[Congressional Record Volume 148, Number 92 (Wednesday, July 10, 2002)]
[Senate]
[Pages S6561-S6567]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]
THE NEED TO ENACT ACCOUNTING AND CORPORATE REFORMS
Mr. LEVIN. Madam President, this week we will hopefully act with
strength and unity to help bring confidence back to the investing
public. The last 18 months have shaken the foundation of the public's
belief in the accuracy of the financial statements of our major U.S.
corporations, beginning with the precipitous fall of Enron last year.
The Public Company Accounting Reform and Investor Protection Act
sponsored by Senator Sarbanes and reported last month by the Banking
Committee, will make significant headway in restoring the needed
confidence in our financial markets, and I strongly support it. Senator
Sarbanes and the supporters of this bill on the Banking Committee have
shown vision and leadership in tackling the tough issues of corporate
and auditor misconduct, and the Congress needs to enact this
legislation as quickly as possible.
On Monday, July 8, in my role as chairman of the Permanent
Subcommittee on Investigations, I released an official Subcommittee
report on the role of the Board of Directors in Enron's collapse. This
bipartisan report found that much of what was wrong with Enron--from
its use of high risk accounting, extensive undisclosed off-the-books
activity, conflict of interest transactions and excessive executive
compensation--was not hidden from the company's directors but was known
and permitted to happen. The report also found that Enron board members
refused to admit any missteps, mistakes, or responsibility for the
company's demise. The refusal of the Board to accept any share of blame
for Enron's fall is emblematic of a broader failure in Corporate
America to acknowledge the ongoing, widespread problems with misleading
accounting, weak corporate governance, conflicts of interest, and
excessive executive compensation. Corporate misconduct is not only
fueling a loss in investors confidence, but also threatens to derail
the recovery of the American economy.
The plain truth is that the system of checks and balances in the
marketplace designed to prevent, expose, and punish corporate
misconduct is broken and needs to be repaired. Action is critically
needed on a number of fronts to restore these checks and balances.
American business success is a vital part of the American dream. That
dream is that any person in this country who works hard, saves, and
invests can be a financial success. If that person sets up a company,
that company's success can be magnified through our capitalist system
which allows other investors to buy company stock, invest in the
company's future, and share in the company's financial rewards.
The American stock market is part of that American dream. In recent
years it has been the biggest and most successful stock market in the
world, an engine of growth and prosperity. It has not only brought
capital to a company so they can set up new businesses and employ more
people, it has brought financial rewards to individual investors who
put their money in the market.
Over the years, the Government has developed checks and balances on
the marketplace to put cops on the beat to try to make sure that people
who are using other investors' money play by the rules. That is why we
have the Securities and Exchange Commission, the Commodity Futures
Trading Commission, and banking regulators. That is why we have rules
requiring publicly traded companies to issue financial statements and
why we have accounting standards to make those financial statements
understandable and honest. That is why we require companies to submit
their books to auditors and why auditors certify whether the financial
statements fairly present the company's financial activity.
Today we are in the middle of another ugly episode. In the aftermath
of the go-go 1990s where American business grew at breakneck strength,
the famed high-tech bubble inflated stock prices and the stock market
got tagged with the strange new phrase ``irrational exuberance.''
Company after company, especially in the high-tech sector, announced
profits that increased by huge percentages year after year. Mergers and
acquisitions proliferated, and corporate fees went through the roof.
Executive pay skyrocketed. The highest paid executives made as much as
$700 million in a single year. By 2000, average CEO pay at the top 350
publicly traded companies topped $13 million per executive CEO, while
the workplace pay gap deepened. In 1989, CEO pay was 100 times the
average worker pay. By the year 2000, it was 500 times.
Some pointed to this alleged prosperity during the 1990s as a
justification for deregulating business, weakening regulators, and
making it harder
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to seek corporate insiders and advisers. But now we are learning that
some portion of the success and profits claimed by the companies during
the 1990s--we still don't know how much--were based on corporate
misconduct.
Lies about income and profits, hidden debt, improper insider trading,
tax evasion, conflicts of interest--the list of recent corporate
malfeasance is an alphabet of woe.
Adelphia Communications. This is a publicly traded company, but the
company founders, the Rigas family, are accused of using the company
treasury as if it were the family piggy bank. The allegation is that
the family borrowed from the company over $2 billion--yes, billion--and
has yet to pay it back. The company recently declared bankruptcy under
Chapter 11.
Dynegy. This high tech energy firm is under SEC investigation for
possibly inflated earnings and hidden debt. The questions include how
it valued its energy derivatives, whether it booked imaginary income
from capacity swaps with other companies, and whether it manipulated
the California energy market. Senior executives, including CEO Chuck
Watson, have recently been forced out.
Enron. This high tech company epitomizes much of the corporate
misconduct hurting American business today, from deceptive financial
statements to excessive executive pay. Its executives, directors,
auditors and lawyers all failed to prevent the abuses, and many
profited from them.
