
on our business of bringing the best new innovative products
and technology to our customers, such as our rebate program for
12b-1 fees and our mortgage on the move product.
Thank you for the opportunity to testify. I would be happy
to answer any questions.
[The prepared statement of Mitchell H. Caplan can be found
on page 49 in the appendix.]
The Chairman. Thank you, Mr. Caplan.
Mr. Hills, welcome back.
STATEMENT OF HON. RODERICK M. HILLS, FORMER SEC CHAIRMAN AND
WHITE HOUSE COUNSEL
Mr. Hills. Thank you, Mr. Chairman and members of the
committee.
I would like to offer you the perspective of spending 32
years working with 18 audit committees and chairing 10 of them.
I suppose the first thing I would say is that as the Enron
scandal fades from memory, it is fairly natural that a whole
lot of complaints about the act might spring up. It costs too
much, say many people. Thousands of honorably run companies
should not have to bear the burden caused by a dozen bad
companies. Board members and audit committee members have been
forced to do much more than they can do. And by the way, some
say the public did not really demand this legislation anyway.
The fact is that something was badly broken and it needed
fixing. A corporate system, a system of corporate governance
that was crafted by the SEC back in the middle 1970s had run
out of gas. Back then, there were hundreds of American
companies, U.S.-based companies that had off-the-books bank
accounts, secret bank accounts where monies were disbursed
without oversight. Much of that money was used to pay bribes.
The SEC took three steps. It mandated internal controls. It
required external auditors to bring anything of a suspicious
nature to the attention of somebody independent of suspicion,
and persuaded the New York Stock Exchange to require
independent audit committees.
Why did that run out of gas? Well, today a quarter of a
century later, we have a knowledge-based economy whose assets
are determined in large part by the judgments, the assumptions,
the estimates made by management, with some oversight by the
auditors. It is not the bricks and mortar economy of the past,
where historical costs were used to fix those values. So
management today has had much greater discretion in fixing the
values used in their financial statements.
As management became more innovative in developing their
values, the FASB, the Financial Accounting Standards Board,
created ever more complex accounting standards and even more
complex interpretations of those standards. Accountants to some
degree became rule-checkers and to a large extent the basic
audit became a commodity. The growing maze of rules became a
magnet for the fertile minds of lawyers, bankers and
consultants who created these complex corporate structures that
wended their way through the maze of rules, satisfying maybe
the letter of the rules, but certainly not the spirit.
Audit committees were passive during that period. Auditors
did not sit down with the audit committees and explain the
alternatives that were available to management in constructing
a financial statement. The audit committees did not play a
meaningful role in selecting the auditor or selecting the
engagement partner, or in fixing the audit fees except in those
rare occasions where they suggested the fee be lowered by 5
percent.
They did not, in short, take charge of the audit. The
auditors for the most part knew that and did not expect to be
protected from management were they to begin disagreeing with
the estimates, assumptions and judgments made by management. A
substantial number of companies took advantage of those
circumstances and intentionally manipulated their financial
statements. An even larger number, probably acting in good
faith, regularly presented a more optimistic view of their
financial statement than a realistic appraisal would have
called for, simply because the rules allowed them to be that
optimistic.
So the question is, will the Sarbanes-Oxley Act fix that?
In one sense, the act really rejuvenated the three ideas of the
SEC in the middle 1970s. Section 404 surely puts strength into
the notion that there must be internal controls. The Public
Company Accounting Oversight Board puts enormous teeth into the
notion that the auditors have a responsibility to come forward
when something is wrong, when something is suspicious. Of
course, the act institutionalizes the independent audit
committee that was created by the New York Stock Exchange.
It has already had a substantial benefit. Auditors now sit
down with the audit committees and say, by the way, here are
the other alternatives that were available to management. The
audit committee really must take a look at those alternatives
and conclude that the way management did it was fair. If the
act had been in place, I sincerely believe that Enron and Waste
Management, two serious cases, would never have occurred.
In addition, the act says in no uncertain terms the audit
committee is responsible for the hiring and the firing of the
auditors. It has already had a substantial impact. For one
thing, the chief financial officers do not get asked to play
golf by the engagement partner anymore.
[Laughter.]
Will 404 cost too much? The danger here is that companies
will treat 404 as a kind of compliance tax, a word used by
Ernst & Young in a publication recently, a bureaucratic
requirement of no practical value. Just as too many companies
have treated the audit as a commodity, 404 can be an expensive
appendage if companies do not understand that it can be used
and have positive effects. Ernst & Young recently noted that
there are a number of companies that believe their investments
in rule 404 can have a meaningful return on that investment.
That is my experience and that is the experience of the several
chief accounting officers with whom I have spoken in the last
couple of weeks. The point is that companies can realize
substantial value of the 404 effort if they utilize it as a
management tool.
The most persistent and legitimate complaint about 404
relates to timing. A lot of companies just did not understand
the degree of change that was necessary. When they came to
understand it, they could not find the talent in the accounting
firms needed to complete it. The SEC I hope will give
consideration to this problem and where important and
necessary, give some extension. That is an issue that I think
should be of particular interest to this committee. The
problem, of course, is particularly severe with respect to the
smaller companies.
Is the burden on directors too great? As Mr. Quigley said,
the audit committee members certainly must better understand
their responsibility, their job. They have to spend more time
at it with more meetings. But the notion that some impossible
burden has been created is just not correct. Audit committees
need to establish firm control over the external and internal
auditors. They have to select their candidates and they have to
take charge of the fee negotiations. In particular, they must
pay far more attention to the selection, retention and
compensation of the internal auditor. If they take those steps,
they will have a large, competent and experienced staff that
will keep them well informed of all their responsibilities as
members of the audit committee.
One final comment, concern has been expressed, particularly
by Peter Wallison of the American Enterprise Institute. He
expresses a fear that the SEC and the PCAOB will use the act to
insist upon strict adherence to existing accounting standards
and will therefore preserve that maze of rules that contributed
to the accounting problems of recent years. I hope not. Both
agencies should take note of the growing body of thought today
that seeks fewer accounting rules and more judgment to be used
in the constructing of financial statements.
I have attached to my testimony a copy of a report done by
an unusually experienced group of professionals with respect to
the accounting profession called the Future of the Accounting
Profession. It discusses this problem at length and then it
endorses a theme the Chairman may have heard me use before,
expressed by Economist magazine, that warns us not to continue
to rely upon the brittle illusion of accounting exactitude
which tends to collapse in periods of economic strain. I very
much hope that this committee would accept that theme.
Thank you.
[The prepared statement of Hon. Roderick M. Hills can be
found on page 67 in the appendix.]
The Chairman. Thank you, Mr. Hills.
Mr. Del Raso, welcome back to the committee. I think you
were here 2 years ago.
STATEMENT OF JOSEPH DEL V. RASO, PARTNER, PEPPER HAMILTON LLP
Mr. Del Raso. Yes, I was. Thank you.
Good morning, Chairman Oxley and distinguished members of
the committee. Thank you for this opportunity to present my
views on the impact of the Sarbanes-Oxley Act over the last 2
years.
I am Joseph Del Raso, a partner in the law firm of Pepper
Hamilton, LLP. My practice focuses on corporate and securities
matters, particularly matters related to securities regulation.
I served as an attorney-adviser with the Securities and
Exchange Commission in the 1980s and I have served as a member
of the board of directors of both public and private companies.
Having experience on the regulatory side, as a lawyer in
private practice, and as a corporate board member, I believe I
offer the committee an important perspective on the practical
effect of the Sarbanes-Oxley Act over the last 2 years.
Overall, I believe the impact has been a positive one.
While there are costs, in some cases material costs, and
occasionally perceived regulatory overkill associated with the
implementation of the act, it has done much to restore the
faith of investors in the way in which public companies operate
and report financial results.
Just as importantly, it has helped give directors and
corporate officers the tool they need to meet their obligations
and be accountable to shareholders. I commend the committee for
its levelheaded and responsible approach to this act.
On the topic of positive changes. I would first like to
address the positive impact of the Sarbanes-Oxley Act on
domestic issuers. The act has increased the awareness of the
need for corporate accountability and transparency and given
greater attention to best practices in corporate governance. It
has prompted procedures to establish internal controls to
ensure compliance. It has highlighted the need to take prompt
remedial action when problems are uncovered in order to
reassure the global markets of the safety and integrity of our
capital markets in those issuers who access them.
It has increased the protection of shareholder interests,
thereby increasing shareholder confidence. It has highlighted
the need for improved risk management and should produce the
long-term effect of mitigating the costs of insurance,
indemnities and potentially large awards, including punitive
damages and governmental fines for systemic failure of the
corporate entity. It has increased attention to the need for
accountability directly to shareholders in matters of corporate
governance.
On the topic of costs and the perception of regulatory
overkill, the implementation of the Sarbanes-Oxley Act has not
entirely been a bed of roses for some. The costs of compliance
often can be burdensome. Reviewing internal financial controls,
improving those mechanisms when necessary, and ensuring that
the processes are well documented is time consuming and costly,
in some cases, costing companies millions of dollars and
thousands of hours annually. However, I believe that what
corporate officers and directors need to keep in mind is that
the cost of compliance is not nearly as burdensome as the cost
of failing to comply.
What was at risk in 2002? What this act was designed to
prevent was the threatened loss of confidence by investors
throughout the world in our capital markets. That loss of
confidence does not just affect companies with poor corporate
governance or negligent or outright criminal leadership. Good
companies as well as bad and millions of investors suffer the
consequences when people lose faith in how companies operate
and result their results.
I look at the costs associated with compliance as a
necessary and prudent investment in the long-term stability and
success of our capital markets. However, we must be careful not
to stifle entrepreneurship and capital formation for emerging
businesses. The initiatives of the SEC in the early 1980s to
adopt rules to allow smaller companies's access to the public
capital markets produced very positive outcomes. Some may argue
that smaller issuers may not be suited for public ownership if
they cannot afford the cost of Sarbanes-Oxley compliance. But
that is not the appropriate focus. We should always encourage
small businesses to grow and not overburden them with intrusive
regulation.
On the other hand, we have learned that an environment of
careless behavior and lack of respect for both the investor and
the government's oversight and regulation produces nothing but
financial and societal losses. We must balance the need for
entrepreneurial freedom and reasonable government oversight,
and for that reason it may be necessary to revisit and fine-
tune this legislation from time to time.
I urge this committee as it examines future regulatory
actions to be careful not to overburden the average issuer with
overzealous enforcement and unreasonable intervention, to not
pile on with additional regulations that make compliance more
difficult, that are simply not practical. Further regulatory
action should be adopted only after a thorough analysis shows
that the benefits of the new regulations outweigh the risks
that will make compliance overly burdensome on the average
issuer.
