[Congressional Record (Bound Edition), Volume 148 (2002), Part 11]
[Extensions of Remarks]
[Pages 15281-15289]
[From the U.S. Government Publishing Office, www.gpo.gov]




                    CORPORATE ACCOUNTABILITY HEARING

                                 ______
                                 

                        HON. RICHARD A. GEPHARDT

                              of missouri

                    in the house of representatives

                         Friday, July 26, 2002

  Mr. GEPHARDT. Mr. Speaker, I submit the attached document, which is 
the transcript of the corporate accountability hearing conducted by 
Members of the House of Representatives, for printing in the 
Congressional Record.

 Opening Statement by House Democratic Leader Hon. Richard A. Gephardt

       Mr. Gephardt. Thank you all for being here. If I could, I 
     would like to make an opening statement, and then we will get 
     to our first panel, with appreciation for all of our 
     panelists for their time and effort to be here with us today 
     for this important hearing.
       We are honored to have with us today some very talented and 
     special guests, an all-star team of experts on the issue of 
     corporate accountability and responsibility that has become 
     one of the most important issues in our country.
       I think many of us are tired of the old left-right 
     political debates because, to my mind, the issue before us is 
     not about politics but about what's right for our country and 
     how to restore people's trust and faith in our economic 
     institutions. This is a discussion about enacting strong 
     safeguards that will protect investors, protect consumers, 
     and move every American forward with an agenda that gives 
     everyone a chance to succeed.
       We need to apply our values to governing. Our values tell 
     us that accountability and responsibility must be operating 
     principles in our markets, especially for the corporations 
     that form the bedrock of our capitalistic system.
       Sensible rules that enable our companies to function 
     effectively will grow the economic pie for every American 
     taxpayer and every American family. Too many times in the 
     last 7 or 8 years the special interests and extremist voices 
     that would like to get rid of almost all regulations have 
     triumphed in the face of common sense and the sentiment of 
     the majority of the American people. Too often these voices 
     have had a real and, I would submit, destructive impact on 
     our laws and our economic health.
       So today we are here to listen and to learn, not simply to 
     what went wrong but, more importantly, to figure out how to 
     make it right.
       Democrats in Congress have spent months seeking solutions 
     to this crisis, and we are prepared to go to any part of this 
     country to figure out what happened, why it happened, and the 
     best way to fix the problem.
       This week, as you all know, the Senate unanimously passed--
     and I'll say it again, unanimously passed, and that's a rare 
     occasion--a crucial bill that would attack the current crisis 
     of confidence. The Sarbanes bill would bring about structural 
     changes in our auditing system, making sure that audits are 
     objective and independent, while imposing stiff criminal 
     penalties on bad actors and actresses.
       We in the House have been working for months to pass a 
     strong initiative that would also protect people's pensions 
     and restore investors' faith. We have offered a financial 
     services bill, a criminal penalties bill, and an offshore tax 
     havens bill as part of a much more comprehensive business 
     Investors' and Employees' Bill of Rights.
       Unfortunately, the leadership in the House in the 
     Republican Party--and, therefore, the leadership--has blocked 
     these proposals. We have faith that these problems can still 
     be fixed. We have the most ingenious entrepreneurs, the 
     brightest minds leading our way to innovation. And we have 
     the hardest working, most resilient, most resourceful people 
     on the face of the Earth. And for that, we are all grateful.
       And today we pledge to continue to work together in order 
     to do what's simply right for the people that we all 
     represent.
       We thank our guests, and especially my brave colleagues in 
     the Congress who every day speak up for the American people 
     and who helped build this country into the greatest nation 
     that's ever existed.


           PANEL 1: PENSIONS, WALL STREET AND CORPORATE FRAUD

       Mr. Gephardt. I'd like to introduce our first panel.
       What can I say about Eliot Spitzer. He was at this a long 
     time before any of us were focusing on these problems of 
     corporate abuse and accountability. At the State level, he 
     helped to launch a national reform effort to close loopholes 
     and to hold people who don't play by the rules accountable.
       The same goes for Richard Moore, State Treasurer in North 
     Carolina. Richard Moore has worked hard to protect the 
     pensions of all the people in his State. He's understood the 
     fundamental truth, that without transparency and clear rules 
     of the road, our investors get hurt, employees suffer, and 
     our economy does not reach its potential. We're lucky to have 
     him with us today, and we thank him for coming.
       Finally, William White is the CEO of WEDGE Group, an 
     investment firm based in Houston. He's been a private 
     executive elsewhere. He served in the Clinton administration 
     as Deputy Secretary of Energy. He has a broad range of 
     experience that he brings to the table in both the private 
     and public sector, and we look forward to having the 
     perspective of someone with considerable experience in both 
     private and public life.
       I am surrounded by many of my colleagues, who I have 
     enormous admiration for. All of them have been deeply 
     involved in all of these issues of trying to increase 
     responsibility and accountability. And I would like to be 
     able to have the time here today to have them all make an 
     opening statement, but I know our guests are on a short time 
     leash, so we're going to go right to our testimony. And then 
     we'll open this up for some questions.
       Attorney General Spitzer, would you lead us off? Thank you 
     for being here.

      Statement of Eliot Spitzer, New York State Attorney General

       Mr. Spitzer. Thank you, Congressman Gephardt, for that kind 
     introduction, and thank you for your leadership in protecting 
     small investors and the integrity of our financial markets.
       Investors must often rely on the judgment and good faith of 
     others to assist them as they make their investment 
     decisions. They rely on the research and recommendations of 
     their brokers. They rely on the judgment of the executives 
     running the companies in which they invest. And they rely on 
     independent auditors to ensure that they are receiving an 
     honest accounting of those companies' profits and losses.
       During the past few months, many investors have learned 
     that their trust was sorely misplaced.
       Research analysts recommended stocks to investors even as 
     they knew those companies were poor investments. Corporate 
     executives cooked the books to enrich themselves at the 
     expense of their shareholders. And accountants who were 
     supposed to provide an independent audit and review of those 
     books and accounts disregarded their duty in search of 
     greater fees from the companies they were auditing.
       Our Nation's economy has been the engine that has brought 
     unprecedented wealth to millions of Americans and their 
     families. Our free market system which allows businesses and 
     entrepreneurs to flourish without excessive government 
     regulation and intervention is unrivaled anywhere in the 
     world.
       But our great economic engine is fueled by a belief that 
     the market participants play by the rules. As companies 
     compete in our free market, we have required them to operate 
     within certain boundaries delineated by carefully articulated 
     rules, standards of conduct, and disclosures. And if those 
     rules cease to address the realities of an evolving 
     marketplace, or if they're easily exploited, we must put into 
     place new rules that prevent the exploitation of investors.
       Throughout our economic history, we have been willing to 
     implement new marketplace rules to address investor concerns. 
     And the lesson that history teaches us is that new rules 
     furthered our economic interests.
       In the early 20th century, when trusts were exploiting the 
     marketplace and undermining the ability of the markets to 
     function, Teddy Roosevelt responded with new rules that 
     restricted the ability of trusts to function. As he said 
     then, ``We draw the line against misconduct, not against 
     wealth.''
       And a few decades later, when massive stock market fraud 
     drove investors from the marketplace, we responded with the 
     formation of the Securities and Exchange Commission and the 
     implementation of the Securities Act of 1933 and the 
     Securities and Exchange Act of 1934.
       The role of government is properly to define the boundaries 
     and rules of fair play in the marketplace. And especially at 
     moments when the rules appear to be broken, government must 
     step back and evaluate the rules themselves. As important as 
     punishing those who break the rules is ensuring that the 
     rules themselves are properly structured.
       With that framework, I want to discuss some of the specific 
     proposals that have been advanced by both parties and to talk 
     about how a national market must respond to the challenges 
     that arise when its rules no longer provide the necessary 
     protections sought by investors.