Global Crossing. This is another high tech corporate failure with
outrageous facts. Less than 5 years old, Global Crossing was founded in
1997 by Chairman of the Board Gary Winnick. In 1998, the company went
public, touting its plans to establish a worldwide fiber optic network.
Global Crossing gave Mr. Winnick millions of dollars in pay, plus
millions more in stock and stock options. In the 4 years the company
traded on the stock market. Mr. Winnick cashed in company stock for
more than $735 million. Other company insiders sold almost $4 billion
in company stock. Then questions began to arise about inflated
earnings, related party transactions, insider dealing, and board of
director conflicts. In January 2002, the company suddenly declared
bankruptcy. The company's shareholders and creditors have lost almost
everything, while corporate insiders have so far walked away with their
billions intact.
Halliburton. The question here is whether this construction company
improperly booked income from contract cost overruns on construction
jobs, before the company actually received the income. The company is
under SEC investigation.
IBM. This all-American company, once a model of American know-how and
can-do, has recently acknowledged misreporting about $6 billion in
revenue and restated its earnings by more than $2 billion. Another high
tech disaster for investors and American business.
ImClone. ImClone's CEO, Samuel Waksal, has been indicted for insider
trading. The company produced a new drug whose effectiveness is still
in question and whose developer, Dr. John Mendelsohn, was not only an
ImClone board member but also the President of M.D. Andersen Cancer
Center in Texas. Dr. Mendelsohn arranged for the Center to conduct
tests on the drug without telling patients that the Center's President
had a direct economic interest in the drug's success. Dr. Mendelsohn
was also a board member at Enron.
Kmart. This once successful company, headquartered in my home state
of Michigan, is now bankrupt and under scrutiny by the SEC for possible
accounting fraud. The pain of the employees who lost their jobs and the
investors who lost their savings is ongoing, not only in Michigan but
across the country.
Merrill Lynch. Once a highly respected investment advisor, this
company has become a poster child for financial advisors who mislead
their investors, telling them to buy the stock of companies the
advisers privately think are losers. Merrill Lynch recently paid $100
million and agreed to change how its financial analysts and investment
bankers operate to settle a suit filed by New York Attorney General
Elliot Spitzer.
Qwest Communications. This is another high tech company under SEC
investigation. Questions include whether it inflated revenues for 2000
and 2001 due to capacity swaps and equipment sales. Qwest's CEO Joe
Nacchio, made $232 million in stock options in 3 years before the stock
price dropped, leaving investors high and dry. Its Chairman Philip
Anschutz made $1.9 billion.
Rite Aid. Last month, three former top executives of Rite Aid
Corporation, a nationwide drugstore chain, were indicted for an illegal
accounting scheme that briefly--until WorldCom--qualified as the
largest corporate earnings restatement in U.S. business history. The
restatement involved $1.6 billion. The indictment alleges that the
company used brazen accounting gimmicks to overstate its earnings
during the late 1990s, and when investigators came after them, made
false statements and obstructed justice.
Stanley Works. This company is a leading example of U.S. corporations
that have pretended to move their headquarters to Bermuda to avoid
paying U.S. taxes. It joins a growing number of companies that want to
go on enjoying US banks, US laws, and US workers, but do not want to
pay their fair share of the costs that make this country work from the
costs of public education, to police and the courts, to environmental
protection laws. To me, these companies are not just minimizing their
taxes, they are demeaning their citizenship. They are taking advantage
of this country by enjoying its fruits without giving anything back. No
company ought to be allowed to get away with this fiction and throw
their tax burden on the backs of other US taxpayers.
Tyco International. Last month, the CEO of Tyco, Dennis Kozlowski,
was indicted in New York for failing to pay sales tax due on millions
of dollars of artwork. The allegation is that Mr. Kozlowski shipped
empty boxes to New Hampshire in a scam to show that $13 million worth
of artwork was sent out of state and exempt from sales tax when, in
fact, the artwork never left New York. This is a millionaire, many
times over, who could have easily afforded the tax bill but engaged in
a sham to avoid paying it. The question is whether he ran his company
the same way he ran his own affairs.
Tyco is one of those companies that has allegedly moved its
headquarters to Bermuda. It has numerous offshore subsidiaries,
including more than 150 in Barbados, the Cayman Islands and Jersey. The
company's U.S. tax payments have apparently dropped dramatically.
Allegations of corporate misconduct by insiders have also emerged.
There was a $20 million payment made to one of the company's directors
and another $35 million in compensation and loans paid to the company's
former legal counsel. That's $55 million paid to two corporate
insiders, allegedly without the knowledge of the Board of Directors.
Added to that is an ongoing SEC investigation allegedly examining
whether a Tyco subsidiary paid bribes to win a contract in Venezuela.