Overzealous regulatory action and enforcement can also
poison the atmosphere between regulators and industry and
stifle the discipline and sense of cooperation between the
government and those it regulates. The vast majority of
corporate officers and directors act ethically and take their
fiduciary responsibilities seriously and will welcome
legislation, regulation and guidance that helps them meet their
obligations to shareholders. However, when the regulators and
the regulated find themselves in a constant adversarial
atmosphere, the spirit of compliance and good corporate
citizenship may erode into one of combat mentality. Operating
in that environment is not consistent with our democratic
traditions of creativity and free enterprise.
In the area of corporate governance, the impact of
Sarbanes-Oxley has been profound. Independent directors are
exercising their responsibilities and paying much more
attention to detail. I can tell you from personal experience
that board meetings are longer and have much broader agendas.
Audit committees are meeting more frequently and are increasing
the number of executive sessions with auditors. Special
committees, especially those charged with internal
investigations, are moving very quickly when troubling matters
surface. No longer are independent directors satisfied with the
assurances of management that everything is in order, or worse,
sweeping corporate problems under the rug.
The act has also increased shareholder activism. In
general, this may be viewed as a good thing. Boards need to be
careful not to confuse, though, the political and social
agendas of shareholder initiatives with their obligations to
meet the goals of the majority of shareholders and to adhere to
best practices.
Impact on global markets. I would like to particularly note
that the impact of the Sarbanes-Oxley Act on the global
financial markets. When first enacted into law, this
legislation was met with some trepidation by foreign issuers.
In speaking with foreign diplomats and issuers, I was impressed
with their positive reaction to the responses of our regulators
in this area. The SEC in particular worked quickly and
effectively to harmonize the effective compliance with the
special concerns of foreign issuers.
I had the opportunity last March to organize a symposium
related to this topic in Italy at the American University of
Rome. The participants included high-level securities
regulators and issuers from several foreign countries. The
consensus of the participants was to America's credit, when
faced with the severity of a crisis such as the corporate
scandals of 2002, we are quick to react and remedy situations.
The swiftness both in prosecution and in legislation reassured
the global markets that America was serious about protecting
the interests of all investors.
It is also interesting to note that issuers who sought to
bypass their Sarbanes-Oxley responsibilities by listing on
foreign exchanges have not been able to find much relief. For
example, regulatory requirements for listing companies on the
exchange in London have also been intensified.
Long-term effects. Returning for a moment to the cost of
compliance, I would offer one more comment. I view the cost of
implementing compliance systems as similar to that of
installing fire protection systems in buildings. While it may
be cheaper to build an office building without sprinklers, in
the long run the increased costs of insurance would likely
outweigh the initial savings. More to the point, if a fire
starts to smolder, it can either be quickly extinguished with
little loss when the alarm is tripped if the building is so
equipped with an effective fire protection system, or ignite
into a raging inferno that consumes the entire edifice. The
corporate entity is no different. Early detection and action is
obviously preferred to the risk of a catastrophic loss.
I have also noticed an increased interest in developing
programs to educate officers and directors. Professional firms,
and more importantly academic institutions, have already
designed and offered to support corporate directors and
executives in these areas.
In conclusion, Mr. Chairman and distinguished members of
this committee, thank you again for the opportunity to testify
on the impact of this important piece of legislation. Much of
the commentary after the passage of the act called it the most
sweeping securities reform since the passage of the exchange
acts of 70 years ago. I believe that is true. No law can
completely prevent scandals such as the collapse of Enron,
WorldCom and Global Crossing. In the end, you cannot legislate
personal character and morality. But I strongly believe that
the Sarbanes-Oxley Act has reduced the risk of such scandals.
Like many corporate officers, directors and professionals, they
may not agree with or like every aspect of this legislation,
but if it continues to have the desired effect, the ongoing
restoration of public confidence in the capital markets, then
the Sarbanes-Oxley Act has indeed met its objectives.
[The prepared statement of Joseph V. Del Raso can be found
on page 61 in the appendix.]
The Chairman. Thank you, Mr. Del Raso.
Mr. Trumka?
STATEMENT OF RICHARD L. TRUMKA, SECRETARY-TREASURER, AFL-CIO
Mr. Trumka. Good morning, Mr. Chairman and members of the
committee.
Two years after its enactment, the Sarbanes-Oxley Act
remains an outstanding example of government acting in the
public interest. While the work of reform remains unfinished,
America's retirement savings are substantially more secure
today because of Sarbanes-Oxley. Both Houses of Congress and
both sides of the aisle have reason to be proud of this act.
Working families's retirement security is, in large part,
dependent on the integrity of our capital markets. We estimate
that union members' pension funds lost over $35 billion in
Enron and WorldCom alone. But for those with the bad luck to
work directly for those companies and other problem companies,
the consequences were far more serious: lost jobs, lost health
care, and for many the complete loss of their 401(k) retirement
savings invested at the urging of their employer in what
ultimately became worthless company stock.
So we are particularly pleased that the Sarbanes-Oxley Act
addressed many of the systematic issues that we had urged this
committee and the SEC to address in our December 2001 testimony
on Enron's collapse, issues like auditor and director
independence. But the success of Sarbanes-Oxley stems not only
from its specific provisions, but also from the tone it set and
the message that it sent. Since its enactment, the act has been
impressively augmented by the work of the SEC, the Public
Company Accounting Oversight Board that the act created, the
New York Stock Exchange and the NASDAQ and the work of state
attorneys general, most notably Eliot Spitzer of New York.
Equally important, the message was heard in corporate
boardrooms across the country. In the two proxy seasons since
the act's enactment, investors themselves have pushed companies
to have truly independent boards to rein in executive pay and
to manage their audit process more effectively. The AFL-CIO is
very proud of the role that unions and worker pension funds
have played in the efforts by sponsoring over 360 such
proposals, 48 of which received majority votes at company
annual meetings.
Of course, Sarbanes-Oxley has its critics. Some companies
seem unhappy with the act's requirement in Section 404 that
companies strengthen their internal controls. There is no
question that compliance with Sarbanes-Oxley imposes costs on
American business. But there is ample evidence that these costs
are far less than the alternative costs of more Enrons and
WorldComs, evidence cited in more detail in my written
testimony.
Recently, Senator Sarbanes noted that the job is not done.
One could conclude this simply by looking at the data on the
one issue of financial statement integrity. Last year, a record
206 public companies revised their annual financial statements
according to preliminary figures compiled by the Hudson
Consulting Group. And PCAOB Board Chairman William McDonough
announced last month that his examiners are still finding
significant problems with auditor compliance.
But there is a deeper sense in which corporate reform is an
unfinished task, Mr. Chairman. We believe the underlying causes
of the corporate governance crisis lie in the weakness of
corporate boards and the short-term orientation of public
company CEOs. As long as CEOs completely dominate the selection
process for company directors, we simply will not see at
problem companies the kind of vigorous independent boards that
we need and that Sarbanes-Oxley called for.
The SEC has proposed to address this problem by giving
long-term investors with a substantial stake in public
companies the right to have their board nominees included on
management's proxy. The commission's proposed rule on proxy
access is an example of real bipartisan leadership. It has
received more public comment than any other proposal in the
commission's history, over 14,000 comments, with the
overwhelming majority supporting the Commission's rule.
Second, investors still have inadequate disclosure of the
facts on executive pay and the financial impact of that pay on
the companies that award it. The most important step in this
area is the proposal by the Financial Accounting Standards
Board for mandatory stock option expensing. Executive stock
options reward short-term decision-making and, as Enron
painfully demonstrated, encourage stock price manipulation
through creative and even fraudulent accounting. They should
not be subsidized by dishonest accounting rules. Yet we
believe, in our opinion, the House bill that passed on Tuesday
truly attacks the integrity of our financial accounting system.
It appears that the battle against option expensing is
being waged on behalf of CEOs with option mega-grants who
frankly want to hide the true costs of their compensation from
their shareholders and would-be investors. According to SEC
filings, the CEOs of the 11 public companies who are the
members of the International Employee Stock Option Coalition
hold on paper a combined $977 million in unexercised stock
options. The CEOs are going against the express wishes of their
shareholders. In 2003, a majority of shareholders at 30
companies voted for stock option expensing. So far this year,
shareholders at Hewlett-Packard, Intel, PeopleSoft and Texas
Instruments have done the same. Clearly, as reform efforts get
closer to the heart of what is going wrong in the corporate
governance system, resistance from the CEO community will
intensify.
However, only by truly creating transparency and
accountability in the boardroom can the underlying dynamics
that brought us Enron and WorldCom be addressed and the
purposes of Sarbanes-Oxley be fulfilled.
Let me conclude, Mr. Chairman, by expressing my deepest
appreciation to the committee on behalf of the working families
of the AFL-CIO for not only inviting the AFL-CIO to appear
today, but for the actions you have taken in making the
pensions of America's working people more secure.
Thank you, Mr. Chairman.
[The prepared statement of Richard L. Trumka can be found
on page 137 in the appendix.]
The Chairman. Thank you, Mr. Trumka. I do not often get
that kind of praise from the AFL-CIO. We are recording this.
[Laughter.]
Before I begin the questions, I just want to comment. This
is almost the 2-year anniversary now of passage and signing of
the Sarbanes-Oxley Act. A lot of folks in this room truly made
it happen. This was a classic example, I think, of bipartisan
legislation where we faced up to a very severe loss of
confidence in our capital markets, something that I had not
seen certainly in my lifetime. Our committee was the first
committee to hold a hearing on the Enron situation. That was
back in December of 2001. That process began with a bill that
we introduced early the next year, 2002, that we called the
Corporate Accountability and Responsibility and Transparency
Act, CARTA.
Ultimately, that was the vehicle that this committee
ultimately passed out by a better than three-to-one margin, and
then took to the floor a few weeks later with virtually the
same success on the floor, with over a three-to-one margin,
which I think made all of us on the committee quite proud. I
want to say to my colleagues that were participants in that it
was one of the best experiences I have had as a legislator here
in my 23 years. I think all of us who had a part in that can
look back with a great deal of pride. All of you gentlemen were
quite praiseworthy and we really do appreciate it. It was, I
think, in the best tradition of legislating and hopefully doing
it right.
Let me begin with Mr. Hills, who has been here before, and
he has been Chairman of the SEC. He has been around the block.
He served on boards. We could not have a better witness than
Rod Hills. I get a lot of questions, particularly regarding 404
and the costs. The questioner is always careful to couch it in
rather benign terms, but the fact is that there are,
particularly among smaller and medium-size companies some
concerns about costs. I have had some very interesting
discussions with corporate CEOs who at least have entertained
the thought of going private. Some actually have, although I
think it is a relatively small number, about the same number
probably of European companies that threatened to de-list after
passage of the act.
Let me ask you this. Did we give enough flexibility to the
PCAOB and the SEC to try to ameliorate some of those costs with
small-and medium-size companies? Or is that something that
perhaps we need to study further?
Mr. Hills. Mr. Chairman, I believe that there is enough
flexibility. Just as we have to learn how the act works, we
have to learn what the flexibility is. There are a couple of
issues that could be dealt with. There is a particularly sore
point between the requirement that the external audit attest to
the efficacy of the work done internally. In a sense, there is
a feeling that you have to do it twice. So the company gets an
external consultant, usually one of the big four. They already
have a big four company as an external auditor, and then they
have the internal auditor do the work. So there is a hesitancy
in these organizations to give the attestation that people
want.