[[Page 15282]]

       It has become increasingly apparent that the Democratic 
     congressional proposals recognize the structural flaws that 
     have been allowed to develop in our marketplace and offer 
     meaningful reforms that would protect small investors. The 
     Republicans' response has been to ignore and deny the true 
     scope of the problems and to measure any reforms by their 
     distance from current practice, rather than their proximity 
     to appropriate standards of behavior.
       Today, the Republicans in Congress are accepting deviancy 
     in the markets and are willing to define marketplace 
     standards by what has become common practice instead of by 
     what is good practice. Hundreds of investment bankers have 
     said to me: ``Market pressures force us to the lowest common 
     denominator. We will feel compelled to sink lower and lower 
     in our behavior unless government defines standards for us.'' 
     That is the proper role for government and the proper 
     response to market pressures that will otherwise define 
     deviancy down.
       The difference between the Democratic and the Republican 
     approaches is perhaps best illustrated by comparing the 
     competing responses to my office's investigation that 
     uncovered Wall Street analysts too often recommend companies 
     to investors based on the investment banking fees that those 
     companies generate instead of the underlying investment 
     value.
       Our investigation revealed that Merrill analysts writing 
     stock reports function as sales representatives for the 
     firm's investment bankers, using promises of positive 
     research coverage to bring in new clients and stock 
     offerings. We uncovered evidence demonstrating that a key 
     factor in setting annual compensation for analysts was their 
     success in generating or facilitating the generation of 
     investment banking fees and not the accuracy of their buy/
     sell recommendations to the public.
       While our investigation in New York is still ongoing, it is 
     fair to say that these practices were not unique to Merrill 
     Lynch. In response to concerns about the conflicts of 
     interest driving research analyst recommendations, 
     Congressman LaFalce proposed a substitute to H.R. 3763 which 
     would require analysts to be evaluated and compensated based 
     on the quality of their research and would insulate analysts 
     from the demands of the investment banking business.
       In short, the LaFalce bill would ensure that analysts serve 
     their true clients, the investors, not the investment 
     bankers.
       The Republican bill, sponsored by Representative Oxley, 
     does not require the investment banks to change their 
     practices but merely directs the kinder and gentler 
     Securities and Exchange Commission to study the issue and 
     report back, and the SEC that has already dawdled and 
     stalled, hesitated and malingered.
       The refusal of the Republican majority to address the 
     investing public's concerns about the conflicts infecting the 
     research recommendations that they receive will simply result 
     in the public's hesitation to reenter the market. That will 
     damage our markets, damage the companies that turn to the 
     capital markets for financing, and delay if not deny the 
     economic turnaround that we so desperately need.
       Beyond a failure to act, the House Republicans have been 
     actively critical of my office's efforts to crack down on 
     analyst conflicts of interest. Indeed, Congressman Oxley has 
     attacked my office's efforts, charging that I have ``burned 
     investors in Merrill,'' who have seen Merrill Lynch's stock 
     price fall.
       Congressmen Oxley and Baker publicly stated in a letter to 
     all attorneys general that if investigations such as mine 
     continued, they would introduce legislation that would 
     prohibit State regulators through law enforcement officials 
     from seeking substantive relief from investment bank analysts 
     who continue to mislead the investing public. Such an 
     amendment circulated in the Senate during consideration of 
     the Sarbanes bill and could still become a matter that could 
     be brought up in the conference committee.
       Let me state very clearly that State enforcement of 
     securities laws is absolutely crucial to protecting the 
     investors' rights in the marketplace. Preempting State 
     activities in this area, removing the cops from the beat, 
     would further undermine investor confidence.
       I will also note in passing the supreme irony of having the 
     so-called States rights advocates crafting amendments that 
     would restrict the ability of State regulators and law 
     enforcement officials to address wrongdoing in their States.
       For years, the Republicans have invoked principles of 
     federalism as they rallied for a smaller, less active Federal 
     Government and advocated for the devolution of power from the 
     Federal Government back to the States. But now that the 
     States have begun to vigorously exercise the powers handed to 
     them, Republicans have undergone a devolution evolution and 
     want their powers back.
       The Republican supporters of these anti-State amendments 
     pay lip service to the need for uniform Federal standards 
     governing our securities markets. Congressman LaFalce, in his 
     legislation, has proposed just such a standard, one that will 
     go a long way toward ensuring that the advice that investors 
     receive is advice that is in their best interest.
       And so I say to the Republicans in Congress: You have asked 
     for uniform standards. Congressman LaFalce has proposed a 
     uniform standard. You should enact the LaFalce legislation.
       Analyst conflicts are only one part of the problem. The 
     collapse of Arthur Andersen and Enron and the massive 
     overstatement of earnings at Global Crossing, WorldCom, and 
     other corporations demonstrate the need for new rules of 
     corporate governance and new standards for the accounting 
     industry.
       The Sarbanes bill would require accounting firms to return 
     to their roots as auditors and separate their auditing 
     function, where they stand at arm's length from their 
     clients, and their consulting practices, where the client's 
     interest is paramount.
       Finally, the corporate reporting scandals illustrate that 
     too many public companies are placing the interests of the 
     executives who run the companies before the interests of 
     their shareholders and employees. The decades' long shift of 
     power from shareholders to CEOs created an era of the 
     imperial CEO so dominant that neither boards nor shareholders 
     could really control either executive compensation or 
     decision-making.
       It is time to restore to boards and institutional 
     shareholders the obligation of serious participation in 
     corporate governance. We need to insist that public companies 
     report results that reflect reality and not clever 
     gamesmanship, and that allow investors to understand their 
     true financial position. And we need to strictly punish 
     corporate executives who falsely certify their companies' 
     financial statements.
       These reforms are not only vital to the integrity of our 
     markets, they are necessary if we are going to achieve the 
     economic recovery that we all seek. Taken together, the 
     reforms we are discussing today will signal to a disenchanted 
     and distrusting public that we will no longer tolerate the 
     betrayal of trust. These reforms will tell investors and 
     stockholders that the markets are governed by rules, and 
     those rules are geared to protect their interests.
       The immediate goal must be passage of the Sarbanes bill 
     without allowing Republican Members to water it down in the 
     conference committee. But once that is accomplished, there is 
     still much more work to be done, much of it embedded in 
     Congressman Gephardt's Investors' and Employees' Bill of 
     Rights. Congress must address the conflicts created when 
     research analysts are required to service their investment 
     banking colleagues instead of the investing public.
       The Securities and Exchange Commission has failed to act on 
     analysts' conflicts of interest. And in his speech last week, 
     President Bush indicated his support for the SEC's weak 
     rulemaking in that area. It is now up to Congress to mandate 
     that analysts who claim to serve the investors' interests 
     actually do so.
       We are now at a crossroads. Democrats have recognized how 
     far the standards of behavior have deviated from what used to 
     be accepted norms and have proposed reforms to raise those 
     standards. We must continue to fight for real reforms that 
     will raise the standards governing the conduct of analysts, 
     accountants, and corporate executives. And we must continue 
     to battle attempts to accept fraud and irregularities in the 
     marketplace.
       Thank you for the invitation to appear here today.
       Mr. Gephardt. Thank you, General, very much, for a very 
     cogent and well put together statement. We appreciate it. 
     We'll come back with questions in just a moment.
       Richard Moore from North Carolina, we're pleased to see you 
     here, and you can carry forward.

       Statement of Richard Moore, North Carolina State Treasurer

       Mr. Moore. Thank you, Representative Gephardt. And I would 
     also like to start out by saying hello to Representative Watt 
     and Representative Etheridge from North Carolina. Thank you 
     all very much for this chance to be here.
       I come before you today as North Carolina's elected 
     guardian of the State Treasury and the sole trustee and 
     fiduciary of $62 billion in public funds, most of which is 
     represented by the pension funds of 600,000 active and 
     retired public workers in the great State of North Carolina.
       Before I get into specific points, two general points to 
     put this situation into context:
       In my prepared remarks, I have several quotes, starting 
     with Alexander Hamilton, George Washington's first speech to 
     the Congress, Woodrow Wilson, and Teddy Roosevelt. All of 
     those go back to make the simple point that we as Americans 
     have always understood that a free market is not the best 
     market in the truest sense of the words. We have always 
     sought to make sure that our markets were bridled in the name 
     of fairness. And this is something that has been a bipartisan 
     issue. It's been understood since the founding of this 
     republic.
       The second obvious point that I believe needs to be made--
     and also, I must take just a second here of personal 
     privilege. I'm a big student of history, and we always seem 
     to go in cycles. The last time we had a tremendous

