Securities and Exchange Commission: Actions Needed to Improve	 
Public Company Accounting Oversight Board Selection Process	 
(19-DEC-02, GAO-03-339).					 
                                                                 
The Sarbanes-Oxley Act of 2002 created, among other things, the  
Public Company Accounting Oversight Board (PCAOB) to oversee	 
audits of public companies. A divided Securities and Exchange	 
Commission (SEC) appointed the first PCAOB on October 25, 2002.  
Amid allegations that the SEC Chairman withheld relevant	 
information from the other Commissioners concerning the 	 
suitability of the newly appointed PCAOB chairman, GAO was asked 
to examine SEC's selection process; determine whether the SEC	 
Chairman withheld information from other Commissioners; determine
what vetting of candidates took place; and identify what actions 
led to breakdowns in the process.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-339 					        
    ACCNO:   A05743						        
  TITLE:     Securities and Exchange Commission: Actions Needed to    
Improve Public Company Accounting Oversight Board Selection	 
Process 							 
     DATE:   12/19/2002 
  SUBJECT:   Accountants					 
	     Accounting standards				 
	     Auditing standards 				 
	     Corporate audits					 
	     Government job appointments			 
	     Securities 					 
	     SEC Name Relationship Search Index 		 
	     SEC Electronic Data Gathering, Analysis,		 
	     and Retrieval System				 
                                                                 

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GAO-03-339

Report to Congressional Requesters

United States General Accounting Office

GAO

December 2002 SECURITIES AND EXCHANGE COMMISSION

Actions Needed to Improve Public Company Accounting Oversight Board
Selection Process

GAO- 03- 339

SEC faced significant challenges in vetting and appointing five members to
the newly created PCAOB within 90 days. The SEC Chairman, who had overall
responsibility for the appointment process, initially, envisioned a
process primarily driven by SEC staff. He asked the Chief Accountant to
take the lead in selecting and the General Counsel in vetting PCAOB
members. However, this approach was not fully understood or endorsed by
the other Commissioners. The overall process that emerged was neither
consistent nor effective and changed and evolved over time.

Several factors contributed to the eventual breakdown of SEC*s selection
and vetting process, including the inability of the Commissioners to reach
agreement on a formalized process that defined the roles to be played by
the Commissioners and staff; insufficient communication between SEC staff
and Commissioners; and the lack of articulated selection criteria beyond
general criteria provided by the act. Finally, inability to choose a final
slate of candidates until the eve of the Commission*s vote resulted in the
appointment of PCAOB members who had not been fully vetted.

On the day of the October 25 vote, the Chief Accountant became aware of
information concerning Judge William Webster, who was slated to be the
chairman of the PCAOB, and his role as the former chairman of the audit
committee of a small company* U. S. Technologies, Inc. However, based on
his review of available information, his experience as an auditor, Judge
Webster*s prominence and reputation, and the fact that additional vetting
would occur post- appointment, the Chief Accountant deemed that the
information would not affect Judge Webster*s nomination. He thus decided
not to share the information concerning Judge Webster*s role at U. S.
Technologies with the SEC Chairman, the other Commissioners, or the
General Counsel.

As Judge Webster*s appointment illustrates, the five individuals chosen
for the PCAOB were not systematically vetted prior to appointment. After
the selection process broke down in early October when the Commission was
unable to agree on a consensus candidate for chairman, the General Counsel
was forced to initiate the vetting process on a postappointment basis, a
fact which the Commission was made aware of before the October 25 vote. At
the time of our review, the vetting process was still ongoing.

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 339. To view the full report,
including the scope and methodology, click on the link above. For more
information, contact Richard J. Hillman at (202) 512- 8678 or hillmanr@
gao. gov. Highlights of GAO- 03- 339, a report to

the Chairman, Senate Banking, Housing, and Urban Affairs Committee;
Ranking Minority Member, House Energy and Commerce Committee; and another
House requester

December 2002

SECURITIES AND EXCHANGE COMMISSION

Actions Needed to Improve Public Company Accounting Oversight Board
Selection Process

The Sarbanes- Oxley Act of 2002 created, among other things, the Public
Company Accounting Oversight Board (PCAOB) to oversee audits of public
companies. A divided Securities and Exchange Commission (SEC) appointed
the first PCAOB on October 25, 2002. Amid allegations that the SEC
Chairman withheld relevant information from the other Commissioners
concerning the suitability of the newly appointed PCAOB chairman, GAO was
asked to examine SEC*s selection process; determine whether the SEC
Chairman withheld information from other Commissioners; determine what
vetting of candidates took place; and identify what actions led to
breakdowns in the process.

GAO recommends that SEC define and reach agreement on a documented PCAOB
appointment process; set selection criteria; develop a vetting process and
complete necessary reviews before appointments; and make greater use of
available technology to do background checks on candidates. While no
written comments were provided, SEC generally agreed with the report*s
recommendations.

Page i GAO- 03- 339 PCAOB Selection Process Letter 1

Scope and Methodology 2 Results in Brief 3 Background 5 SEC Strategies
Evolved in Response to Major Events Leading to

the Appointment of PCAOB Members 7 Chief Accountant Did Not Inform the
Commission of Issues at U. S.

Technologies Prior to the Vote 13 Vetting Process Was Initiated Post-
Appointment 17 Several Factors Contributed to the Breakdown of SEC*s
Selection

and Vetting Process 20 Conclusions 24 Recommendations for Executive Action
26 Agency Comments 26

Appendix I Summary of Key Events Associated with the Selection of the
Public Company Accounting Oversight Board 28

Figure

Figure 1: Detailed Analysis of the Office of the Chief Accountant*s Second
Review of U. S. Technologies 15

Abbreviations

CPA Certified Public Accountant CRM Contract Resource Management, Inc.
EDGAR Electronic Data Gathering and Retrieval System FAF Financial
Accounting Foundation FASB Financial Accounting Standards Board FBI
Federal Bureau of Investigations NRSI Name Relationship Search Index PCAOB
Public Company Accounting Oversight Board RFQ Request for Quotations SEC
Securities and Exchange Commission TIAA- CREF Teachers Insurance and
Annuity Association * College

Retirement Equities Fund Contents

Page 1 GAO- 03- 339 PCAOB Selection Process

December 19, 2002 The Honorable Paul S. Sarbanes Chairman, Committee on
Banking,

Housing, and Urban Affairs United States Senate

The Honorable John D. Dingell Ranking Minority Member Committee on Energy
and Commerce House of Representatives

The Honorable Barney Frank House of Representatives

In response to the unexpected and rapid bankruptcies of large companies
such as the Enron Corporation and WorldCom, Inc., concerns about the
integrity and reliability of financial disclosures, and the adequacy of
regulation and oversight of the accounting profession, the Sarbanes- Oxley
Act of 2002 was enacted into law on July 30, 2002. A cornerstone of this
reform was the creation of the Public Company Accounting Oversight Board
(PCAOB) to oversee the audits of public companies. The PCAOB was given
broad powers to inspect the accounting firms performing those audits, set
rules and standards for such audits, and impose meaningful sanctions if
warranted. The act required the Securities and Exchange Commission (SEC)
to appoint members to this independent, full- time, fivemember board by
October 28, 2002, and to continue doing so as terms of office expired. On
October 25, 2002, amid mounting controversy about who should be selected
as chairman, a divided Commission appointed the first five PCAOB members.

On October 31, allegations emerged that the SEC Chairman had withheld
relevant information from his fellow Commissioners concerning the newly
appointed PCAOB chairman*s, Judge William H. Webster, involvement as the
former chairman of the audit committee of the board of directors of U. S.
Technologies, Inc., a small company. In response to these allegations, you
asked that we thoroughly examine the process SEC used to select and vet
nominees to the PCAOB. Our specific objectives were to (1) describe the
process and significant events leading up to the Commission*s selection of
the PCAOB*s first members, (2) determine what the SEC Chairman knew about
the involvement of Judge Webster in U. S. Technologies and whether the
Chairman withheld information from the

United States General Accounting Office Washington, DC 20548

Page 2 GAO- 03- 339 PCAOB Selection Process

other Commissioners prior to the Commission*s vote, (3) determine what
vetting of appointees took place, and (4) identify any aspects of SEC*s
selection and vetting process that contributed to the eventual breakdown
in the process.