My own sense is that it is working out, that the external
auditors are relaxing a little bit and see that the internal
auditors are doing a pretty good job in creating systems. I do
think that when we finish this season, that it may be possible
for the PCAOB to see that some relaxation is possible. I am
really quite convinced that more and more companies are
understanding this can be a management tool.
I have watched the headlines, as you have, from some of the
more prominent critics of the act. I have called their chief
financial officers to say, well, is it really as bad as your
CEO said? On most occasions, I have found that the audit
committee of that company has been told by the chief financial
officer, well, there are some problems with it, but there
really are very positive aspects to 404.
So the question is a good one. I think that this committee
should ask it. I am quite confident that both Chairman
Donaldson and Chairman McDonough both understand that there may
be some flexibility, some adjustment needed. But I am quite
satisfied there is the capacity to do that.
The Chairman. Thank you.
I would like to ask each one of you to comment if you would
like. One of the provisions that was added in the other body
that was retained in the conference report, which I had some
real concerns about, was the whole issue of corporate loans and
how they would be addressed. I have heard some legitimate
criticisms about that particular provision, how difficult it is
in terms of moving expenses for officers of the corporation,
that kind of thing, insurance coverage and everything. Is that
a legitimate concern? If so, are there ways that we can deal
with that problem to make it work?
I think everybody understood the reason for that provision
being added in the Senate because it was during the WorldCom
meltdown, and this committee had a hearing with Bernie Ebbers
and the top people from WorldCom, who took the Fifth, so they
were not much help. But the fact is that in this case Bernie
Ebbers had gotten a $400 million loan from the board and the
amendment that was offered by Senator Schumer I think was going
at that issue, that abuse, which is understandable. My sense is
it might have gone beyond just that, and included a lot more in
that. I just wonder if we could start with Mr. Quigley and just
go down the panel as to what kind of reaction you have.
Mr. Quigley. I think that perhaps that is one example where
we want to try to swing the pendulum, moving from do not loan
$450 million to Bernie Ebbers, to do not loan anyone a penny
for any purpose, perhaps is going too far. There are legitimate
business purposes where you are trying to relocate an executive
and it is very customary to be able to provide some form of an
advance to pay the costs associated with that relocation, which
is then repaid by the executive at the time that the relocation
is completed.
But I think some moderation with respect to that provision
would be prudent, and it would facilitate business in the
ordinary course. I think we can still have prohibited the
abusive practices that that provision was intended to shut
down.
The Chairman. Thank you.
Mr. Caplan?
Mr. Caplan. Mr. Chairman, I would tell you at the time that
Sarbanes-Oxley was passed, our company was dealing with that.
We had an extraordinary number of loans outstanding to our
executives for a variety of reasons. We have chosen to actually
shut down the process entirely. We are of the view that it is
just not appropriate and that, frankly, if we need to recruit
somebody who needs compensation for the move, we pay it like we
would pay for anybody else. It is part of their compensation
and we report it accordingly. So we are actually quite
comfortable with it. I think it is easier to adhere going
forward to not have any of these loans.
Mr. Hills. I think there are probably two or three
different problems here. One is that understandably law firms
give very broad opinions about what you can and cannot do, and
law firms are very careful never to be wrong, so I do believe
they have pulled the noose too tight. Company credit cards are
now coming under fire because the theory is that if I have
taken a trip and charged it on my credit card, I might have had
my suit pressed. The hotel bill may have been legitimate, but
my suit press was an advance or a loan. So some of that can be
taken care of just by, I would think, the SEC's general counsel
could issue a few statements and you could get there.
I am in agreement with Mr. Caplan's comment. In 1970, I
became the accidental chairman of Republic Pictures. The first
thing I found was that the stock had gone from $80 to $2. The
top five executives of the company had borrowed over $8 million
from the bank for themselves using their stock as collateral.
That was just the practice throughout America, that you got to
be rich, you got your stock blown up pretty high, you borrowed
money against it, the collateral was the stock, and the bank
that loaned the company money loaned you the money. And it was
a disaster.
So saying you cannot do it is a pretty good rule. Chances
are that if a year from now the chances are that it will sort
out and there may be very well something that this Congress
should do to open it up a little bit. But right now, I think it
is sweating out some very serious problems.
Mr. Del Raso. As the lawyer speaking, we are very careful
about the opinions we give out. I would say that anecdotally
you will hear a lot of these stories, but the example we used
at our firm was, if you are traveling on business and you watch
pay-for-view, which is not reimbursable, you have taken an
impermissible loan from the company. That is where the pendulum
I think may have swung too far.
But I think the real core of the problem was the example of
the employee relocation. Reasonable and customary expenses of
operating the corporation that either if expensed out as
compensation or advanced as a loan, were much different than
its senior executives using the company's bank lines as their
margin account. The problem developed with large fortunes being
built up in the company's stock, a reluctance to realize those
gains either to pay tax or to not depress the value of the
stock in the market, and ultimately leverage works well when it
is working, and it is catastrophic when it does not.
I think that is where the idea of some type of safe harbor
guidance Q&A from the SEC would help to distinguish
appropriate, and especially, I do not want to call them de
minimus, but more in the ordinary course of loans for a broader
group of employees than just, again, using the company's bank
account as your own margin account for your stock holdings.
Mr. Trumka. Yes, Mr. Chairman, we support the existing
rule. First of all, we think that there is no way to start
policing exceptions to the rule as they start coming up. They
may be well intentioned at the beginning, but they quickly get
out of hand. We think that corporate reform is only starting to
take root right now, and it would send the wrong message to
change that provision at this time.
The Chairman. Thank you. My time has long expired. We
appreciate your patience.
We are going to recognize the members in order of
appearance. The first questioner is the gentleman from Texas,
Mr. Bell.
Mr. Bell. Thank you very much, Mr. Chairman. I greatly
appreciate the testimony offered here today, coming from
Houston which offered the world the poster child for bad
corporate behavior. Obviously, we were glad to see the
legislation and I am glad to hear what you all had to say about
it today, in that it seems to be having a positive effect.
I do think going forward you have to look at it and see if
there is any room for change and look at perhaps some of the
negative effects. One thing that I have heard, and Mr. Del Raso
I will start with you, and perhaps you have either from clients
or from your own personal experience, some smaller
corporations, some smaller businesses having difficulty finding
qualified people to now serve on boards because of the
heightened liability and the fears associated with that
increased liability. I am curious as to whether you have heard
anything like that, and if you believe that it is a problem
that needs to be addressed.
Mr. Del Raso. It was especially a concern with the passage
of the legislation. I think it still is a concern because
qualified individuals who would be willing to take a corporate
board directorship are going to be a lot more careful about
where they want to get involved. The downside to that is if you
have a situation where an emerging business is seeking public
access to the markets, new technology initiatives or what have
you, are these people who really should serve there, too, as
the stewards of the corporation going to be willing to step up
and take that risk? Because as we all know, the chances for a
problem in the smaller startup companies traditionally were
thought to outweigh those of the larger, more seasoned
companies. In a number of areas we were proven wrong, though,
in the last few years because some very large perceived deep
companies had their problems.
So I think that that is a problem. But the one thing I
would point out is, again, we need the long-term approach. I
think we are seeing now a swing in insurance rates for director
and officer liability insurance, which was just reported in the
last couple of weeks. From a risk management underwriting
standpoint, I think the more these best practices and these
safeguards are in place, we may find that with the perception
that the catastrophic litigation occurs, those losses, either
in derivative suits against the directors directly are actions
that could really damage the corporation. We may find that this
legislation may mitigate that, and you will see then a return
of people more willing to step up to those positions.
Mr. Bell. Mr. Hills, do you have any thoughts on that?
Mr. Hills. I do. It is an extremely good question. For
about 60 years or so, directors were brought on board for their
resumes, not their knowledge. What has happened in these recent
years, both because of Sarbanes-Oxley and because the New York
Stock Exchange has stepped up to the question of governance
committees is that corporate boards are trying to decide what
they need on a board. All of a sudden, the incentives of our
capitalistic world work, all the headhunting firms have hired
all kinds of people, but look much deeper for candidates.
What you have now is a way better quality of person being
considered for boards, not people you may have read about in a
headline, but scientists, doctors, professors who have real
experience. So you have a growing body of people with the
background that should be on these boards. It is an adjustment,
as Mr. Del Raso said. We are going through an adjustment
period, but there is a body of people coming forward as
candidates for boards way better and way bigger than we have
ever seen before.
Mr. Bell. And a willingness to serve by those individuals?
Mr. Hills. Yes. I have, sadly, had more trouble with
companies than anybody would ever want to have, and I still see
a willingness to step up. If quality is wanted on a board,
people of quality will go on the board.
Mr. Bell. So some of the individuals who may be refusing to
serve would be of a lesser quality in some instances?
Mr. Hills. I think this. I get asked a lot about whether
they should go on a board. My answer is, who chose you? If
there is an intelligent governance committee that is really
working the problem to find a competent board, then it is a way
better board to serve on. If you are there at the whim of the
CEO, even a good CEO who played golf last weekend with somebody
and would like that person on the board, then it is probably
not a good board to serve on.
Mr. Bell. Mr. Quigley, I was going to ask you. In a recent
poll, a slim majority of CPAs said management is more
accountable because of Sarbanes-Oxley, but less than a quarter
said shareholders are getting better information. Moreover,
less than 10 percent said investors are making better
decisions. In your opinion, why are the positive effects of
Sarbanes-Oxley apparently not trickling down to those it was
intended to protect in that particular instance?
Mr. Quigley. I did not hear when you said ``more than.'' I
just did not pick up your question exactly. If you would
please, just one more time?
Mr. Bell. Less than 10 percent said investors are making
better decisions, and then only a slim majority of CPAs said
management is more accountable because of Sarbanes-Oxley.
Mr. Quigley. With respect to the majority about management
being more accountable, I certainly would be strongly with that
majority because I have watched the behavior change as the
certification process has unfolded. I have watched how CEOs
act. I have watched how those cascading representations move
through the organization. I truly believe that management
broadly, very, very deep in the organizations, understands the
importance of transparent financial disclosures and those
financial results. It is no longer the purview solely of
financial management. I think that is very positive.
In terms of the quality of investor decisions, I just do
not have a comment on that element of the survey. I think the
transparency and the completeness of the financial disclosures
that are available to investors to consider as they make their
investment decisions, it is absolutely there for them to take
advantage of. If they choose not to, I cannot comment on that.
Mr. Bell. Thank you, Mr. Chairman.
The Chairman. The gentleman's time has expired.
The gentleman from Alabama, Mr. Bachus.
Mr. Bachus. Thank you, Mr. Chairman.