WorldCom. WorldCom is the latest in this list of corporate
embarrassments. It built a glowing earnings record through the
acquisition of high tech companies like MCI and UUNet. It became a
favorite investment for pension companies, mutual funds and average
investors. Then we learn that the longtime CEO Bernard Ebbers borrowed
over $366 million in company funds and has yet to pay it back. After
he's forced out and a new CEO takes over, we learn that the company
booked ordinary expenses as if they were capital investments in order
to string out the expenses over several years and make the current
bottom line look great. The result was $3.8 billion that had been
conveniently left off the books--more than enough to wipe out the
company's entire earnings for last year; more than enough for 17,000
workers to lose their jobs; more than enough to wipe out billions in
investments across the country. Just one example in Michigan is the
Municipal Employee's Retirement System which lost $116 million that
supported workers' pensions. At the same time, we're told that Mr.
Ebbers has a corporate pension that will pay him over $1 million per
year for life.
Xerox. This all-American company has already paid $10 million to
settle an SEC complaint that, for four years, the company used
fraudulent accounting to improve its financial results. As
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part of the settlement, Xerox agreed to restate its earnings after
allegedly recording over $3 billion in phony revenues between 1997 and
2000.
This list is painful in part because it includes some icons of
American business, symbols of what was right about the American dream.
Now they symbolize corporate misconduct damaging to the entire country.
The S&P index has plunged. The Nasdaq has been down 20% and even 30%.
Mutual funds, the equity of choice for average investors, have dropped
in value by more than 10%. The average daily trading volume at Charles
Schwab & Co.--a measure of average investor activity--is down 54% from
the height of the bull market, according to Fortune Magazine. Investor
confidence in the U.S. stock market has dramatically declined. Foreign
investment is fleeing.
There are many explanations for the corporate misconduct now tainting
American business. One key factor is the terrible performance of too
many in the accounting profession.
Auditors play an essential role in the checks and balances on the
corporate marketplace. Under current law, a publicly traded company is
not allowed to participate in the stock market unless its financial
statements have been audited and found by an independent public
accounting firm to be fair and honest. Auditors are supposed to be the
first line of defense against companies cheating on their books.
The Supreme Court put it this way in United States v. Arthur Young,
465 U.S. 805, 1984, a case that contrasts the role of auditors with the
role of lawyers. The Court noted that a lawyer is supposed to be a
client's confidential advisor, but the:
. . . independent certified public accountant performs a
different role. By certifying the public reports that
collectively depict a corporation's financial status, the
independent auditor assumes a public responsibility
transcending any employment relationship with the client . .
. [and] owes ultimate allegiance to the corporation's
creditors and stockholders, as well as to the investing
public. . . . This `public watchdog' function demands that
the accountant maintain total independence from the client at
all times and requires complete fidelity to the public trust.
But that's not what has happened recently.
In Adelphia, the auditors, Deloitte Touche, allegedly missed the fact
that the Rigas family borrowed company funds totaling $2 billion.
At WorldCom, Andersen allegedly never knew that $3.8 billion in
expenses had been incorrectly accounted for as capital investments.
At Xerox, KPMG allegedly missed errors involving $6 billion in
revenue and $2 billion in earnings.
These are not marginal amounts; they involve billions. How did the
auditors miss the accounting errors and dishonest financial reports? Or
are these cases like Enron, where the auditor didn't miss the
problems--they knew of them, had misgivings about the accounting, but
allowed questionable transactions and financial statements to go
forward anyway?
And there are many more cases than the high profile scandals I just
described. In the last few years, there has been a surge in corporate
restatements--financial filings in which a publicly traded company
admits that a prior financial statement was inaccurate and corrects the
earlier information. From 1990 through 1997, publicly traded companies
averaged 49 of these restatements per year. In 1999 and 2000, that
number tripled--publicly traded companies filed about 150 each year.
These restatements go beyond the list of companies I started with,
reaching much deeper into corporate America. In addition to those
already reported in the media over the last few years, I asked the
Congressional Research Service to look at the most recent corporate
restatements, those filed since January of this year. On June 17th, CRS
issued a report listing over 100 completed and expected restatements in
the first six months of 2002, and predicted that the total number of
restatements in 2002 may exceed 200. A smattering of these
restatements, another alphabet of corporate woe, include the following.
American Physicians Service Group. This health services company
restated its 2000 and 2001 earnings due to a revaluation of a private
stock investment.
CMS Energy Corporation. This energy company, which has operations in
Michigan, has restated its 2000 and 2001 financial statements to
include $4.4 billion in revenues attributable to ``wash trades'' with
other companies involving energy commodities.
Dollar General Corporation. This company has restated its financial
results for three years, 1998 through 2000.
Hanover Compression. This company has restated its earnings for seven
quarters in a row, ending September 2001.
Microsoft. Following an SEC investigation, the flagship American
company agreed to restate its earnings for 1995 through 1998, when it
used accounting devices to ``smooth'' its reported earnings.