[[Page 15283]]

     loss of confidence in the public markets was the Great 
     Depression. And the Great Depression brought about the 
     passage, as my good friend Eliot Spitzer has already recited, 
     of the Securities acts of 1933 and 1934, and the passage of 
     the Glass-Steagall Act. I'm extremely proud that my 
     grandfather, Frank W. Hancock Jr., as a business-oriented 
     member of the House Banking Committee, played a significant 
     role in drafting and championing many pieces of the necessary 
     reforms.
       The second general and obvious point, but a point that I 
     really think that this body needs to make in the next couple 
     of weeks, is to remember that we are addressing regulations 
     that apply only to public companies. And I want to say that 
     again because it's so obvious that it's missed: They apply 
     only to public companies, and no one forces a company to 
     become public. The choice to do so means that its corporate 
     leaders voluntarily give up some of their autonomy and agree 
     to be regulated, The tradeoff, which has been incredibly 
     significant over the last 20 years, is that those companies 
     may have access to capital at an incredibly discounted rate, 
     which has been a wonderful thing for everyone.
       But even today, most businesses in America, those located 
     across the Main Streets that you all represent, are not 
     publicly regulated. And when they need additional capital for 
     their businesses, they pay a premium for it. It's an obvious 
     point, and one that I think needs to be stressed more.
       The conclusion is that publicly traded companies have been 
     and must be regulated to make sure that the individual 
     investor, who I am here to represent in a large way today, 
     but the individual investor can properly value his or her 
     risk before an ownership decision is made. This, again, is an 
     obvious point that has been overlooked by those who are 
     afraid that additional government regulation will foul the 
     market.
       Who is the stock market today? The stock market is 
     representative of 80 million Americans who have decided to 
     take part in these public markets. Either directly or 
     indirectly through mutual funds and other pension plans, they 
     have placed their hard-earned savings in these marketplaces. 
     And that in itself is remarkable.
       They have been enticed--and I will use that word again--
     they have been enticed through tax policy and professional 
     advice to participate and share in the American dream.
       Now, it is not your job, nor is it the job of corporate 
     America, to ensure that that dream comes true. However, it is 
     your job to make sure that the marketplace is fair to all so 
     some don't profit and others lose from the exact same 
     investment--from the exact same investment.
       Our markets today hold about $12 trillion in assets; $2.2 
     trillion are held in pension funds like the one that I run. 
     Approximately $8 trillion in the marketplace is controlled by 
     mutual funds. And what a lot of people don't realize is most 
     pension funds are the largest clients of mutual funds. So we 
     have tremendous clout in the marketplace, clout that I don't 
     think that we have learned how to use yet, and we're not 
     equipped at this point to do it.
       The reason for that is that institutional ownerships have 
     evolved over the last 30 years. As a result, we as 
     institutions find ourselves collectively the largest single 
     shareholder in virtually every major company in America. The 
     founders of those companies, or the founders' descendants, in 
     many instances are no longer seated around the board tables 
     advocating in their own self-interests for the rights of the 
     shareholders.
       It is truly today often a setting like government, the 
     arena that we all work in, where people spend other people's 
     money.
       We, as institutional owners, must act like the owners that 
     we have become. However, we cannot do it alone. We need your 
     help. We need Congress and the administration to make sure 
     that we can properly exercise our prerogatives of ownership. 
     We need your help to make sure that we can tell whether the 
     interests of management and shareholders are properly 
     aligned. We need your help in making sure that we as 
     investors can properly price risk. We need your help in 
     making sure that the cop on this particular beat has the 
     resources and tools to do their job.
       We need your help now more than ever. The last few months 
     have shown that our system is currently missing effective and 
     necessary checks and balances to ensure that the fine line 
     between proper incentive and destructive greed is not 
     crossed.
       While I firmly believe that the vast majority of today's 
     corporate managers are smart and honest, it has been 
     disconcerting to see so many unmasked not as captains of 
     industry but as captains of greed with callous disregard for 
     the welfare of the people whose money grows their companies.
       Simply put, where I come from, we know that the fox cannot 
     guard the henhouse. No matter how honest, no matter how well-
     meaning the fox, at some point the temptation to gouge is 
     going to prevail.
       Without proper regulation, history has shown, that 
     hardworking Americans always pick up the tab: the Great 
     Depression; the savings and loan debacle, which I served as a 
     Federal white-collar prosecutor during that and we didn't 
     have anywhere near the resources to do it right 10 years ago; 
     and most recently, what you're dealing with, the power 
     shortage in California.
       In carrying out my fiduciary duty to the 600,000 
     beneficiaries in my funds, last month, with Eliot Spitzer's 
     help, we began to be more aggressive owners. In conjunction 
     with the Treasurer of California, Phillip Angelides, and the 
     Controller of New York, Carl McCall, we announced important 
     investment protection principles. These proposals embodied 
     simple, common-sense market-based solutions to some of the 
     problems that we face.
       We as owners are exercising our ownership rights. We're 
     putting new terms on the table. If you want our money, this 
     is what we've got to have from you. We are demanding that 
     broker-dealers and money managers eliminate actual and 
     potential conflicts of interest from the way they pay their 
     analysts and conduct their affairs, or we will no longer do 
     business with them.
       We are asking our money managers that we utilize to look 
     closer into the areas of financial transparency and corporate 
     conduct. But we, once again, need your help.
       As fiduciaries, we must and will become more assertive in 
     our ownership role. Since we've announced these principles, 
     we have been joined by numerous other States and numerous 
     pension funds. We now have almost $700 billion backing this 
     simple set of principles. And I believe, with your help, we 
     will make a huge difference.
       One final thing: In some areas, we need specific 
     prohibitions. And I believe, Representative Gephardt, what 
     was announced yesterday and what's been going on with the 
     Sarbanes bill will go a long way toward answering those 
     problems.
       In other areas, where specific prohibitions may be unwise, 
     do make disclosure standards tougher. If you're having a 
     tough time with options and other issues, do just as you've 
     done in cigarette packaging, food labeling: make it, in a 
     prudent and appropriate way, required that certain financial 
     information be prominently displayed in plain language in 
     proxy statements and annual reports.
       If you will help the large and the small investor alike 
     learn how to find the information needed to properly price 
     option overhangs and option run rates, we as the market will 
     go a long way in ridding ourselves of truly abusive 
     practices.
       I would also urge you to take a closer look at the 
     difference between defined benefits and defined contribution 
     plans. I think we went way overboard on defined 
     contributions.
       I run them both in North Carolina. I was stopped by groups 
     yesterday, one retired school teacher in particular, who had 
     $300,000 in her 401(k) that is now worth $120,000. She was in 
     tears, and she was thanking me that the management of the 
     traditional retirement fund that I also ran had not suffered 
     anywhere near those kinds of losses, because we were properly 
     diversified.
       I appreciate the opportunity to be here today. And in 
     closing, I must say that I was taken aback by the President's 
     comments a couple of days ago that this was nothing more than 
     a hangover. For many citizens, the people who I have been 
     entrusted to protect, maybe unlike the executives at these 
     companies, they won't be fine by lunchtime. It's going to 
     take years and years of financial rehab for them to be back 
     to normal.
       Thank you.
       Mr. Gephardt. Thank you, Richard, very much. You gave very 
     eloquent testimony, as did Eliot. And I really appreciate you 
     taking the time to be here.
       We're now joined by William White from Houston. As I said, 
     he has a distinguished career in the public and private 
     sector. Thank you, Bill, for being here, and we're ready to 
     hear your testimony.

              Statement of William White, CEO, Wedge Group

       Mr. White. Mr. Chairman, and distinguished Members, I've 
     really looked forward to this because of the perspective that 
     I'll share with you.
       I'm blessed to run a number of large businesses. Not only 
     do we own private firms, but we are the first or second 
     largest shareholder in five public companies, where our 
     stakes range from 9 to 60 percent. Some businesses I've 
     built, and we've been pretty successful by any financial 
     measure.
       In a prior life, before I started in the private sector, 
     for more than a dozen years, I was a public interest lawyer, 
     specializing in accounting fraud and securities fraud, 
     including getting the largest verdict and judgment in Federal 
     securities law history against an accounting firm.
       I've served on the board of a number of public companies, 
     many on the New York Stock Exchange.
       And so you can appreciate that I've been thinking about 
     some of these issues a little bit. And I want to tell you, 
     Mr. Chairman, this is a serious issue, this issue of 
     confidence and the reliability of our financial system. It's 
     not something that we can just sweep under the rug, and I'll 
     tell you why. Because of the chronic trade deficits that this 
     country has--it's the way that our economy has operated for a 
     long time--we depend in this economy, for its strength and 
     its growth, on being able to attract international investment 
     to our economy. If that slows down, we're in a very serious 
     situation.