Mr. Chairman, my first question, well really I want to make
a comment to Mr. Quigley. I want to commend the entire public
accounting profession. I believe that public accounting has
been really at the forefront of restoring public confidence in
corporate governance and investor confidence in financial
statements, in auditor independence and in internal controls. I
would say that in response to that survey, I think that among
knowledgeable people in the financial community, they believe
that things are working much better.
So my question is this. In your statement you talked about
the PCAOB's oversight of public accounting. Have you had your
inspection thus far?
Mr. Quigley. First of all, as I mentioned in the testimony,
the PCAOB is the new regulator for the accounting profession.
After 100 years of self-regulation, we now have a new
regulator. Last year, Deloitte along with the other big four
firms voluntarily submitted to a preliminary inspection. We did
that without it being required, even though we had just simply
registered as a public accounting firm under the act. We were
not at that point required to submit to that initial
inspection. We, along with the other big four firms,
voluntarily submitted to this preliminary initial inspection.
Mr. Bachus. How did that inspection process work?
Mr. Quigley. I believe it was healthy and helpful in terms
of the visibility throughout our firm that our regulator was
inspecting our performance on some selected engagements. We are
in the process right now of reviewing a draft report from those
initial preliminary investigations. Again, I think we are
absolutely committed to improving audit quality. I think we are
making progress and I believe that our new regulator, the
PCAOB, is a very important catalyst in helping us continue to
take these steps forward.
Mr. Bachus. So I take it that the inspection process was,
in your opinion, effective?
Mr. Quigley. I think it was constructive and helpful and
supplemented the existing internal inspection that we have
ongoing every year within our firm. Now our first formal
required inspection is currently under way. I have had my
interview as the inspectors were reviewing and meeting with me,
to assess the tone at the top of our organization. Again, I
think they are an important, constructive catalyst to help hold
us accountable and to continue our efforts at sustained
improvements in audit quality.
Mr. Bachus. If there anything about them that you would
change?
Mr. Quigley. I think it is just too early to tell right now
at this point. I really believe and feel strongly that we have
a shared responsibility to strengthen investor confidence and
to improve trust and confidence that our capital markets
require in order for them to be effective. I think there are
obligations of the regulated, the accounting profession, and
obligations of the regulator to work collaboratively with that
goal in mind, improved trust and confidence. I think we are in
the right direction right now.
Mr. Bachus. Okay.
Mr. Caplan, E*TRADE has extensively revamped its board
structures, as you indicated. Has it been more difficult to
find acceptable board members since Sarbanes-Oxley was enacted?
Mr. Caplan. In fact, it has been easier. As a matter of
course at the time at which we were revamping our board, quite
frankly I had concerns about our ability to get really
qualified new board members because of everything we had been
through. Although we had no issues whatsoever from either a
financial reporting or accounting irregularities perspective,
we certainly had a lot of notoriety with respect to executive
compensation.
As we went through the process, the board worked very
diligently on trying to determine who was missing from a skill
set and what we needed to really round out the board exactly,
as had been described before. In that process when we went out
to look, we were able to find 40 qualified candidates. In fact,
when we began we thought we would only add two new board
members. As a result, we added four because there were so many
really qualified candidates.
Mr. Bachus. Okay.
Mr. Trumka, there is a recent Harris poll of investors that
said almost 60 percent, 59 percent found Sarbanes-Oxley would
help them safeguard their investments. Actually, 57 percent of
investors say they are unlikely to invest in a company not in
compliance with the act. Is that basically your experience?
Mr. Trumka. We are finding more and more investors looking
to Sarbanes-Oxley as a guideline as the minimum that they do
for investment. So the answer is yes, and I think you will see
that percentage increase. Shareholders at existing companies
are urging that, and many of the private companies that are not
subject to Sarbanes-Oxley are now adopting it voluntarily. We
think it made foreign investors, it makes things more
transparent and more likely that, for instance, pensions funds
that do their investing are likely to realize a gain and
protect their beneficiaries.
Mr. Bachus. Okay, thank you.
Mr. Trumka. Thank you, sir.
The Chairman. The gentleman's time has expired.
The gentlelady from Oregon, Ms. Hooley.
Ms. Hooley of Oregon. Thank you, Mr. Chair. I have a couple
of questions.
We have just heard from Representative Bell that said 10
percent of investors feel they have more information as a
result of Sarbanes-Oxley. That is not a very high percentage.
Mr. Caplan, what other information might be useful for
investors so that would not be terribly burdensome on
companies? And what can all of us do to improve transparency in
disclosure?
Mr. Caplan. One of the things that we were challenged with
as we began to go about improving corporate governance was a
perception in the marketplace with both our investors and our
analysts that we were not as transparent as we could be. So we
have taken it upon ourselves not only in dealing with how we
report in ours Q's and our A's, but also we do monthly
reporting as to a lot of our key metrics in our business. When
we do our quarter reporting as a public company, we have
attached now our press release in terms of the information. It
is about a half a page and we have about nine pages of
additional information that we attach, really outlining all of
the key drivers of our business and how we are succeeding or
doing, both on a quarter-over-quarter basis and year-over-year
basis.
So I think it really is incumbent upon companies today to
ensure that investors are getting timely information about the
key drivers of their business and the success or failure
thereof.
Ms. Hooley of Oregon. I think it is really important that
we make sure that investors have confidence in the companies. I
do not think you can give them too much information. We need to
raise that confidence level still now.
Mr. Caplan. I agree.
Ms. Hooley of Oregon. Mr. Quigley, what is your assessment
of the future of the accounting profession? Has Sarbanes-Oxley
changed that perception as a profession? Are you having success
in recruiting people to the profession that have the kind of
depth that we all count on in the accounting profession?
Mr. Quigley. First of all, I am very optimistic about our
future. I believe Sarbanes-Oxley has contributed in a very
constructive way to the relationship that we enjoy with our key
clients, and especially as has been discussed, this new client,
the audit committee. We are finding on campuses very, very
qualified candidates looking forward to the challenge of a
career in public accounting and the increased visibility that
the act has brought has contributed in a positive way to the
quality of the students that are attracted to the profession,
and I believe the career opportunities that we can provide for
them. So we continue to be successful competing in the
marketplace for experienced hires and also competing on
campuses for the very best students.
Ms. Hooley of Oregon. Thank you.
Mr. Hills, I understand that a number of the provisions of
the Sarbanes-Oxley Act are similar to requirements that are
already applicable to banks. Are there increased compliance
requirements for banks because of these dual layers of
requirements? Are there significant costs associated with that
requirement? And the second part of the question, many banks
are not publicly held and therefore not subject to many of the
Sarbanes-Oxley requirements. Are the bank regulators imposing
those requirements on private banks?
Mr. Hills. I can quickly tell you know more than I know.
[Laughter.]
The bank examiner's role is a different role than we have
historically had in the publicly traded industries. I do not
know anything significant by reason of Sarbanes-Oxley has
affected that relationship. I think the question you raise,
though, is kind of interesting both because of its own
background and because of the nature of the Public Company
Accounting Oversight Board. The Chairman Bill McDonough, was
the President of the New York Fed. I think he is approaching
the job not unlike the manner in which bank examiners approach
the job, by going to the accounting firms and by looking at the
high-risk audits to try to find the problems before they erupt,
and in one sense of the word substitute prior examination for
later enforcement.
So having now ducked the question, I will leave it to
somebody else to tell you just exactly what is happening.
[Laughter.]
Ms. Hooley of Oregon. Mr. Del Raso?
Mr. Hills. I would like to add one more thing, though.
Ms. Hooley of Oregon. Yes?
Mr. Hills. In my written testimony, I added this report
called The Future of the Accounting Profession. I surely would
like more people to read it and I hope Mr. Quigley has read it.
There is much to be said for the future of the accounting
profession.
Ms. Hooley of Oregon. Good.
Mr. Del Raso, do you have anything to add to the question
that I just asked?
Mr. Del Raso. I would say that your observation, comparing
the requirements for bank regulatory oversight at the
governmental level, there are some similarities, but not all.
When you work in the field of financial regulation, whether it
is banks, investment companies, broker-dealer operations, you
have much more of an aggressive government regulatory scheme
within which they operate. Especially with banks, the review
goes to safety and soundness, whereas general corporate issuers
under our securities laws, both in the sale of and the
secondary market trading of the securities, was mostly, it not
primarily driving by a disclosure regimen. I think what
happened was, when there was a failure of transparency, the
disclosure failed, and that is what really impinged the
markets.
I do not think you really want to jump into a situation
where you include industries that may not require the same
level and type of regulation as others. But on the other hand,
if you are out from under that very strict and careful
regulation, then the mandate in this legislation is, if you are
only in a disclosure regimen, make sure that transparency
works.
The Chairman. The gentlelady's time has expired.
Ms. Hooley of Oregon. Thank you.
The Chairman. The gentlelady from Illinois, Ms. Biggert.
Mrs. Biggert. Thank you, Mr. Chairman.
My first question is for Mr. Hills. Do you see any
perception or feeling in the corporate community that the
improved practices of companies, like more frequent and
lengthier meetings of the audit committees, are just a
temporary effect and soon that the companies and their
directors will let down their guard?
Mr. Hills. I think here is always a possibility that people
get bored sometimes with doing the same thing every year. But I
think we have created a dynamic with the combination of not
only the revitalization of the audit committee, but the
extraordinary role now played by the governance nominating
committees. This is a real change. We hope that 27 years later
that audit committees will do now what Sarbanes-Oxley has told
them to do. But the nominating committee and the governance
committee is an extraordinarily vital forum. It will keep
people on their feet.
I think we are in good shape. There is a problem that
people have mentioned, and that is with all these directors
with all this new authority to do stuff with respect to
compensation and governance, will they start exercising that
with respect to the management of the business? Will they butt
in where they really should butt out? That is a problem.
As I say, if you sit down and all of a sudden you are
really a powerful person with respect to the outside auditors
and the compensation, you are hiring the compensation guy and
you are hiring the outside auditors, the temptation is to go in
and talk about the engineers and how to design something. So
there is a bridge that still has to be crossed properly.
Mrs. Biggert. It would be kind of like education, where we
all think we know more than we do because we have been parents
and been in school. Thank you.
Mr. Del Raso, have there been complaints about the increase
in insurance costs? I think you have said something about that,
particularly for directors and officers insurance. You state in
your testimony that one of the long-term effects of the act is
that these costs, along with those of indemnity and fines will
decrease. Can you elaborate a little bit more on that? I think
it is a point that is not usually brought up in that matter.
Mr. Del Raso. There was a real spike in premium costs,
especially for business lines related to director and officer
liability coverage issues and the like. Now, I think what we
are going to see, in fact we even see some signs of it now that
may be abating. The interesting thing about that is, too, I
think from a risk-management standpoint, the more this
legislation, is in effect, and again since insurance is written
on experience, the experience shows that the system is working
and the losses are not occurring, then the premiums will adjust
accordingly.
Quite interestingly, I was approached by the dean of a
prominent Philadelphia-area business school who asked for some
advice on structuring an academy for directors. He was going to
start the program. I said one of the things he should really do
is consult with the insurance industry because I think that if
you actually have a formal program of continuing education for
directors and they have an academic program for maintaining
close touch with best practices, you may even find from an
underwriting standpoint insurers will look at the broader
picture of how that whole interplay takes place.