PNC Financial services. This financial services company has restated
its financial results for 2001 after questionable accounting under
investigation by the Federal Reserve and SEC involving the sale of over
$700 million in problem loans and other non-performing assets to three
companies it set up with the insurance conglomerate, American
International Group.
Pacific Gas & Electric. This energy company has announced that it
will restate its earnings back to 1999 to account for off-the-books
``synthetic leases'' involving about $1 billion in financing for
several power plants.
Peregrine Systems. This company announced it would restate earnings
for 2000, 2001, and 2002, and that an SEC investigation was in
progress.
Stillwater Mining Co. This company announced that the SEC had
criticized its accounting practices and a restatement of earnings would
be issued.
There are many more examples. What is happening that more and more
financial results have to be restated, erasing more and more questions
about the reliability of the original financial reports? Why this surge
in corporate restatements?
Part of the answer is that too many accounting firms apparently no
longer value in their watchdog role. Today, they celebrate instead the
earnings they receive as tax advisers and business consultants.
During the 1990s, all the major accounting firms dramatically
increased the non-audit services they provided to their audit clients.
By 1999, 50% of firm revenues at the big five accounting firms came
from consulting, while only 34% came from auditing. A few years later,
the data indicates that almost 75 percent of the fees earned by the big
five accounting firms came from non-audit services. Specific company
proxy statements show that many publicly traded companies now pay
millions more for consulting than they do for auditing, including such
companies as Raytheon, Apple Computer, Nike, International Paper, At&T,
Honeywell and Coca-Cola. A January 2002 Harvard Business School
publication raising questions about auditor independence cited
anecdotal evidence that accounting firms were using their positions as
auditors to obtain consulting work, including by ``lowballing'' audit
fees if a company simultaneous agreed to a consulting contract. The
work done by the Permanent Subcommittee on Investigations, which I
chair, includes evidence that accounting firms are shopping around to
publicly traded companies, including their audit clients, complex
accounting arrangements that they say will improve a company's
financial results and pending complex tax strategies that will lower
its tax bills.
The role of Arthur Andersen at Enron illustrate the profession's
movement from auditor to moneymaker, Andersen was Enron's outside
auditor from the company's inception in 1985. As Enron grew, Andersen's
role at the company grew, with more and more of Andersen's time spent
on financial services other than auditing.
Andersen began to offer Enron business and tax consulting services
which included assistance in designing special purpose entities,
offshore affiliates, and complex structured finance transactions. For
example, Andersen was paid about $5.7 million to help Enron design the
LJM and Chewco partnerships and engage in a series of purported asset
sales to these entities. Andersen was paid more than $1.3 million to
help Enron set up the Raptors, a series of four complex transactions
that were an improper attempt by Enron to use the value of its own
stock to offset losses in its investment portfolio. Andersen also
helped Enron engage in
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ever more exotic and complex transactions, such as prepaid forward
contracts, swaps, and merchant asset sales. For two years, Andersen
even acted an Enron's internal auditor while also serving an Enron's
outside auditor.
By 1999, Andersen was earning more for its non-audit services than
for its audit services at Enron. By then, Andersen had set up its own
offices at the company site to enable it to work with Enron employees
on a daily basis. A number of Andersen employees switched to Enron's
payroll. Enron became one of Andersen's largest clients, In 2000,
Andersen was paid $1 million per week for the many services it was
providing Enron. Andersen partners handling the Enron account earned
millions in bonuses and partnership income.
Common sense tells us that as Andersen's joint efforts with Enron
management increased, it became tougher and tougher for Andersen
auditors to challenge Enron transactions--after all, these transactions
had been set up with Andersen's assistance at the cost of millions of
dollars. How could Andersen auditors say that Andersen consultants were
wrong? And in many cases the same Andersen employee served as both
consultant and auditor, essentially auditing his or her own work. We
now know that internal Andersen documents demonstrate serious
misgivings up and down the Andersen chain of command with respect to
Enron's transactions or accounting. To the contrary, one of the few
Andersen senior partners to raise gentle objections to some Enron
transactions was, at Enron's request, removed from the Enron account.
In the end, Andersen approved questionable transactions and financial
statements that made Enron's financial condition appear better than it
was.
Andersen once had a proud tradition that stressed its commitment to
the public trust to ensure accurate financial reporting and honest
accounting. But that tradition gave way in the Enron case. And it give
way in other recent cases of corporate misconduct as well, from Sunbeam
to Waste Management to the Baptist Foundation of America.
Worse, Andersen was not alone. Media reports are filled with tales of
auditors going along with questionable transactions and financial
reporting. PricewaterhouseCoopers and Microstrategy. Ernst & Young and
PNC Financial. Deloitte Touche and Adelphia. KPMG and Xerox.