[[Page 15284]]

       And one reason why we get that foreign investment is 
     because we are a Nation of laws, and we are perceived to have 
     a transparent and fair financial system. Moreover, as the 
     outstanding witnesses have pointed out, we do right now rely 
     very heavily in our pension and retirement system on the 
     individual savings and investments of ordinary Americans.
       We, the people of the United States, do own the public 
     companies, when you look at the distribution of stock 
     ownership.
       And during the period of the 1990s, there was an amazing 
     transformation as so much household wealth was built up, and 
     the increased worker productivity, and savings and wealth in 
     our families.
       If we do not have confidence in this system, it is the most 
     serious problem that I can think of in our domestic economy 
     for a long time.
       So let me share with you a thought about our response to 
     this and, if nothing more, a way to look at this. I'll be 
     happy to answer questions on some specifics that I have, but 
     my statement focuses on an approach, if you will, because 
     this could take awhile for us to develop, not just instant 
     legislation. But in the future, we need to be thinking about 
     these things.
       Now, we can't exaggerate the abuses. There are a lot of 
     good people who are executives and in management in the 
     American system. More than any other country in the world, 
     people have worked their way to the top. Our ancestors all 
     came here with nothing, and that's true with corporate 
     executives, many of whom have worked their way to the top 
     through hard work.
       But this is more than a case of a few bad apples. I think 
     what you've had is a crisis of leadership. What does 
     leadership really mean? In business or in politics or in our 
     families and churches, leadership means giving more than you 
     take. Leadership means giving credit to others and being 
     first to accept responsibility. Leadership for corporations 
     should mean holding yourself as a CEO--and I'm a CEO--to a 
     higher standard than anyone who reports to you. That's what 
     leadership is. It is servant leadership.
       And too often we've had a situation in this country where 
     CEOs and corporate leaders take credit for whatever happens 
     good in their company. And then when something bad happens, 
     it's the fault of somebody else or the economy or the press.
       Let me give you an example of that. I was with somebody who 
     was an hourly worker on a factory floor, and we were having a 
     discussion about some trade legislation. Now, I will tell you 
     that I'm an advocate for freer trade legislation, and this 
     person, who is a friend of mine, disagreed with me, and I was 
     probing this difference. And this is what he said to me, he 
     said, ``Every time my company announces that there are good 
     earnings or higher profits, it's because of management's 
     strategy and plans, and they get multimillion dollar bonuses. 
     But every time our profits and earnings have gone down, it's 
     because of foreign competition, and workers are fired and 
     bonuses are cut on the working people down the line.''
       So it's a good example of where we've had a failure of 
     corporate leadership. Leadership does not mean giving 
     yourself bonuses and making yourself wealthy when the 
     organization you're leading is performing poorly. And it 
     doesn't mean failing to accept responsibility when things go 
     wrong, and that includes legal responsibility.
       Mr. Chairman, as someone who has both sat on corporate 
     boards and led corporations, and also enforced our existing 
     securities laws in courtrooms before juries of Americans, I 
     want to tell you that laws are important. Values are 
     important. Ethics may be even more important than laws and 
     values, but laws are important.
       And it's simply not true that they will stifle the free 
     enterprise system.
       Look at the difference between this country and Russia, and 
     I'll give you an example. I served in the administration and 
     have had different private business dealings in Russia. 
     Russia in the 1990s had democracy. There was freedom of 
     expression, a lot of freedom of expression. There was free 
     enterprise. But what there was not were laws and fair 
     enforcement and impartial enforcement of those laws 
     regardless of whether somebody is wealthy and powerful. And 
     that's why their economy went down.
       So it's every bit as important for this country as any 
     other country. Strict enforcement of laws does not destroy 
     the free enterprise system. Good business ethics and strong 
     laws are the underpinnings of a successful market economy, as 
     we've seen from nations across the world when those very 
     things are lacking.
       I'd like to make two final notes, Mr. Chairman.
       One is about my own business community of Houston, Texas. 
     For a while there, looking at the television or reading the 
     newspapers, somebody might have thought, ``Oh my gosh, what's 
     going on in Houston, Texas? Is there a problem with business 
     ethics in that one community?'' And it's a community of which 
     I'm proud. But we found that it's not just a matter of one 
     community. It's not just a matter of one industry. It's 
     something that's occurred systematically throughout a number 
     of companies in our economy.
       And I want to tell you, we can't stereotype a community. We 
     can't stereotype an industry. We can't stereotype CEOs. The 
     Democratic Party is a party that has fought stereotypes in 
     all the best days of its existence. But we've got to start 
     with business ethics and values, and reinforce those with 
     strong and predictable laws. This is something that's 
     affected workers and communities throughout this Nation.
       And, Mr. Chairman, in the questions, if people have 
     specific questions, I'm prepared to address issues concerning 
     the governance structure of corporations, pension reform, 
     avoiding conflicts of interest. And just on that, there's 
     usually no good reason for an institutionalized conflict of 
     interest, okay?
       And fourth, how we rebuild the accounting profession, 
     because it's not just what we do with accountants who are 
     wrong, but how do we rebuild an accounting profession so that 
     we have professionals who can enter this profession with 
     dignity and respect?
       On all those issues, the one that may be with us longer 
     than many people suspect may be this issue of pensions and 
     retirement plans. Many people have had unrealistic 
     expectations not simply about what would happen when their 
     401(k) was invested in something bad, but whether their 
     401(k)s currently are sufficient. There have been surveys 
     about this. Americans who are busy going about their daily 
     work, and who read financial planning journals or watch the 
     TV programs, may think that their $80,000 401(k) may provide 
     more retirement security than its worth.
       There was a survey of individual investors in 401(k) plans 
     concerning what their expectations of returns were. Over 20 
     percent of them thought they were going to be 50 to 100 
     percent a year, and another 20 percent thought they were 
     going to be over 20 percent a year.
       And corporations, as Warren Buffet, no socialist, has 
     pointed out, have systematically overstated the returns on 
     their pension investments. They're not making conservative 
     assumptions concerning their returns on pension investments. 
     If those assumptions were made more conservative, those 
     pension funds would be underfunded.
       These are issues that I hope this Congress can address. 
     Thank you, Mr. Chair.


           PANEL II: THE SEC, ACCOUNTING INDUSTRY AND ECONOMY

       Mr. Gephardt. I'd like to first thank our distinguished 
     former Federal Reserve Chair Paul Volcker for appearing here 
     today. You all know that he is not only a brilliant 
     economist, but he also has loads of realistic experience in 
     all the areas we're focusing on today. And we're glad to have 
     him with us and have his expertise on these issues.
       Lynn Turner is a front-line fighter if there ever was one. 
     He learned these issues inside and out from 1998 to 2001, 
     when he served as chief accountant for the Securities and 
     Exchange Commission. He fought with Arthur Levitt to 
     strengthen the SEC's enforcement hand to go after companies 
     that wrongly puffed up their earnings. And through his voice 
     and leadership, he successfully shined a spotlight on these 
     issues in recent months. And we thank him for his service and 
     for being here.
       Bevis Longstreth was an SEC commissioner under President 
     Reagan, where he focused on all the issues that we're talking 
     about today. More recently, he served on independent panels 
     focusing on auditing effectiveness. He's been a professor at 
     Columbia Law, written numerous articles, published a book on 
     investment management, and he's a true public servant in 
     every sense of the word.
       Nancy Smith has considerable experience from her time at 
     the SEC. As director of the Office of Investor Education and 
     Assistance, she worked closely with Arthur Levitt. She's 
     worked in the House of Representatives, which is always a 
     good idea to us, where she focused, among other things, on 
     the SEC and issues of accounting and corporate conduct and 
     standards. And finally, she has a Web site, 
     RestoreTheTrust.com, where investors are able to e-mail their 
     Senators and ask them to support the Sarbanes bill to reform 
     the auditing industry.
       We're very pleased to have this panel. This is a 
     distinguished panel, and I know they are all on a tough 
     schedule, and we deeply appreciate their willingness to come 
     here and be with us.
       Paul Volcker, thank you for being here. It's good to see 
     you again. You look great, exactly as you did when I last saw 
     you here some years ago, so you're doing something right.
       Mr. Volcker. I'm afraid I've gotten older.
       Mr. Gephardt. I doubt that.

 Statement of the Hon. Paul Volcker, Former Chairman, Federal Reserve 
                                 Board

       Mr. Volcker. You will be relieved to know, I hope, that I 
     have no prepared statement that I will belabor you with. I 
     did give a long speech on this problem at Northwestern--
     ironically, in the Arthur Andersen Hall--about accounting and 
     auditing. And I had a rather dismal story from the 
     standpoint.
       It's clear that we face not just an individual problem but 
     something of a systematic problem with this rash of 
     difficulties in auditing, accounting, corporate governance, 
     conflicts of interest in investment banking, which are not 
     exactly a new phenomenon but which have shone brightly in 
     recent months.