Mrs. Biggert. Thank you.
Mr. Caplan, in your testimony you have something about the
signing of the certificates regarding internal controls and
what your company does. Could you talk a little bit about what
your senior management does for the certification? My other
question is, could other companies be able to do what E*TRADE
does?
Mr. Caplan. Within the last year-and-a-half, we have
actually put a couple of procedures in place. The first thing
we did was we internally built our own financial disclosure
committee. It has as its members the most senior of our
financial employees in terms of the accounting department, as
well as the internal audit department. So before every
certification, that group meets independently to review all of
the numbers and all of the reporting.
Immediately thereafter, there is a meeting of the entire
senior-level leadership team. At that meeting, we ask each of
the senior leaders of the company who represent different
business units to attest to their numbers as well, given the
comfort that they have reviewed the numbers, as well as their
corresponding financial partner in the company. And then only
as a result of doing all of that do we actually then attest or
sign, both myself as the CEO and also the CFO.
What is interesting is that at that attestation process or
certification process, we make it very clear to everybody in
the finance department, as well as all the leaders of the
company that they can or should consult with anybody in the
organization, whether it is outside as the audit committee,
whether it is our general counsel, whether it is our internal
auditor, if they have any concerns whatsoever.
The other thing that we have done is we have engaged an
outside third party company to allow us, and have then
broadcast it throughout the entire organization pretty
regularly, that if any employee in our company is concerned in
any way about anything going on from a financial perspective,
they should call that number. It is totally anonymous and then
gets reported to the audit committee. I think as a result of
that, it has greatly enhanced the level of not only
accountability, but also a willingness and an understanding
that if there is a concern, they should speak up and express
it.
The Chairman. The gentlelady's time has expired.
Mrs. Biggert. Thank you.
The Chairman. The gentleman from North Carolina, Mr. Watt.
Mr. Watt. Thank you, Mr. Chairman.
Let me first thank the Chair for convening this hearing. As
one who voted for the Sarbanes-Oxley bill out of committee, on
the floor, and participated in the conference committee, it is
always good to hear favorable results of something that we did.
We do not get a chance to do that very often. I think sometimes
we can also overdo patting ourselves on the back. I would like
to raise a couple of questions that may be a little more
forward-looking than patting ourselves on the back about how
successful we have been in this legislation.
Mr. Caplan and Mr. Trumka put their finger, or at least
mentioned in their testimony, an issue that I think by public
perception at least is a major, major concern, and that is
rationalized executive pay, as Mr. Caplan referred to it, or
excessive executive compensation. Most of my constituents when
I talk to them liken, it is kind of a visceral response, but it
is a public perception at least that athletes are overpaid and
corporate executives are overpaid, and something needs to be
done about that.
So one question I would have, and I am going to pose both
of these questions and then make you all go at them, whoever
wants to address them. In your assessment, is there still a
problem of irrational executive pay or excessive executive
compensation? Is there some way to get a handle on this without
doing it legislatively? Or is there some way to get a handle on
it legislatively? That would be one question that I have,
looking forward. Not that I am advocating anything, I would
just like to get your perception about it.
Second, obviously everybody on this panel thinks that
Sarbanes-Oxley has been exceedingly successful in a number of
areas. I would like for the panel members to identify
additional steps beyond Sarbanes-Oxley, either legislatively or
from a regulatory perspective, that we should be talking about,
not necessarily implementing. But if you were to identify one
thing that you perceive to be either still a public perception
problem, by public perception, or a real problem that is still
in play in this whole corporate governance or accounting
process, what would that one problem still be? What ought this
committee be talking about or thinking about or having hearings
about going forward to try to address that one problem that you
would identify?
I will start with Mr. Trumka, since Mr. Quigley has been on
the hot seat a lot today.
Mr. Trumka. Thank you, sir. My answer succinctly to, is the
excessive executive compensation problem still around? The
answer is yes. It continues to grow. If you look at the CEO
pay, it is still not long-term performance-based. It is still
based on things like stock options. That, I think, is one of
the reasons why we still need something done with expensing
those stock options and reining in that pay, because once it
becomes transparent, plus accountable----
Mr. Watt. Be quick, if you can. I know these are two tough
questions.
Mr. Trumka. The second thing, if you asked me for one
thing, I would say for long-term significant shareholders to
have the right to nominate directors on management's proxy. The
only way you get an independent board is for people to know on
that board that there were two routes to get there: one by
management, and then if you do a good job by the shareholders,
the other one is if you do not do a good job, from the
shareholders themselves.
Mr. Watt. Mr. Del Raso?
Mr. Del Raso. I would be very careful about legislation
that tries to regulate executive compensation. I think the call
went out after the problems in 2002. I can tell you that
compensation committees of boards are paying very careful
attention to compensation. I think we should let this
legislation ride out longer. I think you are going to see that
the long-term effects of it are going to be quite beneficial.
But when the government gets in the business of regulating
executive compensation, I think that is a slippery slope that
we have to be really careful about.
In the area also of expensing options, even though I do
have a degree in accounting, I never practiced the way Mr.
Quigley did, one question I have is and I think that has
confronted a number of those of us who sit in the board room as
opposed to the accounting experts, at a time when we are
looking for clarity and transparency, I think the idea of
attempting to expense an option when you are really trying to
deal with a future value could be problematic without a very
complex set of rules attached to it.
Mr. Hills. The compensation committee, which is also new in
2 years, has come to believe I think almost universally that it
must have its own consultant, and that that consultant cannot
really work for management. That is going to have a leavening
effect, whether it is enough or not, I cannot tell you. There
are enough speeches going on. There can be more speeches.
Chairman Donaldson, Chairman McDonough, Chairman Oxley, all can
make note of the fact that pay should be for performance. So we
need a bully pulpit and we need the compensation committees to
work.
What should we do next? I will just keeping pushing my
Future of the Accounting Profession. If you read that, you will
see some thoughts that I would love to have any or all parts of
this committee be interested in that subject.
Mr. Caplan. Although it is hard for me to comment outside
of my experience directly at our own company, I will tell you
that certainly I have seen dramatic changes with respect to the
board and specifically the compensation committee and how they
look at executive pay. Very quickly, I will tell you in the
past when we had our problem, the executive pay was set
entirely by the compensation committee and the full board was
unaware of it. Today, not only do all the leaders of the
company deal with the compensation committee, but also the full
board approves and endorses everything related to me and
understands it.
I would agree very much with Mr. Hills that the
compensation committees are now looking for outside
consultants. They are looking for guidance. They are taking
their job very seriously. I think both management and comp
committees at well-run companies are understanding it should be
performance-linked.
The change, I would tell you that it is probably most
imperative, and I think it is happening anyway on its own, is
that you need to rotate directors. At a certain age, directors
need to leave. At a certain point in time, if they have been on
the board long enough, they can become stale in terms of their
efficacy. I think it is important to constantly get new talent.
Mr. Hills. Not age-related.
Mr. Caplan. No.
Mr. Hills. Thank you.
Mr. Caplan. No, age in terms of performance.
Mr. Quigley. I would just very briefly say, I believe in
the free market system and I believe in the transparency of the
executive compensation that is there. I think shareholders have
the opportunity to vote with their feet if they do not like the
practices that they see. I think the governance processes are
becoming increasingly effective, as has been stated. I think we
ought to sustain that process.
When I look forward for that future issue, one issue that I
think needs more airing is just simply the enormous cost on our
economy, certainly the enormous cost on our profession of the
explosion of all of the litigation that is out there on every
issue. That has an enormous cost and an enormous drag on this
economy.
The Chairman. The gentleman's time has expired.
Mr. Watt. Mr. Chairman, I know my time is over, but I did
want to make it clear that most of my constituents think that
members of Congress are overpaid, too. So it is just not
athletes and corporate executives. I did want to add that.
The Chairman. That will be noted.
[Laughter.]
You must be talking about your own constituents.
[Laughter.]
The gentleman from the first state.
Mr. Castle. Thank you, Mr. Chairman. If I am going to be
overpaid, I would rather be overpaid like an athlete, rather
than like a member of Congress, but that is all a different
story.
[Laughter.]
I think this is a great panel. I say ``great panels'' when
panels agree with what I am thinking, regardless of what you
said, which is the case here. I am one who believes that
Sarbanes-Oxley is extraordinarily important, and it may be an
inconvenience, I am sure it is an inconvenience and expense for
that matter to corporations in America, but the clarity and
transparency that we have gotten from that makes it in my
judgment abundantly worthwhile. I praise it greatly.
I did hesitate a little bit on praising the panel, though,
after Mr. Caplan's comment about the age-related circumstances
of directors, because that can be translated to members of
Congress as well. I am starting to get a little edgy about
that. So I would just as soon keep that discussion down.
Actually, I would like to go back to Mr. Caplan because in
his written testimony he struck a chord with something I have
introduced and am concerned about, which is a little bit
different, Mr. Chairman, than the subject of the hearing
directly, but it pertains. It pertains to what corporations are
doing, and that is 12b-1 fees. It is something which actually
until we prepared for this, I did not know about, that E*TRADE
is doing, which is a 12b-1 fee rebate program. I have
introduced legislation to eliminate 12b-1 fees for closed
funds. If I thought I could get away with it, I would eliminate
all 12b-1 fees, to be candid, but I do not think anybody would
consider that right now, so I am trying to do it on a more
limited basis.
I think by the fact that E*TRADE is doing this, it shows
that perhaps there is not a need for this. I think most of us
here know that 12b-1 fees are in lieu basically of sales
commissions. They were never structured to be that to begin
with. They were put into place at a time when more advertising
was needed for mutual funds. Now I think they are being used in
a way that was unintended. I think it is frankly a burden to
the shareholders. I think it comes to close to $10 billion a
year now or something of that nature.
So I am very pleased that you are doing this. But I
understand that a number of the mutual fund companies you deal
with have also dropped you, I guess, or listing E*TRADE as a
result of that, which also bothers me somewhat. I would like
your comments on the program in general, why you did it, why
some are staying with it, why some are dropping out of it. I
hope this is an area that evolves and gets changed over the
next two or three years.
Mr. Caplan. I think we agree with you very much. One of the
things that we were quite pleased about is that in this past
quarter, in the past three months we were able to give $1
million back to our customers in connection with the 12b-1
rebate. The premise, as I stated in my earlier comments, for
E*TRADE and its core tenet was always just using technology to
have a lower cost, and taking a significant portion of that
cost savings in its operation and putting it back in the hands
of customers, and trying to evolve itself as a customer
champion.
Earlier this year, we thought one of the interesting and
dynamic ways to do that was to look at the fact that we have a
lower cost platform and take those 12b-1 fees that we would be
paid as a distributor and put 50 percent back in the hands of
customers. We were actually quite hopeful when we did it that
it would spur competition, and that you would see other
distributors thinking about how they wanted to distribute, and
really compete head-to-head with us.