To describe the process and significant events leading up to the
Commission*s selection of the PCAOB*s first members, to determine what the
SEC Chairman knew about the involvement of Judge Webster in U. S.
Technologies, and to determine whether the Chairman had withheld
information from the other Commissioners prior to the Commission*s vote,
we reviewed thousands of internal documents. These documents included
plans, memorandums, and correspondence between and among the Chairman, the
Commissioners, the SEC Chief Accountant, other SEC staff involved in the
PCAOB selection process, and outside parties. We also used this
information to corroborate and verify testimonial evidence collected
through extensive interviews of the SEC Chairman; each Commissioner; the
Chief Accountant; the General Counsel; the Chairman*s Chief of Staff; the
PCAOB appointees; and John H. Biggs, who was among those considered for
the PCAOB chairmanship. We also obtained information from staff in SEC*s
Office of the Chief Accountant, the Office of the General Counsel, the
Division of Enforcement, the Division of Corporation Finance, and the
Office of the Chairman and others within and outside SEC. Finally, we were
benefited greatly from technical support and assistance provided by staff
in SEC*s Office of the Inspector General. We reviewed and used information
collected and assembled by staff of the Office of the Inspector General
throughout our review. A determination and assessment of the details of
Judge Webster*s involvement in U. S. Technologies was beyond the scope of
this review.

To determine what vetting of appointees took place, we reviewed the SEC
Office of the General Counsel*s proposed vetting process for the PCAOB
appointees and other relevant documentation. We also interviewed SEC*s
General Counsel and the PCAOB appointees to obtain information about the
types of information they provided prior to their appointment to the
PCAOB. Likewise, to determine what aspects of SEC*s selection and vetting
process contributed to the breakdown of the process, we attempted to
identify other applicable appointment models to identify common elements
of those models with which to compare the process followed by SEC in
selecting and vetting PCAOB appointees. Finally, we obtained views from
those we interviewed about recommended process improvements. Scope and

Methodology

Page 3 GAO- 03- 339 PCAOB Selection Process

We conducted our work in New York, New York, and Washington, D. C., in
November and December 2002 in accordance with generally accepted
government auditing standards.

When the Sarbanes- Oxley Act of 2002 required SEC to appoint five members
to the newly created PCAOB within 90 days, SEC in many ways faced a unique
challenge. SEC had not played such a role since 1975 and did not have a
formalized and tested process in place that clearly identified and
documented the roles to be played by the Commissioners and staff. 1
Initially, the Chairman asked the Chief Accountant to take the lead in
identifying potential candidates for the PCAOB, but this approach was
never fully endorsed by the other Commissioners. 2 As the selection
process evolved, the Commissioners became more involved than originally
planned. A lack of consensus among the Commissioners, as well as a lack of
staff direction and communication, resulted in SEC*s failure to appoint a
slate of candidates that would elicit a unanimous vote. The staff*s
initial plan was to have the slate determined by the end of September,
which according to the General Counsel would have left time to conduct
some limited vetting of the appointees before October 28. However, this
strategy broke down when the Commission was unable to agree upon and
attract a consensus candidate to serve as PCAOB chairman. As the statutory
deadline approached, SEC was ultimately forced to appoint members to the
PCAOB that had not been adequately vetted.

At the time of the Commission*s vote, the Chief Accountant did not inform
the SEC Chairman or other Commissioners about certain matters concerning
Judge Webster*s role as the former chairman of the audit committee of the
board of directors of U. S. Technologies. Although the SEC Chairman was
aware that Judge Webster had been the chairman of the audit committee and
that the company was failing, he had previously been told that Judge
Webster*s involvement in U. S. Technologies did not

1 SEC was involved in establishing the Municipal Securities Rulemaking
Board, which was created under the Securities Acts Amendments of 1975,
Pub. L. No. 94- 29, S:13, to regulate brokers, dealers, and banks dealing
in municipal securities.

2 Under Reorganization Plan No. 10, most of the Commission*s executive and
administrative functions were transferred to the SEC Chairman, including
the appointment and supervision of Commission personnel, distribution of
business among the administrative units, and the use and expenditure of
funds. Moreover, the Chairman effectively sets the agenda and policy
direction for the Commission and determines what issues staff bring before
the Commission. Results in Brief

Page 4 GAO- 03- 339 PCAOB Selection Process

pose a problem. We found no evidence that the SEC Chairman was informed of
any other information about the company*s history and Judge Webster*s role
prior to the October 25 vote on the PCAOB candidates. Staff in the Office
of the Chief Accountant did not review much of the relevant periodic
filings containing information raising concerns about auditing- related
issues at U. S. Technologies until the morning of the October 25 vote.
Although information contained in these filings was reviewed by the Chief
Accountant, on the basis of his review of available information, his
experience as an auditor, his knowledge of Judge Webster*s previous
federal service, and an understanding that additional vetting would occur
post- appointment, the Chief Accountant concluded that this information
did not have a bearing on Judge Webster*s suitability to be nominated to
serve on the PCAOB. Therefore, the Chief Accountant did not share what he
knew with the Chairman or the other Commissioners prior to the October 25
vote.

As the Judge Webster appointment illustrates, the five appointees were not
systematically vetted prior to appointment to the PCAOB. The SEC Chairman
and staff initially planned that the Office of the General Counsel would
conduct some vetting prior to selection. In addition to administering
certain details, the General Counsel was a resource for potential nominees
who had questions about appointment to the PCAOB. However, after the
selection process broke down in early October when the Commission was
unable to agree on a consensus candidate for chairman, the General Counsel
was forced to initiate the vetting process on a post- appointment basis.
The Commission was made aware of this fact at the time of the October 25
vote. The vetting process was still ongoing at the time of our review.

SEC faced many challenges in selecting the first PCAOB and will not have
to appoint five members in a 90- day time frame again. Nevertheless we
found that SEC did not take steps that could have contributed to a more
efficient selection process. First, it did not take sufficient steps to
reach consensus on the process to be followed among the Commissioners and
SEC staff before they appointed the PCAOB members. Second, SEC did not
identify or systematically utilize any selection criteria beyond the broad
criteria specified in the act to consider candidates for PCAOB membership.
Thus, uncertainty existed about the composition of the PCAOB and views on
the qualifications for board membership varied among the Commissioners and
SEC staff. Finally, SEC did not develop and articulate a documented,
public, or agreed- upon process for screening candidates before they were
interviewed and appointed by the Commissioners; nor did the Commission and
staff collectively determine

Page 5 GAO- 03- 339 PCAOB Selection Process

how and what information would, and should, have been developed and passed
along for their consideration as they deliberated about candidates.

Given the vitally important role of the PCAOB in addressing corporate
oversight and investor protection concerns, we are making several
recommendations in this report that are aimed at improving SEC*s PCAOB
selection and vetting process prior to the appointment of any new PCAOB
members. First, we recommend that the Commission reach agreement upon and
document the process to be followed, the proper sequence and timing of key
steps, and the roles to be played by the Commission and SEC staff in the
selection and vetting of candidates. In so doing, we recommend that the
Commission develop agreed- upon selection criteria for PCAOB members and
chairman that embrace the intent of the act. We also recommend that the
Commission develop a vetting process that ensures that before an applicant
is brought to the Commission for serious consideration, certain minimum
background checks are performed in connection with the individual and that
the vetting process be completed before the Commission votes to appoint
members to the PCAOB. Further, we recommend that SEC determine how such
information on potential nominees should be documented, analyzed, and
shared among the Commissioners and staff. Finally, we recommend that SEC
make greater use of available technology to conduct necessary background
checks that generate sufficient details about the qualifications of
potential applicants so that the Commission can make both timely and
informed decisions on the fitness of potential applicants for the PCAOB.

We requested comments on a draft of this report from all five SEC
Commissioners, SEC*s General Counsel, SEC*s former Chief Accountant, the
Chairman*s former Chief of Staff, and others at SEC involved in the
selection and vetting process. In addition, we requested comments from
Judge Webster and Mr. Biggs. Each of these parties provided only technical
comments on the report*s contents, which were incorporated as appropriate.
The Chairman and each of the other four Commissioners also told us that
they generally agreed with the report*s recommendations.

The act specifies that the PCAOB is to consist of five, full- time
members, with one being designated as the chairman. According to the act,
each PCAOB member is to have a demonstrated commitment to the interests of
investors and the public, an understanding of issuers* financial
disclosure requirements, and an understanding of the obligations of
accountants with respect to the preparation of audit reports. The act also
specifies that two, but no more than two, members be certified public
accountants (CPA). Background

Page 6 GAO- 03- 339 PCAOB Selection Process

PCAOB members generally are expected to serve 5- year terms. However, to
establish staggered terms of office, the terms of office of the initial
PCAOB expire in annual increments, ranging from 1 to 5 years, with the
chairman serving a 5- year term.