[[Page 15285]]

       My message to you is very simple, that there is a clear 
     need for action. But the priority at the moment is that bill 
     you are getting, from the Senate, the Sarbanes bill, which is 
     directed, I think, at an acute part of the problem in a 
     realistic way. It is the reflection of some considerable 
     hearings and discussion in the Senate and elsewhere. And it 
     deals particularly effectively, I think, with two problems 
     related to the fact that the auditing industry has 
     chronically been unable, I think, to regulate itself despite 
     many efforts over the years.
       It would provide a strong oversight body with the kind of 
     discipline and powers that I think are necessary, somewhat 
     analogous to what we've been used to for many years in the 
     securities industry itself. In that sense, it's not a radical 
     change, but it is certainly a change that I think would bring 
     needed discipline to the auditing industry that has been 
     under great pressure and has not handled that pressure, 
     frankly, very effectively.
       And secondly, it deals with what I believe and what many 
     other people believe are obvious conflicts of interest in the 
     practice of auditing by removing large elements of the 
     consulting practice from the auditing practice.
       And I think the combination of those two remedies will go a 
     long way toward providing a kind of backbone of 
     professionalism intent in the auditing profession that's 
     necessary to bring some of the problems that we've seen so 
     evidently under control.
       I would urge you, given that priority, that bill which will 
     be before you in conference that deals with those problems in 
     a rather comprehensive way, that you should go ahead and get 
     that enacted as rapidly as possible without too much 
     extraneous additions, subtractions, or whatever.
       I think in part, in that connection, on the question of 
     stock options, which has attracted a lot of attention, I am 
     not a fan of stock options. I think they have been more 
     abused than used in any appropriate way. I think they give 
     very capricious results. They often reward the unjust and 
     don't reward the just in terms of their effect on the market. 
     But this does not seem to me the time and the place for the 
     Congress to command particular treatment. There are bodies 
     that have that under review.
       I am the chairman of the board of trustees of the 
     International Accounting Standards Committee, which appoints 
     an international accounting standards board. Its overall 
     effort is to get some commonality, some convergence, in 
     accounting standards around the world. By coincidence, 
     yesterday or the day before, they sent out for public comment 
     their proposal for the expensing of stock options. But 
     whether it's the international board, which is obviously at 
     work, or FASB, our own board, it seems to me that the way 
     that is treated is a technical matter which we ought to leave 
     to the accountants and the board.
       And I have to remind you, the last time Congress got 
     interested in this subject, about 8 years ago, they took the 
     opposite position and, in effect, overruled what the 
     accountants wanted to do and prevented the expensing of stock 
     options. So I would suggest that that problem will be dealt 
     with in an appropriate way in a quite different atmosphere 
     today.
       I think your priority ought to be to deal with the bill in 
     conference, with the bill that has passed the House, but make 
     sure that what comes out of that does achieve the essential 
     purpose of a really effective oversight board for the 
     profession and deals with that conflict of interest and also 
     deals with some other matters as well. But I think that is 
     the essential part of that bill that should be preserved and 
     enacted as soon as you can manage it.
       Mr. Gephardt. Thank you very much. We appreciate you taking 
     the time to be here.
       Lynn?

   Statement of Lynn Turner, Former Chief Accountant, Securities and 
                          Exchange Commission

       Mr. Turner. Thank you, Congressman, for inviting me here. 
     It's actually great to be back in D.C.
       I just flew back in from the West where I had actually gone 
     out fishing in the backwoods, if you will. It was 
     interesting, as I got a call about the hearing last week, and 
     I was literally walking out the door with my fly-fishing rod 
     to get away from what seemed to be an all-consuming issue 
     here.
       And we got out on the river the first morning with the 
     guide, and keep in mind that we're in a place where there's 
     no New York Times, no Washington Post, no Wall Street 
     Journal, even the BlackBerry wouldn't work.
       The guide asked, ``What do you do for a living?'' And I 
     said, ``Well, I'm an accountant.'' I admitted it. I figured I 
     was safe. I mean, no papers, not even a daily paper. And he 
     turns around and he looks to me and he says, ``You know, you 
     guys aren't doing very well these days. Have you considered a 
     career change, Mr. Turner?'' [Laughter.]
       And so I spent 3 days on the river with this guide. So it's 
     nice to be back to civilization. [Laughter.]
       But I think what that points out, though, is that there a 
     lot of Americans in all necks of the woods out there that are 
     very concerned about what has transpired here and how it has 
     impacted them and their savings and their families, whereas 
     maybe 10 or 20 or 30 years ago, it wasn't as important as it 
     is today, given that there has been a significant change. We 
     now have 85 million Americans in the markets, either in 
     stocks or mutual funds; that's one out of every two voting 
     Americans. That's significant.
       And they had a third of their wealth at the height of the 
     markets tied up in the stock market. For the first time ever, 
     it was more than they had in the equity in their homes. So 
     the amount of damage that can be done if we don't get 
     significant reforms is quite incredible.
       If you think about Enron itself, the losses were twice what 
     the losses were from the unbelievable tragedy of 9/11, six 
     times the losses Hurricane Andrew when Miami was wiped out, 
     in just one of these tragedies.
       So it is as important, as Chairman Volcker said, that we 
     get this thing fixed.
       But the facts are in today. And in 2001, we had a record 
     number of restatements, 270 restatements; 1,089 over the past 
     5 years. These numbers really do prove that there are more 
     than just a few bad apples out there in the orchard, if you 
     will, that President Bush would have led us all to believe in 
     his speech last week.
       And the accounting profession's refrain that we've heard 
     for years and years here in this building, that 99.9 percent 
     of the audits are okay, is also no longer credible, when you 
     think about the fact that Rite Aid and WorldCom and Xerox and 
     Enron were all part of that 99.9 percent at one point in 
     time.
       And also, the accounting profession would like you to think 
     that, dingdong, the witch is gone now, with Andersen falling 
     by the wayside, despite heroic efforts by Paul Volcker to 
     save that firm, and that they were really the problem. But 
     that isn't true. If you look Rite Aid, it was audited by 
     KPMG, as was Xerox; MicroStrategy and WR Grace by 
     PricewaterhouseCoopers; Deloitte did Adelphi; and Cendant was 
     done by Ernst & Young.
       So each of the firms, and certainly this was my experience 
     at the commission, had their problems. And they were 
     significant problems. The auditors have been investing the 
     cash that they generated from a very profitable audit 
     practice into the consulting practices. They've been writing 
     broad principles-based auditing standards that have been so 
     general that an independent panel chaired by the former 
     chairman of Pricewaterhouse, of which a member was former 
     Commissioner Bevis Longstreth here to my right, they issued 
     200 recommendations to the profession. To date, many have yet 
     to be implemented as noted in a GAO report of just the last 
     month or so.
       So the profession itself has not done very well. And in 
     fact, on some of these audits--if you looked at the audit of 
     MicroStrategy, the problems there were detected in a magazine 
     article that was written about their accounting. And the 
     problems on Rite Aid were detected by a desktop review by an 
     SEC staffer. And it's phenomenal that, on WorldCom, an 
     internal auditor can find the problem that the external 
     auditors never found. On a case like Rite Aid, a desktop 
     review hundreds of miles away found a problem that couldn't 
     be found on site. And in the case of MicroStrategy, a 
     business article turned up something that people onsite 
     couldn't find.
       And at the same time, as we heard from Attorney General 
     Spitzer, certainly the analysts have been a big problem. 
     They've been rewarded for doing marketing rather than 
     analysis, it seems, which the investment bankers, quite 
     frankly, appreciated, as they saw themselves boosted by the 
     analysts' exaggerated research reports and road shows.
       And I'd be remiss if I said--during the last 3 to 4 years, 
     as Chairman Levitt tried to get some of the reforms enacted, 
     that some Members of Congress also opposed and vehemently 
     opposed some of those reforms.
       And if it wasn't for some people like Congressman LaFalce 
     and Congressman Markey, whose support was absolutely 
     fantastic and wonderful as we fought those battles--in fact, 
     I don't think Arthur or I could have survived if it hadn't 
     been for the support that we got from those Representatives.
       We did get some reforms done, but certainly not as many as 
     should have been done at that point in time, given the 
     problems that were out there and problems that were ignored 
     by other Members of Congress who, quite frankly, could have 
     stepped in, I think, at that point in time and help fix the 
     problem.
       As Paul Volcker mentioned, I do think the solution here is 
     in the Sarbanes bill. Congressman LaFalce had a similar bill 
     here in the House that unfortunately the Republicans didn't 
     give the Democrats a chance to bring to a full thumbs-up or 
     thumbs-down vote. And I think Congressman LaFalce's bill, 
     much like Senator Sarbane's, is one that provides a systemic 
     solution for what is truly a systemic problem.
       But now with the Sarbanes bill, it is my hope that, through 
     conference, we'll get that bill out without weakening it. So 
     while it may not have the LaFalce name on it, it will have 
     the LaFalce intent and heart behind it.
       We need to ensure that we have an adequately funded and 
     independent SEC. The funding, there is no question that the 
     handcuffs that were put on us at the SEC prevented us from 
     doing our jobs. When I