Mr. Castle. Has that happened?
Mr. Caplan. In fact, we are a little disappointed that it
has not. It is one of the things that has been most interesting
about our core business, for example, on the brokerage side. As
you have seen with online brokers, it has spurred competition
and you have seen prices come down. To date, anecdotally I
guess, we are disappointed because as we have had some fund
families withdraw, we are hearing that they may feel pressured
from other distributors. I think that disappoints us. We would
be much happier if in fact there was a healthy competition out
there which benefited each of us as businesses, as well as
certainly the customers, by putting money back in their
pockets.
To your point, it is about $6 billion a year, and we would
love to be able to give $3 billion back. So that has been our
premise.
Mr. Castle. Good. Do you do this with any funds? I mean, do
you do it with closed funds as well as still open funds? You do
not distinguish between the two?
Mr. Caplan. No, we do not. Our view is that we are just
operating as the intermediary, as a platform.
Mr. Castle. Good.
I will just close with this. I feel very strongly that if
you look at mutual funds, and I think it is over 50 percent of
Americans now are someway or another involved with mutual
funds, there are just huge cost aspects to it. To the extent
that anybody, be it a distributor of the mutual fund itself,
the holders of mutual funds can somehow interact in such a way
that we can diminish these costs are even eliminate some of
these costs which are unnecessary, and perhaps first just
understanding them. Who really understands what a 12b-1 fee is?
They see it and they do not even know what the heck it is. To
the extent that we can do that and still allow all the
businesses to be profitable, my judgment is that the American
investor is going to be far better off.
So I wish you luck and success with this. Frankly, I hope
all of your competitors imitate you because I think in the long
term it is going to benefit the people who need to be
benefited, and those are the shareholders and mutual funds in
America.
With that, I yield back, Mr. Chairman.
The Chairman. The gentleman's time has expired.
The gentlelady from California, Ms. Waters.
Ms. Waters. Thank you very much, Mr. Chairman.
I am very appreciative for this hearing. I, too, am very
proud of the bipartisan effort that we displayed in this
committee as we passed Sarbanes-Oxley. I like the discussion.
We are beginning to have some transparency. I think there needs
to be a lot more.
I want to ask Mr. Caplan, who indicated that they had taken
some steps to help with transparency. You mentioned better
composition of board members. What do you mean by that?
Mr. Caplan. One of the things that we did for the first
time, really and it was spurred on very much by Sarbanes-Oxley,
was instead of just taking for granted the board and who was on
it, we stepped back and really did an assessment of the
strengths and weaknesses of every board member. By way of
example, as I said in my comments, we completely transformed
our audit committee, our nominating and corporate governance
committee, and our compensation committee.
In the process of adding new directors, we really looked
for what skill sets were missing and assessed what we needed. I
think very much as Mr. Hills said, rather than looking for
names out there, we were looking for skill sets. We were
looking for people who were interested, who were dedicated, who
understood the time commitments. Our board meetings have gone
from what would have been as quick as a half-a-day every
quarter, to 3 days a quarter now. Last year, we did, including
committee meetings, 39 different meetings. So it is an
understanding on the part of all of our board members that it
is a significant time commitment. We looked for those board
members who wanted to give it and also had skill sets that we
viewed were missing.
Ms. Waters. As you know, there are some of us who have been
involved at one time or another in trying to diversify
America's boards of directors. I still think that it is a
problem. It is not to place anyone in any uncomfortable
position, but even as I look out among you today, I walk into
this room committee meeting after committee meeting, and I just
do not see the diversity represented, really, that is
synonymous with what America is all about.
What can we do in dealing with the selection of board
members of the various boards of companies in this country to
diversify them, to get more women, to get more people of color?
I think that if boards are to have the kind of input and
expertise that is needed, that this diversity is very
important. What can be done?
Mr. Caplan. I can tell you that when we looked to add new
directors, that was one of the key criteria for us. As we were
interviewing directors, not only did we look at specific skill
sets, but we recognized that we had no African Americans and we
had no women on our board and we added both. The view was
exactly what you are expressing. There is a diversity of
thought and a diversity of opinion which can only help us as we
think about how we want to build out our business.
I would certainly encourage all other companies to do the
same thing. I think it is imperative. Again, when you were
asking before, when I was asked before about what could change,
I think as you see turnover, the problem is there is sometimes
just not enough turnover on boards, you will see more of a
focus. I know on our board it is a topic of conversation as we
look at those board members who will in turn retire, what are
we looking for, and part of that is diversity.
Ms. Waters. Would you agree with me that it is not
difficult to find women and people of color who have expertise,
who have the desire, who have the time, all that is required to
serve? That is not a problem, is it?
Mr. Caplan. I would agree with you completely. When we
identified, as I said in my earlier comments, 40 different
candidates who were both capable from a skill set and
interested in dedicating the time, we had many choices that
were both women, as well as African American.
Ms. Waters. Any of our other panelists have any thoughts
about this discussion that I am having with Mr. Caplan about
how to diversify boards? What do you do with the power that you
have, Mr. Trumka, to encourage boards to diversify?
Mr. Trumka. We are very, very cognizant of that in
everything we do. We try to diversify more both along racial
and gender lines as well. I think one of the things we can do,
although Sarbanes-Oxley did not mandate this, the experts now
say that it takes about 250 hours per year per board that you
sit on. You hit the nail I think right on the head. People with
the skill sets and the time, that are willing to do this, we
need to make more training available for those people with the
expertise and to develop that pool. We are trying to do that.
On one board that I sit on, we have quarterly training for
board members, but we opened that training to anybody else who
wants to come in as well. I think that is one thing we could
do, but also using just our moral suasion as leaders to demand
that there be better diversity, and that America is more
reflected not only in the streets, but in the boardrooms of
America's corporations, and quite frankly, America's unions.
Ms. Waters. Unanimous consent for 30 more seconds, Mr.
Chairman.
The Chairman. Without objection.
Ms. Waters. I would like to hear from each of our panelists
whether or not you think there is a need to diversify and that
absolutely it can be done.
Mr. Quigley. I would encourage you to continue to speak
about this very, very real issue. I will say on our own board
we have four women, and on our executive committee we have two
African Americans, one Latino and then two women. I believe, it
is a critical business issue for us because I want everyone in
our organization to be able to look up and see someone who
looks like them. And then and only then can we become the kind
of firm that I want us to be.
Ms. Waters. Thank you. Anyone else?
Mr. Hills. I think we can take some comfort from what has
happened in the last 25, 26 years. I think we can have some
hope that the authority now in the nominating committees of
boards, as distinguished from the CEO, will make a big
difference. I think if you look on almost every single large
consumer company board, you will find African Americans and
women. In my own family, my wife sits on more boards than I do,
so I am safe.
[Laughter.]
Ms. Waters. Thank you very much, Mr. Chairman.
The Chairman. The gentlelady's time has expired.
The gentleman from Louisiana, Mr. Baker.
Mr. Baker. Thank you, Mr. Chairman.
I want to speak again to the task you accomplished with
Chairman Sarbanes in a very difficult timed environment to come
to conclusions that I think have ultimately shown to be a very
wise direction for not only corporate governance, but for
investors and our general economic recovery.
Mr. Quigley, I want to just pose a question for your later
written response, not today because time is so limited. There
has been a great deal of controversy circling the question of
auditor independence, scope of service and tax consulting,
particularly in creation of taxation opportunities. Can you at
some point send me just what Deloitte has propounded as to its
own internal policy with regard to that matter going forward?
Mr. Trumka, I listened very attentively, but when you got
to page six of your testimony, particularly attentively as to
your comment about the stock option expense bill passed by the
House. You go on page six to say, it is encouraged that overuse
for executive compensation, contributing to widening gaps
between executives and ordinary workers, the House is bent
again, not just the first time, again, on subverting the
integrity of our financial accounting system by giving runaway
CEO pay less special legislative protection. This battle is
being waged on behalf of CEOs who frankly want to hide the true
cost. You then cite, according to SEC filings, which is a
required disclosure, the amount of $977 million in unexercised
options, the fact that is required to be disclosed, the fact
that it is required to be disclosed today in footnotes makes it
evident to anyone who chooses to find out they can get that
knowledge.
But there is clearly a misread or a no-read of the bill.
The bill requires executives to expense. It does not exempt
them. In fact, what we are attempting to preserve is the right
of employees's ability to participate in broad-based stock
option plans. You go on to say a majority of the shareholders
at 30 companies voted in favor of expensing. The bill not only
preserves, but makes an express declaration that anyone who so
chooses, board shareholders or otherwise, the company may be
required to expense.
In light of this, I thought it particularly ironic in where
my original line of questioning was going with Mr. Caplan, and
I have to be brief, relative to E*TRADE's reforms. I noted on
page four that you cite that the board had to adopt a
requirement that any compensation for its chief executive
officer must be approved by the entire board of directors. I
found that very enlightening that in today's corporate world
that the board may not know what their own CEO is earning in
direct compensation.
I, for the purposes of the record, would just only make the
point that I would very much appreciate receiving the corporate
governance model relative to CEO compensation and other matters
that you think appropriate for the committee to be made aware
of in going forward, because Mr. Everett from Alabama has
proposed a reform for my attention relative to pension plan
approvals that I found of some interest.
I think this swirls in the bigger question that maybe was
raised by Mr. Watt. We should not be legislating necessarily,
but I think the bright focus of examination does a great deal
to bring about responsible governance. To the extent you can
help us with that effort, I would be most appreciative.
Finally, Mr. Hills, I am very taken by your testimony, and
particularly the area where you are discussing non-financial
metric disclosure and the analysis of current GAAP standards
giving us a retrospective historical analysis, and not much of
a forward-looking view about where the company is going. For
example, if you know that there were 10,000 units sold in the
last quarter at whatever price, but you did not know from
customer satisfaction surveys that 8,000 of them were returned
for refund, which piece of information might be more helpful in
knowing what is going on at that corporation.
You did say, however, that you did not think disclosure of
nonfinancial metrics ought to be necessarily a function of
required disclosure. I want to get your thoughts where the FDIC
is now engaged in a project known as expensible business
reporting language, with about 300 banks. Next year, we will
roll it out to all 8,000 insured depositories if it works, the
idea being we are getting away from beating the street every 90
days with earnings expectations, taking the pressure off the
CEO-CFO by having hopefully more real-time, material fact
disclosure of things that shareholders should know in a
timeframe in which they should know it, as opposed to the
arbitrary, beat the street pressure that I think was an
inordinate contributor to the problems we now face in trying to
rein in through Sarbanes-Oxley.
Can you give me a quick view on that because I am just
about out of time?
Mr. Hills. The demand for more information is pretty clear.
The problem is that the buying community, the buy-side analysts
and the sell-side analysts, are not causing it to happen. As
you have seen from this book, the need to have more
nonfinancial disclosure and the need to recognize the so-called
brittle illusion that the financial disclosure has is not as
helpful as you think it is. Those two things seem to be coming
together. There is quite an important committee going on now
which I think Paul Volcker, he is not the chairman of it, but
it is to develop more incentives for nonfinancial disclosure.