Although its activities are subject to SEC oversight and approval, the
PCAOB is an independent board with sweeping powers and authority. It has
the authority to

 register public accounting firms that prepare audit reports for
companies that issue securities to the public (issuers);

 establish rules for auditing, quality control, independence, and other
standards relating to the preparation and issuance of audit reports for
issuers;

 conduct inspections of registered public accounting firms and associated
persons;

 conduct investigations and disciplinary proceedings and, where
justified, impose appropriate sanctions upon registered public accounting
firms and associated persons;

 perform other duties or functions determined necessary or appropriate to
promote high, professional standards among public accounting firms and
associated persons;

 enforce compliance with the act, the rules of the PCAOB, professional
standards, and the securities laws relating to the preparation and
issuance of audit reports by registered public accounting firms and
associated persons; and

 set the budget and manage the operations of the PCAOB and its staff. The
newly created PCAOB is to be structured as a nonprofit corporation that is
funded by fees assessed on public companies. The act specifies that PCAOB
members, employees, and agents are not considered employees of the federal
government.

The act requires SEC to appoint PCAOB members and verify that the
organization meets its statutory responsibilities. Specifically, the act
requires that SEC, in consultation with the Chairman of the Board of
Governors of the Federal Reserve System and the Secretary of the Treasury,
appoint the initial five- member board within 90 days of the act*s
passage* that is, by October 28, 2002. Within 270 days of enactment, SEC
is to determine that the PCAOB has taken actions necessary to carry out
its mission. These actions include hiring staff, proposing rules, and
adopting initial and transitional auditing and other professional
standards. Within 180 days of SEC*s determination that the PCAOB is
meeting its

Page 7 GAO- 03- 339 PCAOB Selection Process

statutory responsibilities, any public accounting firm that is not
registered with the PCAOB may not participate in the preparation or
issuance of any audit report for any public company that issues securities
to the public.

SEC is an independent agency comprising five presidentially appointed
commissioners, 4 divisions, and 18 offices. In total, SEC has
approximately 3,100 staff. SEC is headquartered in Washington, D. C., and
it has 11 regional and district offices throughout the country. To ensure
that the Commission remains nonpartisan, no more than three commissioners
may belong to the same political party. The President also designates one
of the commissioners as chairman, the SEC*s top executive. The
commissioners meet to discuss and resolve a variety of issues that staff
bring to their attention. At these meetings, the commissioners interpret
federal securities laws, amend existing rules, propose new rules to
address changing market conditions, and/ or take action to enforce rules
and laws. These meetings are open to the public and the news media, unless
the discussion pertains to confidential subjects such as whether to begin
an enforcement investigation.

Faced with appointing five members to the newly created PCAOB in 90 days,
SEC lacked a formalized and tested process that documented the roles to be
played by the Commissioners and staff. The SEC Chairman initially asked
the Chief Accountant to take the lead in identifying potential PCAOB
members; however, the other Commissioners never fully endorsed this
approach. A lack of consensus among the Commissioners and a lack of staff
direction and communication resulted in SEC*s failure to find a slate of
candidates that would elicit a unanimous vote from the Commission.
Moreover, these events ultimately resulted in SEC appointing members to
the PCAOB that had not been fully vetted.

In requiring SEC to appoint members to the PCAOB within 90 days, the act
posed a unique challenge for SEC. SEC had not in recent history conducted
a similar selection process; therefore, it lacked formalized and tested
procedures that were familiar to the Commissioners and SEC staff. The
actual process used to appoint PCAOB members was not documented and
evolved as the statutory deadline for appointing members approached. Upon
passage of the act, the Chairman designated the SEC*s Chief Accountant to
lead the search for and identification of PCAOB nominees, with assistance
from the General Counsel, who was assigned to vet the candidates. The
Chief Accountant began identifying potential candidates for the PCAOB from
a wide range of sources, including current and prior SEC Strategies

Evolved in Response to Major Events Leading to the Appointment of PCAOB
Members

Initial Strategy for the Selection and Vetting Process

Page 8 GAO- 03- 339 PCAOB Selection Process

Commissioners, Members of Congress, government officials, regulatory
organizations, trade associations, and industry leaders. SEC also
solicited input from the public through an August 1, 2002, release asking
for nominations and applicants willing to serve on the PCAOB. 3 As
required by the act, early in the process, the SEC Chairman began to
consult with the Chairman of the Board of Governors of the Federal Reserve
System and the Secretary of the Treasury to obtain their input and
suggestions for potential PCAOB candidates.

Early in the selection process, the SEC Chairman*s goal was to find an
outstanding candidate as chairman, an individual of great stature who
could reassure investors and receive unanimous support from the
Commission. The SEC Chairman initially planned that he, along with a
Democratic Commissioner and the Chief Accountant, would approach
candidates for the chairmanship. The Chairman said that he believed this
would help make the process bipartisan. The SEC Chairman wanted the Chief
Accountant to participate because he was the person within SEC who would
have the most contact with the PCAOB chairman; therefore, he needed to be
comfortable with the selection. However, at least one Commissioner told us
that the reason for this approach was neither communicated to him nor
fully understood by him.

Given that the nominees were being considered for service on a board that
was designed to help restore investor confidence in financial reporting
systems and to clean up perceived problems in the accounting profession,
the SEC Chairman said that the PCAOB, and thus each of its members, must
be beyond reproach. To achieve that end, the Chairman asked the General
Counsel to vet nominees and, at a minimum, identify any significant
potential problems or conflicts, real or perceived, involving accounting
and other related issues. The General Counsel said that he saw his role as
working with the Office of the Chief Accountant to develop an application
to collect financial and background information from appointees, to select
a contractor to conduct background checks on the appointees, and to
identify other steps to vet the slate of candidates selected by the
Commission. The staff initially planned to have the slate of potential
PCAOB candidates determined by the end of September, which the General
Counsel thought would have provided time to do at least some vetting of
the appointees before the October 28 deadline. It is unclear whether the
other Commissioners were informed of or fully endorsed this

3 By the October 25 vote, SEC had compiled a list of more than 450 names.

Page 9 GAO- 03- 339 PCAOB Selection Process

plan; some of the Commissioners wanted more involvement in the process and
thought it best for each Commissioner independently to do due diligence on
potential candidates. This selection strategy broke down when the
Commissioners, lacking a documented and formalized process, were unable to
agree upon and follow a strategy to identify, vet, and select members to
the PCAOB and attract a consensus candidate to serve as chairman.

In August 2002, according to those involved in the process, Paul A.
Volcker, the former Chairman of the Board of Governors of the Federal
Reserve System, emerged as the consensus choice for PCAOB chairman. The
SEC Chairman, a Democratic Commissioner, and the Chief Accountant tried
throughout August to persuade Mr. Volcker to consider serving as PCAOB
chairman. The SEC Chairman also asked the Secretary of the Treasury, the
Chairman of the Board of Governors of the Federal Reserve System, and
others to assist him in persuading Mr. Volcker. In early September, Mr.
Volcker declined to be considered for appointment, in part because the
full- time nature of the position required him to give up outside
interests that were important to him. In September, the SEC Chairman, the
Democratic Commissioner, and the Chief Accountant shifted their focus to
Mr. Biggs, the retiring Chief Executive Officer of Teachers Insurance and
Annuity Association - College Retirement Equities Fund (TIAA- CREF).

On September 11, the Chairman, the Democratic Commissioner, and the Chief
Accountant met with Mr. Biggs to discuss his interest in serving on the
PCAOB. According to those involved, the purpose of the meeting was to
persuade Mr. Biggs to agree to be considered for the chairmanship of the
PCAOB. At this meeting, the Chairman and the Democratic Commissioner in
attendance told Mr. Biggs that he would have their support. However, the
SEC Chairman also stated that his final decision would rest in what he
hoped would be a unanimous decision by the Commission. Mr. Biggs said that
he told the SEC Chairman that he would only serve on the PCAOB if he were
appointed its chairman. The following week, Mr. Biggs called the Chairman
and the Chief Accountant to say that he was willing to be considered. On
September 24, Mr. Biggs met with a third Commissioner who also gave his
support, thereby giving Mr. Biggs enough votes for a majority. Mr. Biggs
subsequently met with the remaining two Commissioners and other SEC staff
on September 27. For the Chairman, support of Mr. Biggs was contingent
upon another specific individual being appointed to the PCAOB. Therefore,
when one of the Commissioners informed the Chairman (around Sept. 27) that
another Major Events Leading to

the Appointment of the First PCAOB

Page 10 GAO- 03- 339 PCAOB Selection Process

Commissioner might not be willing to support that individual, the Chairman
became less willing to support Mr. Biggs.

The SEC Chairman continued to discuss throughout September other
candidates who could potentially serve as chairman or members of the
PCAOB. Although potential appointees to the PCAOB had been the subject of
ongoing media speculation, on October 1, a newspaper article indicated
that Mr. Biggs had *agreed to be the first head of a new regulatory
oversight board for the accounting profession.* 4 According to those we
interviewed, this article upset some of the Commissioners because it said
that the job had been offered to Mr. Biggs. Some of the Commissioners said
that the article made them feel that their vote was irrelevant to the
selection of the chairman. The SEC Chairman telephoned Mr. Biggs on
October 2 and informed him that the October 1 article had *complicated

things* and threatened the Chairman*s desire to achieve a unanimous vote.
Although the article reported that Mr. Biggs declined to be interviewed,
the article, together with a subsequent article that appeared on October
4, led some of the Commissioners to believe that Mr. Biggs was the source
of the information included in the articles, directly or indirectly. 5 As
a result, some of the Commissioners raised serious questions about Mr.
Biggs*s independence, judgment, and ability to effectively work on the
PCAOB. At this point, the Commission became divided, with at least one
Commissioner willing to support only Mr. Biggs as the chairman and others
who strongly opposed Mr. Biggs*s nomination as chairman.