The conflicts of interest inherent in auditors performing consulting
services for their audit clients have been building for years and were
not lost on those concerned about accurate financial reporting by U.S.
companies. In 2000, SEC Chairman Arthur Levitt waged a highly visible
campaign to rein in auditor conflicts of interest and restore auditor
independence. In July 2000, under his leadership, the SEC proposed
regulations to stop auditors from providing certain non-audit services
to their audit clients. The rules proposed four principles to determine
whether, in fact and in appearance, an accountant was independent of
its audit client. The proposed regulations stated that an accountant
would not be considered independent if the accountant: (1) had a mutual
or conflicting interest with the audit client; (2) audited the
accountant's own work; (3) functioned as an employee of the audit
client; or (4) acted as an advocate for the audit client. Using these
four principles, the regulations proposed a ban on audit firms
performing certain non-audit services for their audit clients.
The reaction of the accounting profession was to fight the proposal
tooth and nail. The proposed regulations were also pummeled by the
corporate community, which lost sight of how important reliable
financial statements and reliable auditors are to the viability of
American business and investment.
In the end, the proposed Levitt regulations were gutted. Instead of
eliminating auditor conflicts, a compromise emerged that simply
increased disclosure of the scope of the conflicts and the extent to
which auditors were auditing their own work. That was the wrong result,
which I hope the Senate will remedy through enactment of the Sarbanes
bill.
What happened to the board?
In U.S. corporations, Boards of Directors are at the top of a
company's governing structure. According to the Business Roundtable,
the Board's ``paramount duty'' is to safeguard the interests of a
company's shareholders. Persons who serve on corporate boards are
required by state law to serve as fiduciaries to the shareholders and
employees of the corporation for which they serve. As the Fifth Circuit
said in 1984:
Three broad duties stem from the fiduciary status of
corporate directors: namely, the duties of obedience, loyalty
and due care. The duty of obedience requires a director to
avoid committing . . . acts beyond the scope of the powers of
a corporation as defined by its charter or the laws of the
state of incorporation. . . . The duty of loyalty dictates
that a director must not allow his personal interest to
prevail over the interests of the corporation. . . . [T]he
duty of care requires a director to be diligent and prudent
in managing the corporation's affairs.
One of the most important duties of the Board--along with corporate
officers and company auditors--is to make sure that the financial
statements are in fair representation of the company's financial
condition. It requires more than technical compliance; it requires, as
the Second Circuit Court of Appeals said in 1969, that the Board ensure
that the financial statement ``as a whole fairly present[s] the
financial position'' of the company.
The key committee of a board in carrying out that function is the
Audit Committee, and a Blue Ribbon Commission in 2000 issued a report
on what Audit Committees should do to meet their obligation to the
shareholders. Among the responsibilities the Audit Committee should
meet are: ensuring that the auditor is independent and objective;
assessing the quality, not just the acceptability, of an auditor's
work; discussing with the auditor significant auditing issues; and
making sure that the financial statement are ``in conformity with
generally accepted accounting principles.''
As I mentioned at the beginning of this statement, the Permanent
Subcommittee on Investigations, which I chair, looked in depth at the
actions of the Board of Directors on the Enron Corporation in light of
its sudden collapse and bankruptcy. The Subcommittee on a bipartisan
basis found that the Enron Board failed to safeguard Enron shareholders
and contributed to Enron's collapse. If failed, we found, because the
Board allowed Enron to engage in high risk accounting, inappropriate
conflict of interest transactions, extensive undisclosed off-the-books
activities, and excessive executive compensation. Based on review of
the hundreds of thousands of Enron-related documents by the PSI staff
and dozens of interviews, the Subcommittee concluded that the Board
knew about numerous questionable practices by Enron management over
several years, but it chose to ignore these red flags to the detriment
of Enron shareholders, employees, and business associates. In short,
the Enron Board failed to meet its fiduciary responsibility to the
shareholders and employees of Enron.
When pressed to explain their conduct at a PSI hearing, the Board
accepted no responsibility for Enron's failure. The Board members
claimed they didn't know what was going on in the company--that
management didn't tell them, and that the auditor, Arthur Andersen,
told them everything was OK. The Subcommittee didn't accept that
answer, because a review of the documents, the Board meetings, the
Audit and Finance Committee meetings, and interviews with the Board
members revealed that the Board Members did know what was happening at
Enron and went along with it.
The Board failed with respect to the Enron Corporation, and my guess
is that the boards of the other corporations now under investigation
for investor fraud and auditing misconduct will fare little better.
Although the performance of corporate boards in American corporations
must be addressed by the corporations themselves, Congress must also do
everything it can to ensure that this important watchdog of corporate
governance operates properly in each U.S. company.
What happened to other corporate players?
The auditors and the Boards of Directors are not the only ones with
oversight responsibility for corporate conduct who have let down the
investing
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public. Top-name law firms wrote legal opinions that allowed some of
the worst deceptions to go forward. Financial analysts who depend upon
large corporations for investment banking business and at the same time
promote the stock of those corporations to their clients, operate with
clear conflicts of interest. They may know inside information about the
financial condition of the companies with which they do business, but
keep that information from the investors to whom they are promoting the
company stock.