The passage of Sarbanes-Oxley and the role of the audit
committee and the obligation now of the auditor to tell the
audit committee, hey, the management could have done it
differently, they could have said something differently, all of
a sudden people understand that we are dealing with ranges of
numbers, not precise numbers. The idea that you can have the
profits of the company go up by 1 percent every quarter for 50
companies, I think the world now understood that that is
ridiculous. It did not happen.
Mr. Baker. Thank you.
Mr. Chairman, just unanimous consent request, Mr. Everett
asked that I insert into the record his statement regarding his
proposal on compensation.
The Chairman. Without objection.
The gentleman from Alabama, Mr. Davis.
Mr. Davis. Thank you, Mr. Chairman.
Let me try to pose three sets of questions for you all, and
get you to give fairly succinct answers to them. The first one
I would direct to Mr. Caplan and Mr. Hills. It deals with the
level of knowledge or intent that is required for a CEO to be
liable under Sarbanes-Oxley. Let me get first of all your
answer to the question, what do you understand the level of
mens rea to be, the level of knowledge to be? Is it sufficient
if a CEO signs a financial statement and the statement is
false, for that CEO to be liable? Or what is the extra level
that is required? Does it have to be a willful disregard
standard? That seems to be something that is not 100 percent
clear, and we have had so few prosecutions that we have not yet
developed a good answer to that.
The follow-up to that, if you feel that the standard is one
that is something other than knowledge, if it something other
than the usual criminal standard, is that problematic? Is there
a discomfort level that we have or should have with holding
CEOs liable unless we can show deliberate disregard or
willfulness on their parts? This is the first set of questions.
The second one, Mr. Del Raso, I would direct to you. There
was a period of time last year when the SEC was considering a
new set of regulations involving attorneys. There was a lot of
talk about a noisy withdrawal requirement. As you and the other
lawyers in the room know, in the overwhelming class of cases
around this country attorneys have very little leeway to get
out of cases even permissively. Attorneys are able to get out
of cases if there is a possibility of imminent physical harm or
if a lawyer has knowledge of imminent wrongdoing.
As I understood what the SEC was contemplating, there was
some consideration that if an attorney became aware of
corporate misconduct, that there was actually not just as
permission to get out of the case, but an affirmative duty to
withdraw in some instances. As a lawyer, that struck me as a
radical change from the normal rule of special responsibility.
Can you briefly comment on that?
The final set of questions would be to Mr. Hills and Mr.
Del Raso. It deals with the sentencing guidelines. We know
because of the recent decision that the guidelines are very
much in flux right now. We do not know what will eventually
come about. But one of the things that was worked in the
Sarbanes-Oxley, as I understand it, is a dramatic ratcheting-up
of the penalties and the collapse of any distinction between
theft and between fraud. As I understand the guidelines right
now, pre-Blakely, if a wrongdoer causes a certain amount of
loss, whether or not he or she receives any direct financial
benefit from it, it is treated the same as if he or she had
received benefit. Are we comfortable with collapsing fraud and
theft together? Does it create problems either in terms of
getting plea bargains efficiently? Or does it create some
broader problem if we dramatically ratchet-up the sentences for
people who are not financially benefiting themselves from the
fraud?
Those are the three sets of questions. The first would be
to Mr. Hills and Mr. Caplan.
Mr. Hills. The standard for Sarbanes-Oxley compliance with
respect to signing the document, the principal change, which is
so important, is that the CEO cannot win simply if he says, I
did not know anything about it. He has to be bloody certain
that that company has done everything possible to uncover the
problem. That is what 404 does also. He has to make certain
that every possible effort has been made to surface problems
with it.
So if he sits there and says, I did not know anything about
it, and he does not have a compliance situation in place, he is
in trouble. I think that is the way to look at that part. I am
sure somebody else is going to answer the second question.
Mr. Davis. Mr. Caplan, do you have anything to add to that?
Mr. Caplan. I would agree completely. I think that
Sarbanes-Oxley has worked quite effectively in terms of its
intent. There is very little doubt in my mind that in
certifying either on my behalf as a CEO or the CFO, there
really is an understanding of the severity that is intended
when you certify, whether it is quarterly or whether it is with
respect to 404. I would tell you that it is impossible,
particularly the larger the organization gets, to know
everything that is going on at all times. But the duty to
investigate, as Mr. Hills has said, is dramatically escalated.
The amount of work that goes into the processes I described
earlier, whether it is quarterly or with respect to 404, has
really transformed the way companies are looking at these
checks and balances.
Mr. Davis. Mr. Del Raso, can you comment on the attorney
issues?
Mr. Del Raso. Sure. One of the more discussed aspects of
Sarbanes-Oxley was the notion of the responsibility of the
attorney, this concept of reporting up and then reporting out.
The responsibility of reporting up at the attorney level inside
the corporation is one that was a little easier to deal with.
But the idea that if you are not listened to and then reporting
out, as you know, the American Bar Association and even some
states really took opposite positions from what was required in
the act. They are issues that I think were very troubling to a
number of practitioners at the time, but I think we are working
our way through them.
I would recommend to you one of my partners was actually
appointed by the court to be the special SEC examiner in the
Spiegel case last year. A large part of that report deals with
the role of the attorneys in reporting. That was probably one
of the last major cases before the enactment of legislation
that dealt with these issues.
Mr. Davis. Can you just quickly comment on the fraud-theft
issue?
Mr. Del Raso. I think that is one that really does require
attention. I am sure you are referring to the Dynegy case and
maybe the sentence that was imposed there, big distinction
between outright fraud or negligent responsibility in the chain
of command in the certification process, and really quite
frankly weighing and balancing the societal effects again, too.
I mentioned even in my testimony, one of my concerns is that
outside of the framework of the legislation, when you get to
regulatory enforcement, if you have prosecutorial misjudgment
and in discretion, you could really start then to have a
deleterious effect on this legislation if it is not properly
enforced.
The Chairman. The gentleman's time has expired.
The gentleman from Texas, Mr. Hensarling.
Mr. Hensarling. Thank you, Mr. Chairman.
I have long since been convinced of the absolute necessary
and profound benefits of Sarbanes-Oxley and what it means to
the protection of our free market system. But let me take my
limited time to focus on what some may perceive as the cost or
risk and unintended consequences of the legislation.
Obviously, the subject of corporate board independence,
independent members of the board, is discussed often these
days. Sarbanes-Oxley has required that the audit committee be
comprised totally of independent members. If we look at what I
think my colleague from Houston described as the poster child
for corporate malfeasance, Enron, I am told that 86 percent of
their board was independent and had a dozen non-employee
outsiders. This included four CEOs, four academics, and the
board was chaired by an accounting professor from the Stanford
Business School.
Just for the sake of argument, I am told Berkshire Hathaway
would not pass anybody's test of having an independent board,
yet I do not believe they have had a hint of corporate scandal,
and except for 4 years out of 40, they have always beat the S&P
500.
So my question really focuses on where theory meets
empiricism. The question is, with our limited history, what do
we know about the impact of having independent members and what
that means to corporate governance? Why don't we start with
you, Mr. Quigley.
Mr. Quigley. I believe that we need independent directors,
but we also need audit committee effectiveness, understanding
and executing their effective role. If it is an audit committee
composed on the golf course, the likelihood of it being
effective is much, much lower.
Mr. Hensarling. Mr. Hills, how about you?
Mr. Hills. Independence does not at all guarantee quality.
I think if you go back to 1976 and just see the impact on
corporate America by simply having an audit committee be
required, so you had three independent people on the board at
least, it has had a substantial impact. But independence is not
enough. You need to have a sufficiently independent quality on
every board to deal with those matters that need that
independent quality. I do not see anything wrong with having
employees on the board. It is a matter that each company is not
the same.
But if the background for the question is, can we carry the
independence question too far, of course we can. I think if we
stay with the principle that every board needs a sufficiently
independent quality to deal with those things that need that
independence, then we are fine. At Berkshire Hathaway, the
board is a very good example. They do have a substantial
independent quality on that board.
Mr. Hensarling. I have a lot of different studies crossing
my desk. I am never quite sure of their reliability or their
methodology. But I saw a Wall Street Journal article that dates
back to about a year-and-a-half ago saying that since the
advent of Sarbanes-Oxley, D&O insurance has quadrupled. I have
seen another study saying that the cost of going public for
mid-size companies has now doubled. Directors's fees have
doubled. Accounting, audit and legal fees have doubled.
Again, I am uncertain of the methodology and reliability of
these reports, but I am curious about the hard data out there
on the cost of compliance. More specifically, what does that
mean as far as companies making their decision to go public,
not to go public, and the impact of that on job and wealth
creation? Do you have any hard data on what these actual costs
may be and how CEOs and boards are deciding on the decision of
going public? Again, why don't we start with you, Mr. Quigley.
Mr. Quigley. I view the cost of Sarbanes-Oxley compliance
as a new element of the cost of capital. It is an issue that
management must evaluate as they look at their various
financing alternatives for their growth plans. I believe that
in return for the privilege of becoming the steward of the
public's money, if that is in fact the vehicle you use to
finance your growth plans, you have to be willing to step up
and pay these costs that go with that stewardship
responsibility.
There is lots of liquidity in private equity. There is lots
of liquidity in banks and insurance companies to finance growth
plans through private transactions if you do not want to pay
the cost of participating in the public markets.
Mr. Hensarling. I see my time is just about to run out.
Perhaps other answers could be submitted in writing. I had one
other question. I saw a particularly critical report from a
study from the Cato Institute on Sarbanes-Oxley that says it
has so many ambiguities and contradictions that companies are
faced with draconian punishments for vaguely defined offenses,
which is somewhat following up on my colleague Mr. Artur Davis'
line of questioning. I was just curious to know to what extent
do you see ambiguities and contradictions that need to be
addressed in the legislation? Having said that, I see I am out
of time, Mr. Chairman, so those answers will have to wait for a
later time.
The Chairman. I would have the witnesses respond, if
anybody has a particular response. Mr. Del Raso?
Mr. Del Raso. As the lawyer, I would tell you that this is
not really a lot different than any other regulatory or
legislative act that we work with. We have had the securities
laws around for all these years, and Mr. Hills knows this all
too well. That is why you have a system in place where you deal
with the regulators. You either request positions from them,
either in interpretive letters or through rulemaking, or you
come back to the legislative side and ask for changes.
But I think what you are finding here is every day that
passes since the act went into effect, the questions are
probably a little more easily answered. There was a lot of work
that was done in the very beginning. So I think that you will
never get to ground zero with respect to having no issues or no
questions with regard to any type in either the legislative or
regulatory framework you are working in.
The Chairman. Thank you.
The gentlelady from New York.
Mrs. Maloney. Thank you.
Mr. McDonough in testimony before this committee brought up
the idea that possibly we should have two standards, one for
larger companies and one for smaller companies for the
enforcement of Sarbanes-Oxley. Many smaller companies are
complaining that the burden is too great for them. I would like
a response in writing to that.