SEC*s Chairman and Chief Accountant said that they originally planned for
the Commissioners to meet with only about five to seven PCAOB candidates,
who would be identified by the Chief Accountant. Again, this approach was
not communicated to or endorsed by all of the Commissioners. Therefore, in
late September, with time running out and little progress made in
selecting candidates, the selection process changed. At the urging of one
of the Commissioners, the Chief Accountant and each of the Commissioners
began to interview candidates. In total, each Commissioner interviewed
about 25 candidates for the PCAOB from late September to October. Although
the SEC Chairman and the Chief Accountant were considering a number of
candidates, Judge Webster, former Director of the Federal Bureau of
Investigation (FBI) and the

4 The New York Times, *Chief of Big Pension Plan Is Choice for Accounting
Board,* October 1, 2002. 5 The New York Times, *SEC Chief Hedges on
Accounting Regulator,* October 4, 2002.

Page 11 GAO- 03- 339 PCAOB Selection Process

Central Intelligence Agency, emerged as a leading candidate for PCAOB
chairman. Although his name had surfaced in early August along with
others, he was not seriously pursued at that time. According to Judge
Webster, the SEC Chairman first contacted him on September 27 about
considering a position on the PCAOB and later sent him some background
material. On October 15, Judge Webster met with the SEC Chairman, the
Chief Accountant, and the SEC Chairman*s Chief of Staff, who urged Judge
Webster to consider serving as PCAOB chairman. They discussed a number of
items at this meeting. At some point during the meeting, the Chairman said
that there was one reason for Judge Webster not to consider the position,
which was that Judge Webster*s nomination would be criticized by some and
that he could be attacked in the media. According to those in attendance,
Judge Webster said that he had been confirmed by the Senate for other
federal posts on five occasions and nothing in his past would pose a
problem. He added that people might make something out of the fact that he
was the former chairman of the audit committee of the board of directors
of U. S. Technologies, a company that he described as on the brink of
failure. According to Judge Webster, he also asked the SEC officials at
that meeting to check SEC*s records to see if they indicated any problems
relating to U. S. Technologies. As discussed in detail in the next
section, an initial review of this matter conducted by staff in SEC*s
Office of the Chief Accountant did not reveal, in the Chief Accountant*s
opinion, any disqualifying problems involving Judge Webster*s role in the
company. Based on the information he obtained, the Chief Accountant passed
along information to the Chief of Staff, indicating that there was no
problem with Judge Webster*s involvement in U. S. Technologies. The Chief
of Staff communicated that message to the SEC Chairman. Neither the
information provided by Judge Webster nor collected by the Chief
Accountant was provided to SEC*s General Counsel for vetting purposes.

On October 21, Judge Webster met with the SEC Chairman and the Chief
Accountant to discuss the position further. According to Judge Webster,
the Chief Accountant and the SEC Chairman independently told Judge Webster
on October 22 or 23 that his involvement with U. S. Technologies would not
be a problem. Judge Webster also spoke, in person or on the telephone,
with the other Commissioners and the General Counsel on or around October
22, but U. S. Technologies was not mentioned or discussed. Late in the
afternoon of October 23, Judge Webster agreed to have his name considered
for PCAOB chairman. The SEC Chairman and the Chief Accountant finalized
the choices for the other members of the PCAOB and developed a five-
member slate on October 24. On that day, in part due to concerns about a
leak to the press, the draft slate was not

Page 12 GAO- 03- 339 PCAOB Selection Process

shared with the full Commission. However, the Secretary of the Treasury
and the Chairman of the Board of Governors of the Federal Reserve System
were informed of the draft slate on October 24, and at the request of the
SEC Chairman, they signed a joint letter endorsing Judge Webster and the
other members on the slate.

There was additional research into Judge Webster*s involvement with U. S.
Technologies after Judge Webster agreed to have his name submitted for
consideration on October 23. On October 24, the Chief Accountant received
a draft newspaper article, which mentioned that Judge Webster had served
on the board of directors of several companies, including U. S.
Technologies. This prompted the Chief Accountant to ask one of his staff
to do some additional follow up on any open or closed enforcement activity
concerning U. S. Technologies. This review also included a review of
certain corporate disclosures filed with SEC by U. S. Technologies,
including documents indicating that the company had dismissed its external
auditor a month after material internal control weaknesses were reported.
The Chief Accountant received this information on the morning of October
25, a few hours before the scheduled open meeting of the Commission. Again
as discussed in detail in the next section, in the opinion of the Chief
Accountant, this review revealed nothing that would have disqualified
Judge Webster as a nominee. Therefore, the Chief Accountant did not pass
on any information about U. S. Technologies or Judge Webster*s role to the
SEC Chairman or the other Commissioners to consider prior to their vote to
appoint members to the PCAOB. He also did not share this information with
the General Counsel.

The SEC Chairman said that he and the Commissioners had planned to vote
seriatim* whereby the slate of nominees would be passed among the
Commissioners for signature* on Thursday, October 24, rather than holding
an open Commission meeting. However, on October 23, one of the
Commissioners requested an open meeting. On the morning of the October 25
vote, the Office of the Chief Accountant provided the Commissioners with
the slate of names for the PCAOB and formally notified them that vetting
would occur post- appointment. At the open meeting, one Commissioner voted
against all of the board nominees, stating that the selection process was
inept and seriously flawed. Another Commissioner voted against Judge
Webster, stating that he was not as qualified for the post as Mr. Biggs,
but voted in favor of the remaining slate. The SEC Chairman and the
remaining two Commissioners voted in favor of the slate of five. Judge
Webster therefore was approved by a vote of three to two, and the
remaining PCAOB nominees were approved by a vote of four to one.

Page 13 GAO- 03- 339 PCAOB Selection Process

Staff in the Office of the Chief Accountant continued to research matters
associated with U. S. Technologies from the morning of the vote into the
week of October 28. On October 31, allegations emerged that the SEC
Chairman, before the October 25 vote, withheld from his fellow
Commissioners material information about Judge Webster*s role at U. S.
Technologies, which was relevant to the appointment of Judge Webster as
chairman of the PCAOB. 6 Later that same day, the SEC Chairman and another
Commissioner separately called the SEC Inspector General to investigate
these allegations. The SEC Chairman also asked the SEC Office of the
General Counsel to conduct an investigation into Judge Webster*s
involvement with U. S. Technologies.

Amid the subsequent controversy, the SEC Chairman announced his intention
to resign on November 5, the Chief Accountant announced his resignation on
November 8, and Judge Webster resigned from the PCAOB on November 12,
effective upon the appointment of a new chairman. To date, the PCAOB has
had two planning meetings, which have included Judge Webster. The PCAOB is
expected to hold its first official meeting on January 6, 2003, at which
time members* terms officially begin. At this time, no acting chairman or
replacement chairman has been appointed to the PCAOB. See appendix I for a
more detailed chronology of major events.

As discussed above, the Office of the Chief Accountant performed two
reviews into Judge Webster*s involvement in U. S. Technologies prior to
his appointment as PCAOB chairman. According to those in attendance, in an
October 15 meeting, which included the SEC Chairman, the Chief Accountant,
and the Chairman*s Chief of Staff, Judge Webster mentioned that he had
formerly served as chairman of the audit committee of the board of
directors of U. S. Technologies, a company on the brink of failure. He
said that he asked SEC officials at that meeting to check SEC*s records to
see if they indicated any problems relating to U. S. Technologies. 7
According to the SEC Chairman, he told Judge Webster that they would
contact him if any problems were found. Following this meeting, the SEC

6 The New York Times, *Audit Overseer Cited Problems in Previous Post,*
October 31, 2002. 7 Judge Webster told us that he was not concerned about
the financial activities of the company, given that the company was
receiving clean audit opinions from its external auditors. However, he
said that he was concerned about certain activities of the company*s chief
executive. Chief Accountant Did

Not Inform the Commission of Issues at U. S. Technologies Prior to the
Vote

Page 14 GAO- 03- 339 PCAOB Selection Process

Chairman asked the Chief Accountant to look into U. S. Technologies. No
one who attended the meeting contacted SEC*s General Counsel, who was
responsible for vetting PCAOB candidates. Instead, the Chief Accountant
asked his secretary to follow up on whether there were any open or closed
SEC investigations of the company. Contact with the Division of
Enforcement revealed that SEC was looking into allegations of misconduct
by an officer of U. S. Technologies, not Judge Webster, involving a
Schedule 13D filed in 1999. 8 Staff in the Office of the Chief Accountant
received information from Enforcement staff that led them to believe that
Enforcement staff expected to close the matter. Because the matter
involved an officer of U. S. Technologies and not the company directly nor
the activities of its board of directors, the Chief Accountant concluded
that this did not affect Judge Webster*s nomination to serve as chairman
of the PCAOB. According to the Chief Accountant, he passed along
information from Enforcement staff to the SEC Chairman*s Chief of Staff
that indicated there was no problem as a result of Judge Webster*s
involvement with U. S. Technologies, and the Chief of Staff reported the
same to the SEC Chairman. According to Judge Webster, the SEC Chairman and
Chief Accountant independently informed him on October 22 or 23 that his
involvement in U. S. Technologies would not pose a problem. The SEC
Chairman said that he recalled contacting Judge Webster, but the Chief
Accountant said that he did not recall contacting Judge Webster.