[[Page 15286]]

     walked into the SEC in July of 1998, we had a total of 15 
     accountants to do all the enforcement cases against 240 
     enforcement cases at the time. They physically were not able 
     to do it.
       And in fact, as we went through those enforcement cases, we 
     knew we had a number of good cases that, quite frankly, we 
     had to drop and couldn't prosecute, because you just didn't 
     have enough hours in the day. And that was directly due to 
     the lack of funding, that we had received and the handcuffs 
     that had been put on us. So we need to get that fixed.
       We need to allow them to have enough people to review the 
     filings last year. There was one staff accountant at the SEC 
     for each 1,000 to 1,100 filings that come in. Many of these 
     filings are a foot thick. So, again, physically, you can't 
     work enough hours in a day. Unless you extend the days by an 
     act of Congress to about 48 hours, we're just not going to be 
     able to get the job done with $776 million in funding in the 
     Sarbanes bill, which is sorely needed.
       And it's interesting to note that finally this 
     administration and Chairman Pitt are coming around and 
     starting to look like they might support some additional 
     funding, which is great. I only wish they had done that when 
     they submitted their original budget to Congress in February, 
     which actually reduced the number of budgeted positions for 
     the SEC well after Enron and Global Crossing had come to 
     light.
       We also need to make sure that we get adequate funding for 
     the Justice Department. It is the Justice Department that has 
     to bring all of these criminal prosecutions. The SEC will not 
     bring one of those. And as the guide on the fishing trip 
     said, he wanted to know, would we see these people, if 
     they're found culpable of a wrongdoing, brought to justice. 
     Well, the only way they'll be brought to justice is if we 
     give Justice the tools and resources to do it. Absent doing 
     that, we might as well turn around and put a 55 mile an hour 
     speed limit sign out there on 1-95 with a sign about 5 feet 
     behind it, saying ``No police for the next 100 miles.'' And 
     you know everybody is going to be in the fast lane.
       That's, in essence, what we're doing with the Justice 
     Department and the SEC, unless we give them additional 
     funding.
       As in the Sarbanes bill, without a doubt we need to 
     increase and improve upon the independent auditors, banning 
     them from providing the services that really do impact their 
     economy, regardless of size. It doesn't matter if it's a 
     small company or a big company; you need to have integrity in 
     the financial statements.
       We need that strong oversight board. Restatements of the 
     magnitude of $3.8 billion on WorldCom and $1.6 billion on 
     Rite Aid, $6 billion on Xerox--as I tell my students in class 
     these days, if you can't get the numbers any closer than the 
     nearest billion bucks, you're not going to pass this class. 
     [Laughter.]
       We need to get that fixed. That board needs to have the 
     ability to set the standards by which we measure the 
     performance of the auditors. The auditors I know have been up 
     here saying, ``Well, if you don't have auditors doing it, how 
     can you get good standards?'' Well, Congressmen, we've had 
     knowledgeable standards written by knowledgeable auditors for 
     the last 60 years, and it hasn't got the job done. What we 
     found is those knowledgeable auditors have been writing 
     standards that protect their interests in case of litigation 
     and have dismally failed to protect the interests of 
     investors and the integrity of numbers.
       And as for the analysts, as Attorney General Spitzer said I 
     think very eloquently, we need to go further than President 
     Bush proposed when he suggested sticking with the rules the 
     stock exchanges have already adopted. Those rules absolutely 
     fail to provide analysts with protection from the very 
     retribution of executives and underwriters who might be 
     displeased by a negative research report.
       We need to definitely strengthen the corporate governance. 
     It has failed us. We need good, independent corporate boards, 
     just like we need good, independent analysts and good, 
     independent auditors.
       And finally, we need good, independent accounting standard-
     setters with adequate funding and trustees who are 
     representatives of the public, not trade organizations.
       It's interesting to note that former Chairman Volcker 
     brought up the issue of stock options. As a former executive, 
     I actually think stock options can be a very good tool, if 
     used properly and governed right within a corporation. 
     There's nothing wrong with that. But I hear people say, 
     ``Well, you can't adequately measure them.'' Having been an 
     executive of a large, international semiconductor company, I 
     would tell you that if an executive can't figure out what 
     he's compensating employees, including with the stock 
     options, if he can't measure them, he shouldn't be an 
     executive there in the first place.
       We all participated in the same surveys. We all knew what 
     they were worth. And we all turned around and calculated that 
     number using standard methodologies. It can be done. And 
     people just need to put their heart behind it and get it 
     done. In fact, a survey of approximately 2,000 analysts last 
     year showed that 80 percent of them feel that the accounting 
     standards for stock options are deficient and don't provide 
     them enough information to do their job. We need to fix that 
     so that the analysts can get the job done right and so 
     investors can make informed decisions.
       And the market I think has responded to President Bush's 
     call for a crackdown on corporate fraud, but it has rejected 
     his proposals as too little, too late, when it was shown in 
     the market to where it dropped over 400 points in just the 
     first 2 days after his speech before I went on my fishing 
     trip. And since then, I've seen it's dropped more.
       Legislation proposed by Senator Sarbanes advances the ball 
     much further than the President's plan or the legislation the 
     House has adopted or the proposals from Chairman Harvey Pitt. 
     Sarbanes' bill is the only one to ensure the independence of 
     auditors, corporate boards, and analysts. It provides 
     effective and timely discipline, and it offers the funding 
     necessary for the SEC and accounting standard-setters to do 
     their job. It's a good start to solving what ails the market.
       Congress needs to find the will to pass it without 
     weakening it anymore, and send it on to the President. And if 
     not, I can tell you that I've heard many an angry American 
     investor that says they will vote for reform in November.
       Thank you.
       Mr. Gephardt. Thank you, Lynn, very much.
       I failed to ask you if you caught any fish on this trip. 
     [Laughter.]
       Did he take you to anyplace where you caught anything?
       Mr. Turner. We did very well.
       Mr. Gephardt. Good. Well, we'll try to get this bill passed 
     so that you can retain his confidence and he'll take you 
     back. [Laughter.]
       Professor Longstreth, we appreciate you being here, and 
     we're ready to hear you.

 Statement of Bevis Longstreth, Former Member, Securities and Exchange 
                               Commission

       Mr. Longstreth. It's a pleasure to be here. And it's a 
     pleasure to be in this room. The last time I testified on 
     this subject before the House, it was in the House Commerce 
     Committee, and I was so far away from you, I wasn't sure you 
     were really there. [Laughter.]
       So this is a very intimate gathering, and I appreciate the 
     chance to communicate.
       S. 2673, the Sarbanes bill, is a critically important piece 
     of legislation that, in my judgment, should be passed by the 
     House and placed on the President's desk without delay. 
     Nothing I can think of would do more to restore the public's 
     trust in our financial markets than the simple adoption by 
     the House of this bill, and make it the House's own bill.
       The need for this bill to become law transcends party. To 
     its credit, the Senate confirmed this fact by its vote of 97-
     0.
       While my roots are in the Democratic Party, what I want to 
     say today is intended to be completely bipartisan. I would 
     say precisely the same thing if this were a Republican 
     Caucus. It's designed to appeal to both sides of the aisle 
     and to get the objective I just stated done.
       There's much to applaud in the Sarbanes bill. But I'm going 
     to concentrate on the very heart of that bill, the most 
     important parts of it, which should not be compromised and 
     must be adopted. These measures I'm going to talk about 
     relate to the creation and the empowerment of an oversight 
     board to regulate auditors of public companies.
       For decades, the auditing profession claimed that despite 
     the obvious conflicts of interest it could effectively 
     regulate itself. It has now become evident to just about 
     everybody in the country, outside a tiny circle of leaders in 
     that profession, that self-regulation has been a failure. 
     It's not a new failure, for it has never worked. But the 
     failure now is of such magnitude in terms of cost to the 
     investing public that it can no longer be ignored.
       It's not being ignored by the SEC. In its recent release 
     proposing a public accountability board, it based that 
     proposal on a scathing account. I was shocked and delighted 
     to read the scathing account in that release on the 
     profession's efforts over decades to self-regulate itself.
       The Wall Street Journal quoted Chairman Pitt as saying, 
     ``The era of self regulation by the accounting profession is 
     over.'' So the SEC is basically on board with Sarbanes in 
     that statement and in that release.
       The OMB, for its part, on July 9, in its statement of 
     administration policy regarding Sarbanes, said, ``A two-
     tiered regulatory framework is necessary to protect 
     investors.'' That's not what Congressman Oxley seemed to be 
     saying as of 2 days ago.
       And the OMB went on to conclude that ``a newly established, 
     independent accounting oversight board should set, oversee, 
     and enforce professional audit, quality control, and ethics 
     standards.''
       Now, we have the Senate, and they've spoken to the same 
     effect and in appropriate detail with care, clarity, and the 
     force of unanimity.
       So now it's the House's turn. And with all this agreement 
     afoot as to the need for an effective oversight board, one 
     could reasonably