But in my brief time, I would like to focus on something
that Mr. Trumka brought up in his testimony and ask the other
witnesses to comment on it further. We made a promise in
Sarbanes-Oxley, but broke it this week on the floor. That
promise was our promise to insist that companies tell investors
the truth about their financial status. We said that we would
insist on transparency and that we would empower the SEC to
enforce that promise.
Yet just 2 days ago, the House passed legislation that has
the exact opposite purpose and effect. H.R. 3574, the stock
options bill, walks away from our commitment to investors. It
walks away from our commitment to independent standard setting,
in the interest of a few companies that do not want to show
investors the true cost of their stock options that they pay
their employees. The bill passed the House overwhelmingly,
despite the opposition from every single financial luminary
from Alan Greenspan, who reiterated his opposition to the bill
yesterday literally in this room before the committee in a
hearing, to Arthur Levitt, to Warren Buffett, to John Bogel, to
Bill Donaldson, John Snow, all four big accounting firms and
many others.
Today, it is getting slammed in the financial press
precisely because that bill violates the premise of Sarbanes-
Oxley. I request permission to place that article in the
official record of this committee.
The Chairman. Without objection.
Mrs. Maloney. I deeply believe, and I have really been
extremely upset about this vote, that Sarbanes-Oxley is the
most important and significant corporate governance bill that
Congress has passed since the 1934 act. Like the 1934 act, it
was a necessary response to a grave situation in order to
restore investor confidence.
Although we have made some improvement, we have some
unfinished business. My main question to the panel today is, do
you believe that the principle of independent standard setting
and SEC oversight was a critical part of Sarbanes-Oxley, and I
would say the 1934 act? And if so, how much damage did we do
with the stock options bill? On this precise point, I had an
amendment which likewise failed on the floor, which merely
reinstated the authority that the SEC has had since 1934 to
override rules if they see fraud or the public interest
jeopardized. That failed on the floor.
So I invite all the panelists to answer. I would like to
start with Mr. Trumka and Mr. Hills, since he is a former chair
of the SEC, and then of course the big four, Deloitte Touche,
and everyone if you would like. Thank you.
Mr. Trumka. My testimony, I think you have just reiterated
most of my written testimony. We think it sends the absolute
wrong message at this time. We think it paints a roadmap for
CEOs that want to cover and prevent investors and would-be
investors from knowing what the real costs of their salary is,
and what the real costs to the corporations are, and allows
them to hide it.
The bill that was passed only purports to make the top five
people report those expenses. The other people at the bottom,
it pretends like it does not exist, so it is intellectually
incompatible. Then it does something that I think is the
world's greatest fiction. It says that stocks are nonvolatile.
If anybody believes that stocks are nonvolatile, I have some
beachfront property in southwestern Pennsylvania that I would
sell them.
We think it has done tremendous damage and we think it
sends the wrong message. It says to CEOs that if you put on a
big enough effort, you can overturn all the good and the
momentum that has been built up by Sarbanes-Oxley and in fact
reverse what the experts in the field say is necessary.
The Chairman. The gentlelady's time has expired. We would
ask for just some brief responses to the gentlelady's question.
We are going to have votes momentarily on the floor of the
House and I would like to complete the hearing.
Mrs. Maloney. Mr. Hills?
Mr. Hills. Of course, it has not done any damage yet. I am
very much in favor of independent standards. I am very much in
favor of allowing information in, not keeping it out. The fight
over options pricing is in many respects a sad fight. The
information in a balance sheet in the 10Ks tells any analyst
worth his salt how many options are there and what it costs.
The question is, why not put it in the profit-and-loss
statement? It should be in the profit-loss statement because
everything else is in there.
The issue is how do you treat the profit-and-loss
statement. I will just go back to the quote I gave you at the
end of my testimony, and that is this constant reliance upon
the brittle illusion of accounting exactitude. The problem is
that by throwing it in there, too many analysts are going to
take more from it than they should, and therefore much of the
industry does not want it in there. My own view is that the
world has wised up to the fact that whether it is in or not is
not going to make much difference because the analysts now do
understand that stock options have a cost.
So I am in favor of it. I am sorry there is such a fight
about it.
Mr. Quigley. Congresswoman, I would just quickly comment
that I, along with the other three CEOs of the big four firms,
signed the letter that you referenced. I support fully private
sector standard setting and believe it is one of the factors
that has made our capital markets the envy of the world.
The Chairman. The gentleman from Ohio, Mr. Tiberi.
Mr. Tiberi. Mr. Del Raso, we have heard since the passage
of Sarbanes-Oxley from some different public companies
complaining about the legislation. You have counseled foreign
companies. You have traveled overseas. What are you telling
them? Can you give us the state of foreign affairs right now
with respect to this issue?
Mr. Del Raso. I think when the legislation first passed,
there was some real concern and trepidation about the fact that
the foreign issuers, especially larger ones, thought it was
intrusive. Why should they have to comply? Well, if they want
to access our capital markets, that is a cost of doing business
here, but more importantly it was to stabilize global markets
because we are such a large player.
I think, though, in the light of some of their own scandals
that came home to roost in their countries, most notably just
in the last year or so, the Parmalat scandal in Italy and some
others, they are even more keenly aware of what we were faced
with and the importance of this type of legislation. If you do
take a look at what has happened overseas, they will in their
legal process set up their own investigation and prosecution. I
do hear from the diplomats or even the foreign business
executives, than they do envy our system because it works much
more efficiently and fairly than their inquisitorial systems
which in some countries are worse.
Mr. Tiberi. Thank you.
Mr. Quigley, in your testimony you stated that a final
human resources aspect of Sarbanes-Oxley that is worthy of note
is the increased personal risk that our partners and
professionals perceive about our profession. The stress creates
long-term impact on the ability to attract and retain people.
In addition to that statement, are you concerned about the
future of the your industry, with that issue and the issue of
the increase of liability that you face and your partners face?
Mr. Quigley. It is the single biggest cloud associated with
the future of the profession. I, though, am very optimistic
about that future and believe we will find a way to try to
manage our way through that. I hope one day we can have
meaningful securities law and other tort reform that can take
that very, very large cloud off the horizon.
Fifteen cents of every audit dollar that we collect is
required for litigation, claims and insurance costs. That is an
enormous cost on our business, on our operation, and frankly
does reflect somewhat the burden that our partners feel
associated with this aspect of practicing public accounting.
Mr. Tiberi. Mr. Chairman, I yield back my time.
The Chairman. The gentleman yields back.
The gentleman from Staten Island.
Mr. Fossella. Thank you, Mr. Chairman. Welcome and thank
you to the panel. I thank you, Mr. Chairman, being the last, I
know I get unlimited amount of time to ask questions. I
appreciate that as always.
The Chairman. Yes, we always play that game.
[Laughter.]
Mr. Fossella. I thank the panel, and especially welcome Mr.
Caplan in moving so aggressively at E*TRADE and doing the right
thing. And my friend Mr. Quigley, thank you for coming and
offering as always insightful testimony.
Briefly following up on what Mr. Tiberi just talked about,
and that is, to what degree, if at all, should we be concerned
with the flow of capital from foreign countries? For example, I
know John Thain, who is the CEO of the New York Stock Exchange,
has argued that some of the new governance requirements may
scare some of the foreign firms. I think he has indicated that
the number of IPOs have been down relative to prior years.
Whereas the head of NASDAQ has said there should not be
concern, or more to the point, has not slowed down the IPO
pipeline.
Just out of curiosity, why is there a disconnect? Is it
because, as has just been indicated, that now these nations are
going to their own problems, so therefore we should not lower
our standards until they raise theirs? I was wondering if you
can offer anything on that.
Secondly, from Mr. Quigley, a two-prong question. One, in
your testimony you seem concerned about the new requirements,
the shortening of filing time, as opposed to the concern
regarding internal control assessments and attestations. I
guess as you say, you are concerned about the quality of
financial reporting, again not intended, but that could be in
place. And next week, you are going to offer to the SEC that
that extension on the filing deadline be delayed by a year.
If you can shed some light on why you think that is a
concern and why that should be modified. I will just leave it
at that. So for the first question, if someone can chime in.
Mr. Caplan. I would say it is probably not the first and it
will not be the last time you will have a difference of opinion
between NASDAQ, Mr. Greifeld and Mr. Thain with respect to the
New York Stock Exchange. Having lived first-hand some of the
issues around governance, I would tell you that certainly our
view is that corporate governance really should have no
boundaries. Watching first-hand in the part of our business
that deals with equity trading, the importance of investor
confidence and the return of that investor confidence, nothing
should be allowed to shake that.
I think if you do not extend it to companies who want to
access capital in the United States, regardless of where they
are abroad, you really pose too great a risk, because if
ultimately there is a problem, it will shake investor
confidence again. I have watched the behavior of our customers
in these last 2 years. One of the things that is interesting is
that we sent a survey out to our customers about a year after
Sarbanes-Oxley was enacted, and asked them were they more
willing in light of general governance to trade. There was a 37
or 38 percent increase as a result of that.
So generally speaking, I think you are seeing the recovery
in the marketplace due to what is happening economically, but I
also think you are beginning to see a rebound in confidence. I
really feel confident that we should not allow anything to
shake that. If somebody wants to access capital in the United
States, it is the cost of doing business.
Mr. Quigley. Just to comment quickly with respect to the
Sarbanes-Oxley 404 and its impact with respect to the
accelerated filers, as we shorten that filing period to 60
days, I do not know how many, but some registrants are going to
find as we get towards the end of February an enormous
pressure. I believe that additional 2 weeks could be valuable
to the registrants, to the auditors and could contribute to the
quality of reporting this year. Accelerating from 75 to 60 days
and overlaying the internal control reporting are two very
significant changes that were not contemplated at the time the
initial accelerated dates were put in place by the SEC. That is
why we are going to recommend deferring for 1 year.
Mr. Fossella. Just finally, Mr. Quigley, are there any
State provisions that in your opinion conflict with Sarbanes-
Oxley? If so, is this a problem?
Mr. Quigley. There are States that are talking about
broadening the application of Sarbanes-Oxley provisions to
other than public companies. There are some States that are
also debating whether they need their version of Sarbanes-
Oxley. I am concerned about the complexity and the cost that
continuing to layer additional levels of regulation on top of
this through the States would not be a good move at this
juncture.
Mr. Fossella. Okay. Thank you, Mr. Chairman.
Thank you, gentlemen.
The Chairman. The Chair wants to thank all of you profusely
for what has been an excellent tutorial and review of the
Sarbanes-Oxley Act. I think it was an opportunity for all of us
to talk about the highlights and perhaps some of the changes
ultimately that we need to make, though it has never been
perfect legislation. For that, we are most appreciative of your
candor and your expertise.
The committee stands adjourned.
[Whereupon, at 12:21 p.m., the committee was adjourned.]
A P P E N D I X
July 22, 2004
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