There was a second inquiry into U. S. Technologies and Judge Webster by
the Office of the Chief Accountant. This inquiry was prompted late on
October 24 when the Chief Accountant reviewed a draft newspaper article,
which mentioned that Judge Webster had formerly served on the board of
directors of U. S. Technologies and had served as the chairman of its
audit committee until July 2002. The Chief Accountant asked one of his
staff to do some additional follow up but indicated that he thought it was
*clean*

on the basis of the initial review. This second review, as described in
greater detail in figure 1, included examining certain corporate
disclosures that U. S. Technologies filed with SEC, such as the most
recent annual and quarterly filings. Early on the morning of October 25,
staff became aware that the company had disclosed in a 2001 filing that it
dismissed its external auditor in August 2001, a month after the auditor
informed the

8 The Securities Exchange Act of 1934, Section 13( d), requires certain
persons who acquire beneficial ownership of more than 5 percent of certain
classes of equity securities to file an appropriate disclosure with SEC.
These disclosures are usually made on a Schedule 13D.

Page 15 GAO- 03- 339 PCAOB Selection Process

company of material internal control weaknesses. Upon learning about the
change in auditor, staff in the Office of the Chief Accountant did not
contact Judge Webster to obtain additional information on this issue, nor
did they contact other audit committee members, the company, the current
or former external auditor, or the SEC General Counsel.

Figure 1: Detailed Analysis of the Office of the Chief Accountant*s Second
Review of U. S. Technologies

Note: SEC requires a publicly held company to file a Form 8K when the
company changes its auditor.

Similar to his initial determination of October 15, the Chief Accountant
evaluated the additional information that had been collected, including
information on U. S. Technologies*s change in external auditor and
determined that, in his view and his staff*s view, nothing had come to
light

Page 16 GAO- 03- 339 PCAOB Selection Process

that affected the suitability of Judge Webster to serve as PCAOB chairman.
The Chief Accountant told us that his decision was based on his review of
financial disclosure documents filed with SEC; his experience as an
auditor; the stature and reputation of Judge Webster, who had been
confirmed by the Senate five times; and his knowledge that additional
vetting would occur post- appointment. The Chief Accountant also said the
documents filed with SEC by U. S. Technologies, which were determined to
be late and reported internal control weaknesses, described problems that
were not unusual in small, rapid- growth companies. He said that such
companies often outgrow their existing financial and accounting systems
and the capacity of their chief financial officers. Moreover, he was
persuaded by the fact that U. S. Technologies*s auditor had ultimately
given the company a clean opinion. Having decided that U. S. Technologies
posed no problems with regard to Judge Webster*s nomination, the Chief
Accountant did not believe that he needed to share this information with
the SEC Chairman or the other Commissioners. The Chief Accountant said
that he had made a similar judgment about Mr. Biggs who had been on the
audit committee of the board of directors of McDonnell- Douglas when it
entered into a consent decree with SEC regarding issues involving
accounting irregularities several years ago.

According to the SEC Chairman, he knew that Judge Webster was the former
chairman of the audit committee of the board of directors of U. S.
Technologies before the October 25 vote. He said that he learned after the
vote that law enforcement authorities were investigating the Chief
Executive Officer of U. S. Technologies. Specifically, Judge Webster told
us that he telephoned the SEC Chairman on October 28 to inform him that he
had learned during the weekend of October 26 and 27 that law enforcement
was investigating U. S. Technologies*s Chief Executive Officer. Further,
the SEC Chairman and the other Commissioners told us that they learned for
the first time of reported *allegations of fraud* against U. S.
Technologies and that the company had dismissed its external auditor
following an audit that uncovered material internal control weaknesses
from a reporter*s inquiry on October 30 or from the October 31 newspaper
article. 9 This disclosure prompted the SEC Chairman to ask the General
Counsel to investigate Judge Webster*s role in these matters. The Office
of the General Counsel has subsequently suspended the investigation due to
Judge Webster*s resignation.

9 The New York Times, *Audit Overseer,* October 31, 2002.

Page 17 GAO- 03- 339 PCAOB Selection Process

Vetting candidates is a vital component of the appointment process. The
General Counsel was asked to vet the appointees, and according to the SEC
Chairman, he expected that some vetting and background checks would be
performed by the General Counsel on candidates throughout the process.
Although the Chairman said that he knew that some vetting would occur
post- appointment, he was surprised at how little was done before the
vote. We found that after the selection process broke down in early
October and Commissioners began to interview a larger number of candidates
than staff originally planned, the General Counsel met with many but not
all of the potential candidates who were interviewed. Specifically, the
General Counsel told us that prior to October 25, he had met with 17 of
the roughly 25 candidates who were interviewed. However, the Office of the
Chief Accountant did not schedule meetings for him with three of the five
individuals who were ultimately appointed to the PCAOB.

The General Counsel said that he understood that his role in interviews
with candidates beginning in early October was to address questions
regarding service on the PCAOB, such as pay, location, ethics
restrictions, and other matters important to attracting quality
candidates. He also informed candidates that they would be required to
submit questionnaires and be subject to a background check. The General
Counsel said that he expected that the final slate would be subject to
additional interviews and vetting. As a result, the candidates with whom
he met were not systematically queried about current or previous
membership on boards of companies nor were they subject to the other
planned elements of the vetting process. For example, we found that SEC
also did not systematically use its available internal technological
capabilities and resources to the fullest extent possible to begin to
collect fundamental information on the applicants being interviewed as it
had initially planned to do. Moreover, SEC staff did not consistently
search internal databases such as the Name Relationship Search Index
(NRSI) and the Electronic Data Gathering and Retrieval System (EDGAR), or
periodical databases such as LexisNexis and Westlaw, for any information
on potential candidates. 10 Instead, if any candidate brought up an issue
that might

10 NRSI is an internal SEC system that tracks open and closed
investigations, proceedings, and other relevant information. EDGAR is a
database system through which public companies electronically file
registration statements, periodic reports, and other forms to SEC. In
addition to the EDGAR system, which is publicly available, SEC also has an
internal system that includes the status of filings reviewed by SEC staff
and the results of those reviews. LexisNexis provides authoritative legal,
news, public records, and business information. Westlaw is an on- line
legal research service, providing a broad collection of legal resources,
news, business, and public records information. Vetting Process Was

Initiated PostAppointment

Page 18 GAO- 03- 339 PCAOB Selection Process

potentially affect his or her fitness to serve, the General Counsel would
look into the matter. This occurred in at least two instances during the
interview process. The General Counsel met with Judge Webster prior to his
appointment, but there was no discussion of U. S. Technologies. The
General Counsel said that he first learned of potential concerns about
Judge Webster and U. S. Technologies from press inquiries in the days
leading up to the October 31 newspaper article.

Early in the selection process, there also was no clearly defined and
agreed- upon method for vetting of candidates, and SEC staff considered
various approaches to vetting the slate of five candidates. Initially, the
Office of the General Counsel explored using the FBI to conduct background
investigations into PCAOB appointees. However, because the PCAOB was not a
federal government entity and the FBI was unlikely to be able to complete
required investigations within SEC*s tight time frames, SEC staff decided
that it would be more appropriate to hire an outside contractor to perform
this role.