[[Page 15287]]

     ask, what's the problem? Why are we here? The problem is 
     found in a very fundamental difference of opinion as to what 
     it takes to assure that the oversight board will be 
     effective.
       Chairman Pitt and the administration believe the SEC itself 
     could create an effective board by administrative action. 
     Professors Coffey and Seligman and I strongly disagree, and 
     the specifics of that disagreement are in a letter that I am 
     going to attach to this testimony to give you. We gave that 
     letter to Chairman Sarbanes.
       The Oxley bill was passed some time ago, before WorldCom 
     created a tailwind behind real reform. And it is woefully 
     deficient in arming the oversight board with powers 
     sufficient to permit it to function effectively.
       Now, I think everyone would agree that effectiveness in 
     creating any government agency is essential. It's not useful 
     to spend taxpayers' money on going through motions that don't 
     accomplish anything, ab initio don't have a prospect of 
     accomplishing anything.
       Nothing could do more harm to investor confidence than the 
     passage of a bill that has only a patina of reform allowing 
     legislators to claim victory when in fact it fails to provide 
     the tools needed to get the job done. An already skeptical 
     public can be counted on to punish anyone engaging in that 
     kind of sham.
       Without going into detail on Oxley, let me mention a few of 
     the most glaring problems. Oxley would allow the profession 
     to control the oversight board; it would allow the profession 
     to control the oversight board. That's the same defect that 
     is in the Pitt proposal in the administrative version. And we 
     pointed that out in our letter.
       In reality, the Oxley bill as it is now written would 
     simply dress in new clothes the failed system of self-
     regulation. Watchdogs selected by those whom they are 
     intended to watch will do nothing to restore investor 
     confidence in the audit function. To the contrary, it will 
     further erode it.
       Second, Oxley would not assure funding for the board free 
     of influence or control by the profession. In the past, this 
     profession has not hesitated to withdraw funding from 
     entities itself had created to carry out self-regulation when 
     those entities dared to do something that the profession 
     didn't like.
       The third point: Oxley would deny the oversight board the 
     power to prohibit a firm from providing non-audit services to 
     its audit clients. Even the nature and/or amount of such 
     services would impair the auditors' independence.
       In his testimony before the Senate this week, Chairman 
     Greenspan said, wisely, I think, humans haven't become any 
     more greedy than in generations past. He said the problem was 
     ``that the avenues to express greed had grown so 
     enormously.``
       And indeed they have. As applied to the audit profession, 
     the immense growth in non-audit services has become a 
     superhighway for the expression of greed. Today over 70 
     percent of all fees paid by public companies to their 
     auditors are for non-audit services. For the oversight board 
     to have a chance to be effective in taming the profession's 
     infectious greed, to borrow the chairman's newly minted 
     phrase, the board must have the power to prohibit non-audit 
     services.
       The fourth point: Oxley fails to grant the oversight board 
     adequate investigative enforcement and disciplinary powers. 
     Without a set of powers at least comparable to what the NASB 
     and the New York Stock Exchange enjoy with respect to broker-
     dealers, the oversight board is doomed to ineffectiveness.
       There are lots of other deficiencies which a careful side-
     by-side comparison with the Sarbanes bill would quickly 
     reveal.
       I think a legislatively empowered oversight board is so 
     important to restoring investor trust, transcendentally 
     important in terms of the other things in that bill. The 
     reason for that is found in the audit function itself.
       Since 1934, public companies have been required to have 
     independent public accountants vouch for their numbers. The 
     auditors are the last line of defense against management's 
     inclination to fudge the numbers. Unlike the companies they 
     examine, auditors are simply not supposed to be taking risks. 
     They're not entrepreneurs. And yet with the enormous growth 
     in consulting and other non-audit services rendered to 
     management, they became co-venturers with management to such 
     a degree that their independence as auditors was often 
     compromised.
       They put themselves in a severe conflict of interest when 
     they perform non-audit services, on the one hand trying to 
     woo management to be retained to perform highly profitable 
     services that management could easily procure elsewhere, 
     while on the other hand trying to serve the audit committee 
     and the company shareholders by being questioning and 
     skeptical of management in reviewing the numbers.
       The cause and effect of allowing this conflict to persist 
     any longer is no secret, even to those untrained in finance. 
     Listen to what R. L. Butler, a retired clergyman in Denver, 
     said, as quoted on the front page of the New York Times 
     yesterday. ``The worst thing now is you can't even trust the 
     earnings reports. When you find the auditors in bed with the 
     managers, there's nobody to believe.''
       Mr. Butler understands this, and so does a rapidly growing 
     number of very angry investors who have lost much of their 
     life savings in stock markets and all of their faith in 
     audited numbers.
       And these people vote. They want their trust restored. 
     Congress has a chance to accomplish that, and it can be done 
     through legislation, ensuring a system by which companies 
     present their financial condition and that that system is 
     worthy of trust.
       S. 2673 is the vehicle. It's sitting there ready and 
     waiting. My dream is to watch bipartisan leadership in the 
     House get behind the wheel, drive that vehicle over to the 
     White House, and park it on the President's desk.
       Mr. Rangel. Thank you, Mr. Longstreth. That's our dream, 
     too.
       Those bells indicate that there is a vote taking place on 
     the floor. In the interests of time, this hearing will 
     continue. Members can vote and return.
       But it's my privilege to recognize Ms. Nancy Smith. And 
     thank you once again for taking the time to share your views 
     with us.

   Statement of Nancy Smith, Former Director, Investor Education and 
             Assistance, Securities and Exchange Commission

       Ms. Smith. Thank you very much. It's a pleasure to be back 
     in the House of Representatives and see so many faces that I 
     remember from when I worked here. And thank you for inviting 
     me to be on the panel today.
       I am the director of the RestoreTheTrust.com. 
     RestoreTheTrust.com is a nonpartisan campaign dedicated to 
     educating the public about accounting reform and to make sure 
     that real reform is signed into law. The Web site was created 
     to give individual investors a place to go to learn about 
     what is at stake and to voice their support for the only true 
     reform proposal on the table, the Sarbanes bill.
       At the Web site, you can send an e-mail in support of the 
     Sarbanes bill and real reform to your Members of Congress, 
     the President, and SEC Chairman Harvey Pitt.
       We launched the Web site just weeks ago on July 1. In that 
     short time, individuals have sent 46,000 letters in support 
     of the Sarbanes bill to decision makers.
       Individual investors have suffered enormous losses because 
     our lax regulatory system overseeing auditors let them down. 
     We hear from investors who have suffered enormous losses. 
     Some retirees wonder how they are going to make ends meet now 
     that their retirement funds have been slashed by a third or 
     more.
       To say people are angry is an understatement. People expect 
     the market to go up and down. As one investor wrote to us, 
     ``I can understand losing when things like the economy and 
     certain markets sour. But now I'm losing largely because the 
     information on which I depended turned out to be false. I 
     guess I was naive. I thought the American system of corporate 
     reporting was basically honest.''
       We all know that restoring trust in our stock market is 
     critical. The health of corporate America, their ability to 
     raise capital and raise jobs, drives the well-being and 
     financial security of every American. When investors don't 
     trust corporate America to tell the truth about their 
     financial health, it means investors don't give corporations 
     the money they need to grow and prosper. And as a result, our 
     economy suffers.
       One investor who wrote to us brought this point home. ``I 
     will not invest any more of my hard-earned money to line the 
     pockets of thieves.''
       It's imperative that we make sure the numbers tell the 
     truth and that people believe they are truthful. So how do we 
     do that? Increasing penalties for lying and stealing, and 
     sending corporate executives and their auditors to jail, 
     sounds great. But strong enforcement is only half the answer. 
     You can't pay the mortgage or the grocery bill with the 
     satisfaction of seeing some tycoon sitting behind bars. We 
     must prevent these accounting frauds and the losses they 
     cause from happening again.
       It's unbelievable that we let the auditors police 
     themselves. The lax regulatory system we have in place today 
     has got to go. It needs to be replaced by the sensible and 
     effective regulatory system in the Sarbanes bill that 
     provides independent oversight of the accounting industry and 
     prohibits auditors from consulting for the companies they 
     audit.
       The litmus test for true reform is twofold: create a full-
     time independent board free from industry control to oversee 
     auditors and punish wrongdoers; and, two, restrict auditors 
     from providing lucrative consulting services to the firms 
     they audit. Auditors should not be tempted to get cozy with 
     management. They can't get consulting fees and fight hard for 
     audits that protect investors.
       The Senate bill is the only bill to restore investors' 
     trust and prevent future scandals. Investors want real reform 
     in the Senate bill, and they want it now. They will know if 
     any backroom deals allow industry lobbyists to water it down.
       There's a basic problem with the House bill, the Oxley 
     bill: It doesn't meet the litmus test, and it doesn't fix the 
     problem. There's a reason the accounting industry