What needs to be done now?
The Sarbanes bill, with additional amendments, will address the
duties and failings of their corporate players. After 10 days of
hearings, the Banking Committee has reported to the Senate floor a bill
that significantly addresses not only the audition failures, but
failures of corporate governance and conflicts with financial analysts.
I understand there may be an amendment to hold the legal profession
accountable as well.
We have got to take action on this legislation now, this Congress. We
need to restore the checks and balances on the marketplace, and we need
to give our cops on the beat the tools and resources to crack down on
corporate misconduct.
We need to change the laws to make it possible to punish corporate
and auditor misconduct swiftly and with appropriate penalties. We need
to ensure that crime does not pay for corporate executives seeking to
profit from corporate misconduct. We need to shake up the auditing
industry and remind them that their profession calls for them to be
watchdogs, not lapdogs for their clients. We need to give SEC
administrative enforcement powers and more funds for investigations and
civil enforcement actions. We need to increase investor protections to
restore investor confidence.
The Sarbanes bill takes many of the actions needed, and I want to
commend the hard work of not only Senator Sarbanes who chairs the
Banking Committee, but also the many other Senators on that Committee
who contributed to this much needed bill. It offers strong medicine,
and it is what this country needs.
On corporate misconduct, the bill presents a number of new provisions
to deter and punish wrongdoing. For the first time, CEOs and CFOs would
be required to certify that company financial statements fairly present
the company's financial condition. If a misleading financial statement
later resulted in a restatement, the CEO and CFO would have to forfeit
and return to the company coffer any bonus, stock or stock option
compensation received in the 12 months following the misleading
financial report. The bill would also make it an unlawful act for any
company officer or director to attempt to mislead or coerce an auditor.
It would also require auditors to discuss specific accounting issues
with the company's audit committee, which will not only increase the
understanding of the company's board of directors, but also prevent
directors from later claiming they were not informed about the
company's accounting practices. The bill would also enable the SEC to
remove unfit officers or directors from office and to bar them from
holding any future position at a publicly traded corporation. These are
powerful new tools to help prevent and punish corporate misconduct.
The Sarbanes bill takes on another great issue of importance that
I've been working on for years, strengthening the independence of the
Financial Accounting Standards Board or FASB, which has the task of
issuing generally accepted accounting principles or GAAP. Among other
important measures, the bill grants statutory recognition to FASB and
sets out its obligation to act in the public interest to ensure the
accuracy and effectiveness of financial reporting; states that the
trustees who select FASB's members must represent investors and the
public, not just the accounting industry or corporate interests; and
streamlines FASB's operations by requiring it to act by majority vote
instead of through a supermajority.
Most important of all, the bill sets up a system that provides FASB
with an independent, stable source of funding through fees assessed on
publicly traded companies. Once this new system is set up, it will no
longer be the case, as it has been for years, that FASB will have to go
hat in hand for funds from the very companies and accounting firms that
want to affect its decisionmaking. I have no doubt that this conflict
of interest has contributed to some of the distortions and weaknesses
in current accounting standards. I proposed a similar change in FASB's
funding status in my Shareholder Bill of Rights Act, and I appreciate
the Committee's including the provision for my bill making it clear
that FASB's funding cannot be affected by the congressional
appropriations process and the political pressures that can be exerted
through it. The point of the bill is to set up an independent, stable
source of funding that is insulated from political pressure and funding
threats so that FASB can do its work free of such pressures and
threats. Once the new funding system is in place, I urge FASB to begin
to reassess U.S. accounting standards and to begin to clear up some of
the problems that have allowed so many companies to engage in dishonest
accounting while claiming to be in compliance with GAAP.
On auditor conflicts of interest, the bill takes concrete action to
stop auditors from providing non-audit services to their audit clients.
For the first time, the bill specifically prohibits auditors from
providing 8 types of non-audit services to their audit clients. The 8
prohibited services are bookeeping services; financial information
systems design; appraisal and valuation services and fairness opinions;
actuarial service; internal auditing services; management functions and
human resource services; broker-dealer, investment adviser of
investment banking service; and non-audit legal or expert services. The
bill also enables a newly established Public Company Accounting
Oversight Board to specify other prohibited services. Any other non-
audit service can be provided by an auditor to its audit client only if
the client's audit committee specifically authorizes the auditor to
undertake the service. While I would have preferred an even stronger
provision barring auditors from providing any non-audit services to an
audit client, this bill makes a meaningful change in law that would
help put an end to auditor conflicts of interest.
Additional work is needed. For example, many of the key terms in the
8 prohibited non-audit services were left undefined after the Banking
Committee, as part of the negotiations over the bill, dropped a
requirement for the SEC to promulgate the July 2000 Levitt regulations
which would have defined many of the terms. If enacted into law, the
new Board and the SEC would need to place a priority on further
defining the key terms in the 8 prohibited services. That task would be
a key test of their willingness to use the bill's authority to
eliminate auditor conflicts of interest and restore auditor
independence.