The General Counsel agreed to develop an appointee questionnaire that then
would be supplied to the outside contractor that would be performing the
background checks. It was the General Counsel*s expectation throughout the
process that background checks would be performed only for the five
individuals actually nominated for the PCAOB. Early in the selection
process, the SEC Chairman and staff believed that the selection process
would be completed by the end of September and that at least some vetting
of the appointees would be completed before the October 28 statutory
deadline for the appointment of the PCAOB. However, by midOctober the
slate had still not been agreed upon and the General Counsel had just
hired a contractor to conduct background checks on the appointees.
Therefore, it became clear that vetting of candidates could not be
completed prior to appointment and the General Counsel concluded that it
would be necessary to vet the PCAOB members postappointment. Ultimately,
the General Counsel did not know the final slate of names selected from
among those who were interviewed until October 24, the night before the
vote. As a result, insufficient time remained to properly vet the PCAOB
members prior to their appointment, and the General Counsel and his staff
were able to perform only a very limited inquiry into enforcement
activities before the Commission*s vote. Although some indicated surprise,
all of the Commissioners were informed before the vote that background
checks had not been performed on the candidates and that the Office of the
General Counsel planned to use a questionnaire and outside contractor to
vet the appointees. At the

Page 19 GAO- 03- 339 PCAOB Selection Process

October 25 Commission meeting, the Commissioners selected the first
chairman and members of the PCAOB and authorized background checks.

On November 1, 2002, the Office of the General Counsel formally notified
the Commission of the specific steps that staff from the Office of the
General Counsel had taken or planned to take to examine the background of
each PCAOB member. The Office of the General Counsel also provided the
Commissioners with a copy of the questionnaire, which was based on the
federal *Questionnaire for National Security Positions* and the

*Statement for Completion by Presidential Nominees,* that each PCAOB
member was asked to complete. This questionnaire was sent to the PCAOB
appointees on November 6, and all documents were completed and returned by
November 13. A supplemental questionnaire was sent to the PCAOB appointees
on November 14, and all documents were completed and returned to SEC by
November 20.

Also on November 1, the Office of the General Counsel provided additional
information on the role of CRM Consulting, the private contractor hired to
verify the information on the questionnaires. At the time of our review,
CRM Consulting was reviewing the appointees* completed questionnaires and
expected to complete its review by the end of the year. SEC staff are to
review the information provided by CRM Consulting and look into certain
issues, such as outstanding or anticipated lawsuits, administrative
proceedings against the member, legal judgments, pending civil or criminal
inquiries involving the member in any way, investigations or sanctions of
the members by professional associations, financial obligations that might
affect a member*s service, potential conflicts of interest, and other
matters that if they became publicly known could subject the Commission or
the PCAOB to embarrassment or disrespect. In addition to staff from the
Office of the General Counsel, staff from the Division of Enforcement will
be involved in this process. The Office of the General Counsel had planned
to include a review of Judge Webster*s activities involving U. S.
Technologies and other relevant matters. However, this review was
suspended following Judge Webster*s resignation on November 12. The Office
of the General Counsel described the staff review of the background checks
as limited; SEC plans to rely primarily on the contractor*s check. The
staff review also will not involve an assessment of the sufficiency of the
member*s education, professional competence, or experience to serve. The
review process was still ongoing at the time of our review.

Page 20 GAO- 03- 339 PCAOB Selection Process

Although SEC lacked a documented and formalized selection and vetting
process for nominees, several factors contributed to the eventual
breakdown of the Commission*s ability to select a slate of nominees that
could be unanimously appointed. First, lacking formalized and tested
procedures familiar to SEC staff and the Commissioners, the SEC Chairman
did not reach consensus with the other Commissioners about the process;
therefore, the Commission was unable to provide clear direction to staff.
Second, the Commission neither agreed upon nor articulated formal
selection criteria beyond the general criteria provided by the act.
Finally, the lack of pre- appointment background checks and vetting
exposed SEC to risks.

Perhaps the biggest impediment to the smooth functioning of the selection
process was a lack of initial consensus among the Commissioners and key
SEC staff on the selection process. As previously mentioned, the Chairman
initially decided that staff, primarily the Chief Accountant, who would
have most contact with the PCAOB, would drive the effort. Although we
found some evidence that staff from the Office of the Chief Accountant and
General Counsel had informal meetings about the selection and vetting
process in August, the process was not formalized and continued to change
over time.

SEC did not find viable solutions to deal with Sunshine Act constraints
nor did the staff formalize a selection process and submit a plan to the
Commission for its approval. 11 One option would have been to hold an open
meeting to discuss and agree to a process. Another option, which was
subject to constraints identified by the General Counsel, would have been
to hold a closed meeting. However, some of the Commissioners did not want
to hold an open meeting because of privacy concerns about potential
nominees and public scrutiny. Others were concerned that a closed meeting
would have raised questions about the transparency of the process. A third
option, which was suggested by at least one of the Commissioners, would
have been to formalize the process in writing, circulate it, and reach
agreement among the Commissioners. Reaching a consensus through a process
meeting early in the process on the roles,

11 The Government in the Sunshine Act (Sunshine Act), Pub. L. No. 94- 409,
S: 2, generally requires that every meeting of an agency be open to public
observation. Therefore, if more than two SEC Commissioners meet a quorum
is present, which requires public notice and the meeting must be open to
the public. However, SEC has some latitude in holding a closed meeting to
discuss certain matters. Several Factors

Contributed to the Breakdown of SEC*s Selection and Vetting Process

Selection Process Broke Down in Absence of a Consensus among Commissioners

Page 21 GAO- 03- 339 PCAOB Selection Process

responsibilities, and duties of the Commission and SEC staff would have
helped to provide direction and focus on how the selection process could
best be accomplished. Without the benefit of an organizational meeting to
share their thoughts and perspectives, it was difficult for the
Commissioners to discuss the process and how they thought it should work.
Instead, the Chief Accountant usually provided information to the SEC
Chairman or his staff, and that information was expected to be relayed to
the other Commissioners through weekly meetings between the SEC Chairman
and each Commissioner. The SEC Chairman said that he also thought the
Chief Accountant was meeting with the other Commissioners, but the Chief
Accountant said that he relied to a great extent on the SEC Chairman*s
weekly meeting with each Commissioner to keep them apprised. As a result,
the Chief Accountant and the Chairman acted as intermediaries in keeping
the Commissioners involved in the process.

The lack of early consensus and approval of the process by the Commission
continued to affect the selection process. For example, some of the
Commissioners complained that they were not sure about what was occurring
and that they did not want to receive a final slate of names without being
able to independently query candidates. As Commissioners raised concerns,
the SEC Chairman and the Chief Accountant would adjust the process to
accommodate the input provided. For example, early in the selection
process, one Commissioner suggested that SEC focus on selecting a chairman
and build the rest of the membership around that person. Another
Commissioner, unhappy with the lack of a process and the apparent lack of
progress, began arranging meetings with candidates on his own. However, he
did not initially include the Chairman, which created a problem. Both
concerns listed above led to adjustments and expanded the selection
process. The Commissioners ultimately were not able to reach agreement on
an individual to serve as the chairman, and each of the Commissioners
interviewed more candidates than originally planned. The lack of an
articulated, agreed- upon process also eroded communications as the
deadline drew closer. The evening before the October 25 vote, only three
of the five Commissioners were provided with a draft of the names of the
final slate.

Although the act provides broad selection criteria, SEC did not develop
more specific selection criteria on the composition of the PCAOB other
than the two mandated CPA slots. Staff discussed developing more specific
selection criteria but decided that any additional criteria might draw
criticism from some observers or potentially eliminate otherwise worthy
candidates from being considered. Developing more specific Commission Did
Not Have

Formalized Selection Criteria Beyond Those in the Act

Page 22 GAO- 03- 339 PCAOB Selection Process

selection criteria was especially important because the statute provided
only broad requirements, and SEC had to use discretion and judgment in
making its selections. For example, the act left it up to SEC to decide
how much auditing experience the two CPAs should have to serve on the
PCAOB. However, SEC staff neither documented nor clearly articulated,
what, if any, additional selection criteria SEC planned to use to evaluate
the hundreds of names that it had received for consideration on the PCAOB.
For example, SEC*s August 1, 2002, release restated the broad criteria
established by statute that members should be appointed from

*among prominent individuals of integrity and reputation who have a
demonstrated commitment to the interests of investors and the public, and
an understanding of the responsibilities for and nature of the financial
disclosures required of issuers under the securities laws and the
obligations of accountants with respect to the preparation and issuance of
audit reports with respect to such disclosures.*

However, these criteria alone made it difficult to narrow the list of
nominees and applicants.

We considered the process followed by other entities that appoint boards,
nominate agency heads, or fill staff positions. Generally, the process
includes some sort of selection criteria. For example, the Financial
Accounting Foundation (FAF), which appoints members to serve on the
Financial Accounting Standards Board (FASB) as terms expire, has specific
selection criteria for board membership. In addition to knowledge of
financial accounting and reporting and an awareness of the financial
reporting environment, FAF*s selection criteria include other skills such
as critical thinking, communication, and interpersonal skills. Likewise,
SEC has a similar process for hiring staff for senior- level positions.
Although the task faced by SEC was unique in some respects, there are
valid comparisons that can be made; SEC staff also indicated that they
considered the FAF approach among others when framing its selection and
vetting process. However, we found no evidence that any additional
selection criteria were identified, documented, and applied consistently
among the candidates. Nor was consistent and sufficient information
collected that would have allowed staff and the Commissioners to apply
such criteria as considered appropriate.