[[Page 15288]]

     supports it over the Senate bill; the House bill keeps the 
     accounting industry firmly in control.
       We've learned a costly lesson: When the accounting industry 
     polices itself, they get themselves and investors in big 
     trouble.
       The auditors cooked the books; don't let them cook the 
     legislation. The House bill is just a warmed-over version of 
     the status quo.
       There's no time to waste. The Senate voted 97-0 for a bill 
     that gives us a sensible regulatory system that is designed 
     to work. Let's follow the lead of Democrats and Republicans 
     in the Senate and get the Sarbanes bill to the President for 
     his signature right away.
       Thank you very much.
       Mr. Gephardt. Let me ask one question, and then we'll end.
       And, again, I deeply appreciate all of you being here. I 
     wish all of America and all these investors that we worry 
     about here could have heard this panel. I think their 
     confidence, just by hearing you, would have been enormously 
     restored.
       It's always reassuring to me, as a citizen of this country, 
     that we have people like each of you, who is willing to give 
     a large part of your career to public service, so that the 
     greatest system that's ever been devised in the history of 
     the world of democracy and capitalism can work properly. So I 
     hope to get your testimony out to as wide an audience as we 
     can.
       My question is really a follow-on. I think Paul's answer is 
     what I certainly agree with, that we've got this thing in 
     front of us now. It got a unanimous vote in the Senate; that 
     rarely happens. So we have to seize the moment and try to get 
     this bill through without interrupting it or diluting it or 
     changing it dramatically and watering it way down.
       My question is this: Do any of you think that further 
     legislation, assuming we get this done, on the stock option 
     question--Paul talked about it, and I think Lynn talked 
     about. And I understand that the International Accounting 
     Standards Board made a recommendation today or yesterday.
       Mr. Volcker. More than a recommendation.
       Mr. Gephardt. Yes, they did it.
       There is, I'm told, a Levin-McCain bill now that would ship 
     this off to the new independent board, or the FASB, I'm not 
     sure which, and ask them to reconsider a lot of rules and to 
     come back with recommendations within a year. I'd like to 
     have your thoughts about that.
       And I'd like to have your thoughts about the pension 
     issues, profit-sharing issues. Some of those George Miller 
     brought up. Do you think that we should try to get a bill 
     done there? We did do a bill here. It had some deficiencies 
     in it, from my viewpoint. The Senate is going to try to deal 
     with it. What do you think is the heart of anything that 
     needs to be done in that area, if anything?
       Those are the two questions.
       Mr. Volcker. Well, on the pension side of things, let me 
     say that I think there probably is a need for some 
     legislation there, in order to better protect the pensioner 
     himself. But that is a classic case of something has its own 
     complications and should not be added to the current bill.
       Mr. Gephardt. Right.
       Mr. Volcker: I think that is something you have to think 
     about a little more, about how to do it. But I think there is 
     good reason to proceed.
       I am not so sure about the stock option question. I think 
     we have a designated arrangement for dealing with that 
     question. It's hard to object to a bill that tells FASB to 
     reconsider it. I think they will reconsider it anyway, 
     whether there's a bill or not.
       My hesitancy is, I don't want to create a precedent that 
     Congress is going to write the accounting rules. And that's--
     --
       Mr. Gephardt. That would not be a good idea. [Laughter.]
       Take my word for it.
       Mr. Volcker. That's what you would be doing in this 
     particular case, and I don't want to see that precedent. I 
     feel quite confident that the board that I am involved with--
     I may agree or disagree with the very specific action they 
     take, but they have that problem well in mind. And they're 
     trying their best to come up--they've expressed their view 
     that it should be expensed. The question is how it should be 
     expensed. And I would leave that question up to them, 
     frankly.
       Mr. Longstreth. I have one comment on the stock options. I 
     agree completely with Paul that Congress ought not to 
     legislate either on expense or non-expense. And that gets 
     back to the history of this. They really overruled FASB.
       And I think FASB, once burned in that way, even with the 
     present situation, may be reluctant to take it up. I have no 
     expertise on that, but I think there are so many people in 
     this country who argue strenuously, and they're bright 
     people, and some of them are highly motivated people, for not 
     expensing options. And I feel so strongly they should be 
     expensed that I think that--I don't see a problem, Paul, with 
     having the Congress undo the damage it did earlier by simply 
     saying we encourage or even direct, but I think you could--a 
     sense of Congress to invite and encourage FASB to revisit 
     this issue would be, I think, a good idea, because it would 
     give FASB the cover, the sense of direction, that they may 
     need.
       I mean, this market can turn around again, and the momentum 
     will be gone. But it won't be gone for those people who have 
     an enormous stake in hiding these numbers.
       Mr. Volcker. I think it's a little naive to suggest that 
     Congress could suggest that and pass such a law without it 
     carrying the implication that you'll do this. And I don't 
     think it's appropriate.
       FASB will be forced to take it up if the international 
     takes it up and passes it. I didn't say they're going to do 
     anything, but they can't sit there. They're either going to 
     have to say yes or no.
       Mr. Longstreth. Okay, that's a good point.
       Mr. Turner. Let me jump in between these two distinguished 
     gentlemen and stay down low. [Laughter.]
       First of all, back to the Sarbanes bill, quite frankly, 
     this is a very, very simple issue: You're either for reform 
     or you're not. You're either for the Sarbanes bill or you're 
     not.
       The Oxley bill, the Pitt program, and the 10-point 
     President's program all have some good things in there, but 
     they fall a mile short. They are not reform.
       And I think the House could just vote for the Sarbanes 
     bill. To have to beat this to death in conference and perhaps 
     water it down is not being for reform. If the House 
     leadership wants to demonstrate that it's clearly for reform, 
     it will have the Members vote on the Sarbanes bill straight 
     up and get it to the President's desk before the end of the 
     week, tomorrow.
       And I feet passion about that. This is very simple. America 
     wants a simple answer. Let's just get reform. Let's get it 
     down.
       So I commend you, Representative Gephardt, for holding this 
     hearing, because I think it's important that the public 
     understands who is for reform and who is against.
       With respect to the two pieces of legislation, again, 
     having run a company where we had many employees, many 
     pension programs, I would agree with Paul Volcker, that you 
     should do some additional legislation there to protect the 
     employees in those situations. Again, do it in a separate 
     bill outside of Sarbanes.
       As far as the stock option issue, the reason we're in the 
     dilemma we're in, to some degree, is because of congressional 
     interference with the FASB in the past. I mean, we would have 
     had a good standard if it hadn't been for that interference.
       So I do agree with Bevis Longstreth that it doesn't do 
     harm, in this case, if you undid the damage that you did in 
     the past. But you should not legislate what the accounting 
     should be. I think to ask the FASB to put it on the agenda, 
     and then let them go through their normal due process, is 
     fine.
       I saw earlier drafts of some legislation over in the 
     Senate, though, where some people wanted FASB to conduct a 
     study, but it was almost biased from day one.
       I think if you asked the FASB to do something, it should be 
     simple and should not have a bias. It should just be, ``Would 
     you consider putting it back on your agenda? And then go do 
     whatever you think is right,'' and leave it at that, nothing 
     more, nothing less.
       I have been on panels with two of the members of the FASB 
     where they have been very adamant. Given the tremendous fight 
     and the difficulty that they went through the first time, 
     both of these members vowed that they would not, absent some 
     outside support, they absolutely would not put it back on 
     their agenda, including if the ISB undertook the project.
       And if the ISB undertakes the project and gets something 
     out--as Paul indicated, the exposure draft is out there--and 
     gets something done, I think that the opposition from the 
     American business community may still present an obstacle to 
     the FASB ever putting it back on its agenda, given what 
     happened 8 years ago.
       So I would have no problem, if you kept it simple. I think 
     it would actually be good if you asked them to put it back on 
     the agenda and reconsider it, because it may get us to 
     convergence on international standards, and that would be 
     very helpful, as long as people let the process run the way 
     it should turn around and run. And I'd encourage you to do 
     that.
       Mr. Gephardt. Thank you.
       Nancy, do you have a last thought here?
       Ms. Smith. Well, I agree with what the gentlemen have said. 
     I think the bottom line is the American people want to hear 
     the truth. And when we look at these issues, what our guide 
     should be is: Are we telling the truth about these numbers? 
     Are we shading the profitability of a company by what we're 
     doing on stock options? That doesn't serve the investing 
     public. That's what the investing public is upset about right 
     now.
       So let's restore the trust. Let's tell people the truth. 
     That's all people want.
       Mr. Gephardt. Thank you again. This has been a fabulous 
     panel. I have really benefited from hearing you. You have 
     enormous experience and practical advice to give us, and we 
     have benefited from it enormously. And we'll try to get your 
     testimony as widely spread as we can.
       Thank you very much.

[[Page 15289]]

       [Whereupon, at 4:00 p.m., the hearing was adjourned.]

       

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