Let me give you an example. The bill currently prohibits auditors
from providing their audit clients with ``investment banking services''
but does not define this term. Based upon the work of the Permanent
Subcommittee on Investigations into the Enron scandal, I believe it is
crucial for that term to include prohibiting auditors from working with
their audit clients to design special purpose entities and structured
finance arrangements, as investment bankers do, and then audit the
structures they helped to create. In the case of Enron, Andersen was
paid about $7 million to help Enron design the LJM, Chewco and Raptor
structures, which Andersen then audited and approved. That never should
happen. Auditors should not be auditing their own work. To make sure
that this conduct is stopped, the SEC and Board would have to prohibit
it either by further defining the term ``investment banking services''
or by specifying another prohibited service. The public companies'
audit committees could also accomplish this goal by prohibiting the
company's auditor from designing these structures and then auditing its
own work.
In addition to defining the key terms in the 8 prohibited services,
additional work is needed to clarify how auditors and companies are
supposed to treat the issue of ``tax services.'' The bill states
explicitly that an auditor may provide ``tax services'' to an audit
client if the specific tax services are cleared beforehand by the
company's audit committee. There are several
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problems with this approach. First, like investment banking services,
one danger is that an auditor will end up auditing its own work, which
means that a critical check and balance on possible company misconduct
will be circumvented. No auditor should assist a company in designing a
tax strategy to lower the company's tax bill and then also serve as the
auditor approving the accounting for that tax strategy. Two different
parties must be involved--one to design the strategy and one to audit
it for improper accounting and possible illegal tax evasion. A second
problem involves the fees paid for various types of tax services. In
the July 2000 regulations proposed by the SEC under former Chairman
Levitt, concerns were raised about allowing an auditor to provide an
audit client with written opinions related to a tax shelter or other
tax strategy to lower the client's tax bill. Providing these opinions,
especially for complex or questionable tax strategies, can lead to
lucrative fees for an accounting firm and, in so doing, raise the same
conflict of interest concerns that have so damaged auditor
independence.
These and other non-audit service issues needed to be examined by the
Board and the SEC, not only to develop definitions for key terms, but
also to determine whether additional non-auditing services should be
added to the list of 8 prohibited services now specified in the Senate
bill. Audit committees must also confront these issues and take the
steps necessary to prohibit the company's auditor from engaging in non-
auditing services that raise conflict of interest concerns or lead to
an auditor's auditing its own work for the company.
On auditor misconduct and oversight of accounting firms, the Sarbanes
bill offers fundamental change that is sorely needed. The new Public
Company Accounting Oversight Board that the bill would establish is
designed to be free of domination by either accounting or corporate
interests and would enjoy an independent and stable source of funding.
This Board would have several duties including issuing auditing,
auditor independence, and auditor ethical standards; inspecting and
reporting on the internal controls and operations of registered public
accounting firms; and conducting disciplinary proceedings regarding
accountants suspected of wrongdoing.
With respect to investigating possible auditor misconduct, the Board
will have the authority to subpoena documents, take sworn testimony,
and impose meaningful sanctions on individual accountants and
accounting firms found to have engaged in wrongdoing. The sanctions
include revoking the registration that a firm needs to audit public
companies, barring a person from participating in a public company
audit, imposing a civil fine on an individual or firm, and issuing a
censure. The Board must also disclose its disciplinary proceedings to
the public so that we will know what misconduct was involved and what
sanction was imposed.
This provision represents significant improvement over existing
disciplinary proceedings which are dominated by the accounting
industry, secretive, time-consuming, and ineffective. It also has at
least two weaknesses. First, although the bill requires the Board to
issue a public report on any disciplinary proceeding that results in a
sanction on an auditor, the bill is silent on public disclosure of
disciplinary proceedings that do not result in a sanction. The bill
apparently leaves it to the discretion of the Board on whether to
disclose these disciplinary proceedings, but a better approach might
have been to direct the Board to disclose such proceedings when doing
so would be in the public interest. A second, more serious weakness is
that the provision imposes an automatic, unlimited stay on any auditor
sanction imposed by the Board if the sanction is appealed to the SEC.
Until the SEC lifts the stay, the Board is prohibited from disclosing
to the public the name of the auditor, the sanction imposed, or the
reasons for the disciplinary action. These provisions are out of line
with broker-dealer disciplinary proceedings and only serve to prolong
criticisms of auditor disciplinary practices as overly secretive and
slow moving.
On the issue of auditing, auditor independence, and auditor ethical
standards, I fully support making the Board the final arbiter of these
standards. The standard-setting process has for too long been under the
direct control of the accounting industry, and one of the most
important changes the bill makes is to put an end to this arrangement.