In keeping with the notion of augmenting the act*s selection criteria, the
Chief Accountant said that his goal was to create a *balanced* board,
which he defined as a diverse board representing a variety of
constituencies and ideologies. He also stressed that he and the
Commissioners sought a racially and gender- diverse membership. Given

Page 23 GAO- 03- 339 PCAOB Selection Process

that the act required that two of the PCAOB*s five members be CPAs, the
Chief Accountant wanted to ensure that the other members had skills needed
to establish a new organization. The Chief Accountant said that he
generally categorized nominees or applicants into broad groups, including
investor advocates, former chief executive officers or business
executives, attorneys, politicians, academics, regulators, and
accountants. This approach was also consistent with the FAF model for
FASB, which is balanced among academics, investors, industry
representatives, and CPAs. However, unlike FAF, this approach does not
appear to have been wellarticulated or communicated to the Commission or
the public, nor does it appear that all members of the Commission ever
endorsed the Chief Accountant*s balanced board approach. One Commissioner
wanted the board to have a strong law enforcement orientation because of
the PCAOB*s mandate to enforce its regulations and standards. Yet another
Commissioner wanted the board to include a majority of *reformers,*

reflecting what he considered was the purpose of the act. At times, some
Commissioners believed that balance also involved political party
affiliation. The lack of agreement and open dialogue about these issues
hampered the Commission*s ability to reach a consensus and eventually
contributed to the ineffectiveness of the process. Participants in the
process also believed that it was complicated by the involvement of a wide
range of external parties and media scrutiny. As a result, the split
Commission vote on the PCAOB, most notably the vote on the chairman,
raised speculation about the integrity of the process.

As previously mentioned, after the Commission was unable to appoint a
consensus candidate for PCAOB chairman by the end of September, the Office
of the General Counsel was forced to vet the final slate postappointment.
Although the Chairman had tasked the General Counsel with vetting the
PCAOB appointees, the Commission and staff did not discuss or reach
agreement on the role to be played by the General Counsel in the interview
process after early October when the process changed. One method of
vetting would have been for the General Counsel, in addition to serving as
a resource to candidates, to use a uniform list of questions to ask of
potential candidates before the Commissioners interviewed them. 12
Similarly, staff in the Office of the Chief Accountant had developed a
list of interview questions that apparently was not used during the
interviews,

12 In August, staff in the Office of the General Counsel developed a list
of questions for vetting the final slate of candidates, but the questions
were not used. Lack of Pre- Appointment

Background Checks and Vetting Exposed Process to Risk

Page 24 GAO- 03- 339 PCAOB Selection Process

but which would have allowed the interviewers to solicit consistent
information from candidates. The General Counsel said that he was not
consistently scheduled for interviews with candidates and that he did not
see the final slate of candidates until the evening before the vote.
Therefore, the General Counsel could not elicit background information,
adequately utilize existing SEC databases, or access other publicly
available sources to conduct a minimum level of due diligence on potential
members* board memberships, affiliations, conflicts of interests,
litigation, or other activities that might raise actual or apparent
conflicts of interest or raise issues that could hamper the effectiveness
of the PCAOB or embarrass the Commission. Due to the process and
communication breakdown, the Office of the Chief Accountant in connection
with the Office of the General Counsel, the Division of Enforcement, and
the Division of Corporation Finance did not explore all internal sources
of information early enough or fully enough to ensure that no conflicts
existed. The Office of the General Counsel also was not able to review
other publicly available sources of information in a timely manner. For
example, the Office of the General Counsel could have learned about
pending litigation through sources such as Westlaw and LexisNexis. The
absence of vetting, while made known to the Commission prior to the vote,
may have prevented the Commission from making a fully informed vote about
the candidates.

Given the short time frame to appoint members and the lack of an existing
formalized process, the PCAOB selection process was a difficult
undertaking for SEC. Based on our reviews of various correspondence and
extensive interviews with the principals involved, it is clear that the
Commissioners never collectively discussed establishing a process nor
reached consensus on how best to proceed in selecting members for the
PCAOB. This lack of consensus was evidenced by a fundamental disagreement
about whether the Commissioners should have played a lead role in
identifying potential PCAOB candidates or whether the process should have
been staff- driven as envisioned by the Chairman. Although Sunshine Act
requirements may have made it more difficult for the Commission to reach
this much needed consensus, SEC did not identify effective alternative
methods for ensuring that the views of all the Commissioners were
reflected in the process. As a result, the process changed and evolved
over time and was neither consistent nor effective. Although the
Commission was informed that background checks and vetting had not
occurred before the vote on October 25, the Chairman and Commissioners
generally believed that the Office of the General Counsel and/ or the
Office of the Chief Accountant was undertaking some type of Conclusions

Page 25 GAO- 03- 339 PCAOB Selection Process

vetting of candidates throughout the process. Given the highly
scrutinized, political nature of the appointment process, any decisions
had to be able to withstand intense public scrutiny and, hence, the lack
of vetting proved to be a significant flaw in the selection process.

Based on our reviews of thousands of pieces of correspondence and
comprehensive interviews, we found no evidence that the SEC Chairman knew
anything before the October 25 vote other than that Judge Webster had once
been chairman of the audit committee of the board of directors of U. S.
Technologies, a company on the brink of failure. This information, which
the SEC Chairman heard from Judge Webster on October 15, was not detailed
and did not raise a major concern at that time, and prior to the vote, the
Chairman*s Chief of Staff had told the Chairman that Judge Webster*s
involvement in U. S. Technologies was not a problem. However, in making
this conclusion, insufficient due diligence was performed by the Office of
the Chief Accountant. In addition, the Chief Accountant*s failure to
communicate any information to the General Counsel, who had responsibility
for the vetting process, could have contributed to this incomplete
assessment.

When staff in the Office of the Chief Accountant conducted further
analysis into U. S. Technologies on October 25, they became aware that the
company*s 2001 filings disclosed that the company had dismissed its
external auditor a month after that external auditor reported material
internal control weaknesses related to the company*s accounting and
financial reporting infrastructure resulting from the lack of an
experienced chief financial officer. Based on the factors previously
discussed including his experience as an auditor, his knowledge of Judge
Webster*s long and prominent record of public service, and an
understanding that additional vetting would take place post- appointment,
the Chief Accountant concluded that this matter did not raise a concern
and decided that it was not necessary to inform the Chairman, the other
Commissioners, or the Office of the General Counsel of these issues. In
light of the current environment surrounding auditors, the role played by
audit committees of boards of directors of publicly held companies and the
expectation that new members of the PCAOB be beyond reproach, it is clear
from our review of the relevant documents that these matters, especially
when viewed in the current environment, should have prompted SEC to
perform additional, in- depth evaluation before reaching a conclusion
about U. S. Technologies and Judge Webster*s involvement. Further, in our
view, the information concerning Judge Webster*s role as chairman of the
audit committee of the board of directors of a company that had dismissed
its external auditor after the auditor had found material internal control

Page 26 GAO- 03- 339 PCAOB Selection Process

weaknesses should have been shared by the Chief Accountant with the SEC
Chairman and other Commissioners prior to the vote.

SEC was under enormous pressure in selecting the PCAOB members and had
little time to do so. SEC also had difficulty getting certain outstanding
individuals to agree to be PCAOB members because of the full- time service
requirement and the need for members to give up certain forms of income
and other professional or business activities. However, going forward, the
Commission will be tasked with establishing a more credible process to
replace individual PCAOB members, starting first with selecting a
replacement for the chairman and then conducting annual staggered
reappointments.

Much can be done to improve the selection and vetting process. Before any
additional members are appointed to the PCAOB, especially the chairman, we
recommend that the Commission

 reach agreement and document the process to be followed, the sequence
and timing of key steps, and the roles to be played by the Commission and
the staff in the selection and vetting of candidates;

 develop agreed- upon, detailed selection criteria for PCAOB members and
the chairman that fully embrace the principles articulated in the
SarbanesOxley Act of 2002;

 develop a vetting process that ensures that before an applicant is
brought to the Commission for serious consideration, certain minimum
background and reference checks are performed to ensure that the
individual has no potential legal or ethical impairments and ensure that
the vetting process is completed before the Commission votes to appoint
members to the PCAOB; and

 determine what candidate information should be documented, analyzed, and
shared among the Commission and staff.

Moreover, we recommend that the SEC Chairman, direct staff involved in the
PCAOB selection process to make greater use of available technology to
conduct necessary background checks and to generate sufficient details on
the qualifications of potential applicants so that the Commission can make
informed decisions on the fitness of potential applicants to be PCAOB
members.