Of course, the accounting industry is not and should not be excluded
from the Board's standard-setting process; the bill requires the Board
to engage in an ongoing dialog with the accounting, corporate and
investor communities to take advantage of their expertise. The bill
explicitly requires the Board to ``cooperate'' with any designated
professional group of accountants or any advisory board convened by the
Board to assist its deliberations. The bill also states that the Board
must ``respond in a timely fashion'' to any request for a change in the
standards if the request is made by a designated professional group or
advisory committee. It is important to note, however, that the bill
does not grant any preferential status to these groups compared to
other participants in the standard-setting process, and participants
such as the SEC, state accounting boards, other federal and state
agencies and standard-setting bodies, and investors are entitled to
receive equal consideration from the Board in its standard-setting
deliberations.
On the issue of accounting oversight, the Sarbanes bill again offers
vast improvement over the status quo. The newly created Board offers
oversight authority that will be more independent, more systematic and
more public than the existing system. And, again, one comment. With
respect to the inspection reports that the Board is supposed to
disclose to the public regarding a registered public accounting firm's
operations, the bill states that the Board must develop a procedure to
allow the registered public accounting firm that is the subject of the
inspection an opportunity to comment on the draft report before it is
finalized. I support this process. However, it is also my understanding
after consulting with the Committee, that the bill is not intended to
require the Board to submit the actual text of its draft report to the
subject firm prior to making it public, but rather to inform and
discuss the key points with the firm and provide the firm with a
meaningful opportunity to comment on the Board's analysis, commit to
specific steps to cure any defects in the firm's quality control
systems, and commit to other reforms.
Finally, on the issue of increased resources, the Sarbanes bill takes
long needed steps to beef up the SEC's enforcement staff through
authority to hire new accountants, lawyers, investigators and support
personnel. It also increases the SEC's budgetary authority. Once this
is enacted into law, it will be up to the Bush Administration and the
Appropriations Committees to give the SEC what it needs to respond to
the current wave of corporate scandals and help restore investor
confidence.
There are many other provisions in the bill that I could comment on,
but I will stop here. The bottom line is that the Sarbanes bill is a
strong bill. It provides new tools and resources to go after corporate
misconduct. It offers fundamental change in the way we oversee the
accounting industry and punish auditor wrongdoing. It tackles auditor
conflicts of interest by setting up, for the first time, prohibitions
on the non-auditing services that an auditor can provide to an audit
client. It provides new ways to hold corporate insiders accountable, so
the next time a public company erupts in scandal, the senior officers
and directors can't claim that they were out of the loop and not
responsible.
As strong as it is, the Sarbanes bill would benefit from a number of
strengthening measures. This includes the amendment by Senator Leahy to
strengthen criminal penalties for corporate misconduct and to protect
corporate whistleblowers, which I am cosponsoring, and an amendment by
Senator Edwards to require legal counsel to play a more active role in
deterring corporate misconduct.
I intend to offer several amendments myself.
Administrative penalties: Senators Bill Nelson, Tom Harkin, and I
will offer an amendment to give new authority to the SEC to impose
administrative penalties for corporate wrongdoing. The amendments would
allow
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the SEC to impose civil monetary penalties on persons who violate the
securities laws such as companies, officers, directors, auditors, and
lawyers and to bar unfit officers and directors of publicly traded
corporations without having to go to court to do so. The amendment
would also allow the SEC to subpoena financial records as part of an
official SEC investigation without notifying the subject of the records
request. This amendment would also increase the maximum civil fines the
SEC can impose on securities laws violators under current law and the
new authority provided by this amendments. Today's fines of $6,500 to
$600,000 per violation would increase to $100,000 to $10 million.
Auditor certification. A second amendment I intend to offer would
require that auditors of publicly traded corporation provide a written
opinion on whether a client company's financial statements fairly
present the financial condition of the company. The Sarbanes bill has a
similar provision with respect to CEOs and CFOs. Many think this is
already required of auditors of publicly traded companies, but there is
no provision in current law that imposes such a requirement; there is
only guidance pursuant to SEC regulation.
Auditors communication with board of directors: My third amendment
would require that an auditor of a publicly traded corporation discuss
with the Audit Committee on the Board of Directors the ``quality,
acceptability, clarity, and aggressiveness'' of the company's financial
statements and accounting principles. This amendment will eliminate any
excuse that the Board of Directors of a company didn't know what the
company was doing.
There were many investors and commentators in the 1990's who
expressed their awe of the astronomical growth in the stock market by
saying it was too good to be true. Well, they were right. It was too
good to be true, and now we know that. This bill, particularly with
some strengthening amendments will bring credibility and accuracy back
to the financial statements of our publicly traded corporations. It
will bring reality into the marketplace and make the deceptive
practices of the 1990's the true exception rather than the rule.
I suggest the absence of a quorum.
The PRESIDING OFFICER. The clerk will call the roll.
The assistant legislative clerk proceeded to call the roll.
Mr. NELSON of Florida. Madam President, I ask unanimous consent the
order for the quorum call be rescinded.
The PRESIDING OFFICER. Without objection, it is so ordered.
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