We requested comments on a draft of this report from SEC Commissioners,
SEC*s General Counsel, SEC*s former Chief Accountant, Recommendations for

Executive Action Agency Comments

Page 27 GAO- 03- 339 PCAOB Selection Process

the Chairman*s former Chief of Staff, and others at SEC involved in the
selection and vetting process. In addition, we requested comments from
Judge William H. Webster and John H. Biggs. Each of these parties provided
only technical comments on the report*s contents, which were incorporated
as appropriate. The Chairman and each of the Commissioners also told us
that they generally agreed with the report*s recommendations.

We will send copies of this report to the Ranking Member of the Senate
Committee on Banking, Housing, and Urban Affairs; the Chairman of the
House Committee on Energy and Commerce; the Chairman of the House
Committee on Financial Services; and other interested congressional
committees. We also will send copies to the Chairman and Commissioners of
the SEC, the former Chief Accountant, Judge Webster, Mr. Biggs, and others
upon request. In addition, this report is also available on GAO*s Web site
at no charge at http:// www. gao. gov.

If you or your staff have any questions concerning this letter, please
contact Orice M. Williams or me at (202) 512- 8678. Toayoa Aldridge,
Wesley Phillips, Derald Seid, David Tarosky, and Barbara Roesmann made key
contributions to this report. In addition, Robert Cramer of our Office of
Special Investigations and Nelson Egbert and Mary Beth Sullivan of the SEC
Office of the Inspector General made key contributions to this report.

Richard J. Hillman Director, Financial Markets and

Community Investment

Appendix I: Summary of Key Events Associated with the Selection of the
Public Company Accounting Oversight Board

Page 28 GAO- 03- 339 PCAOB Selection Process

Date (2002) Event

July 30 Sarbanes- Oxley Act of 2002 is signed into law, requiring the
Securities and Exchange Commission (SEC) to appoint a fivemember Public
Company Accounting Oversight Board (PCAOB) within 90 days. August 1
Chairman delegates responsibility for identifying candidates for the

PCAOB to the SEC Chief Accountant. The General Counsel was tasked with
vetting candidates. The legislative deadline to appoint the board is
October 28, but SEC staff plan to complete the process by September 30.

SEC issues a release calling for nominations and applications for the
board to be submitted by September 2. SEC also begins to directly solicit
names of potential candidates from various stakeholders. a Early August
Paul A. Volcker emerges as the consensus choice for PCAOB

chairman. August 9 SEC Chairman has initial meeting with the Secretary of
the Treasury

and the Chairman of the Board of Governors of the Federal Reserve System
to discuss candidates and obtain input. August 14 List of PCAOB candidates
with 210 names is distributed to the

Commissioners. August 18 Chief Counsel in the Office of the Chief
Accountant suggests that a

meeting be scheduled to discuss the mechanics of selecting the members of
PCAOB. August 23 Office of the General Counsel formalizes procedures for
vetting

candidates. August 26 Chief Accountant recommends that SEC engage a
private firm to

conduct background investigations of PCAOB candidates. August 28 Updated
list of candidates with 325 names is distributed to the

Commissioners. September 2 SEC cutoff date for receipt of nominations and
applications.

SEC Chairman, one Democratic Commissioner, and the Chief Accountant meet
with Mr. Volcker in New York City to discuss the PCAOB chairmanship
position. Mr. Volcker agrees to inform SEC Chairman of his decision by
September 5. September 5 SEC learns that Mr. Volcker will not accept the
chairmanship. September 11 SEC Chairman, a Democratic Commissioner, and
the Chief

Accountant meet with John H. Biggs in New York City to discuss the PCAOB
chairmanship. Mid- September Charles Niemeier, PCAOB appointee, receives
call from the Office of

the Chief Accountant requesting a copy of his resume. September 19 Kayla
Gillan, PCAOB appointee, receives call from the Office of the

Chief Accountant to schedule a telephone conference with the Chief
Accountant. September 20 SEC Chief Accountant interviews Ms. Gillan by
telephone. September 23 Willis Gradison, PCAOB appointee, receives call
from the Office of

the Chief Accountant requesting a copy of his credentials. September 24
Mr. Biggs meets in New York with third Commissioner.

Appendix I: Summary of Key Events Associated with the Selection of the
Public Company Accounting Oversight Board

Appendix I: Summary of Key Events Associated with the Selection of the
Public Company Accounting Oversight Board

Page 29 GAO- 03- 339 PCAOB Selection Process

Date (2002) Event

September 25 Ms. Gillan meets in New York with one Commissioner. September
26 Ms. Gillan and Mr. Biggs meet in New York City at the suggestion of

a Commissioner. One Commissioner schedules interviews with fellow
Commissioners for Ms. Gillan and another candidate. The Chairman was not
included. Late September Office of the Chief Accountant begins scheduling
interviews of

PCAOB candidates with the Commissioners. Mr. Gradison receives a call from
the Chief Accountant to come in for interviews. Mr. Niemeier is also asked
to come in for interviews. September 27 For the Chairman, Mr. Biggs*s
appointment is contingent upon

another specific individual being appointed to the PCAOB. One of the other
Commissioners informs the Chairman that a Commissioner may not be willing
to support that individual.

SEC Chairman calls William H. Webster to ask him to consider taking a
position on the new PCAOB.

Mr. Biggs has meetings with two Commissioners at SEC headquarters.
September 27- 30 Two Commissioners inform the SEC Chairman that three of
the

Commissioners are unclear as to what is the PCAOB selection process, which
they urge the Chairman to articulate. The two Commissioners suggest that
all five Commissioners have a meeting about the selection process and
*discuss where we are and where we are going.* September 30 Daniel
Goelzer, PCAOB appointee, receives a call from the Chief

Accountant requesting a copy of his resume. October 1 Article in The New
York Times reports that Mr. Biggs had *agreed to

be the first head* of PCAOB. Ms. Gillan meets with three Commissioners at
SEC headquarters. Mr. Biggs and the Chairman of the Board of Governors of
the Federal Reserve System speak by telephone about the PCAOB. October 2
SEC Chairman calls Mr. Biggs to inform him that the prior day*s

newspaper article had created consternation at SEC and

*complicated things* regarding the consideration of Mr. Biggs for chairman
of PCAOB.

Mr. Goelzer meets with the SEC Chairman and the Chief Accountant. Mr.
Gradison has meetings with three Commissioners at SEC headquarters.
October 3 Mr. Goelzer has meetings with remaining four Commissioners at

SEC headquarters. Mr. Gradison has meetings with the Chief Accountant, one
Commissioner, and the SEC Chairman.

Appendix I: Summary of Key Events Associated with the Selection of the
Public Company Accounting Oversight Board

Page 30 GAO- 03- 339 PCAOB Selection Process

Date (2002) Event

October 4 Article in The New York Times alleges that the SEC Chairman was

*backing away from* Mr. Biggs as PCAOB chairman. For the SEC Chairman,
this raises questions about Mr. Biggs*s independence.

Through the issuance of a Statement of Work and Request for Quotations
(RFQ), SEC solicits bidders to conduct background investigations of
prospective PCAOB members. The RFQ requests that quotations be furnished
by October 8. October 8 Mr. Niemeier meets individually with Commissioners
at SEC

headquarters. October 11 Ms. Gillan has telephone interview with the SEC
Chairman. October 15 Judge Webster meets at SEC headquarters with the SEC
Chairman,

the Chief Accountant, and the Chairman*s Chief of Staff, who together
explain to Judge Webster the value he could bring to the PCAOB. During
this meeting, Judge Webster mentions that he was the former chairman of
the audit committee of the board of directors of U. S. Technologies, Inc.

At the request of staff in the Office of the Chief Accountant, staff in
SEC*s Division of Enforcement searches the Name Relationship Search Index
database for information on U. S. Technologies.

Around this time, the Office of the General Counsel realized that vetting
would have to be completed post- appointment. October 17 The Office of the
Chief Accountant and the Office of the General

Counsel file an Order for Supplies or Services to have Contract Resource
Management, Inc. (CRM), conduct background investigations on PCAOB
appointees. The order is for five to eight background investigations.

During a meeting with the Federal Reserve Chairman concerning a
supervisory matter, the SEC Chairman shared several names of potential
nominees for the PCAOB. October 21 Judge Webster meets with the SEC
Chairman, the Chief Accountant,

and the Chairman*s Chief of Staff at SEC headquarters a second time to
again discuss the possibility of Judge Webster serving on PCAOB.

SEC Chairman meets with Mr. Niemeier. October 22 Judge Webster meets with
remaining Commissioners in person or by

telephone. Judge Webster meets separately with the SEC General Counsel to
discuss the full- time nature of PCAOB service and what that would entail.

Appendix I: Summary of Key Events Associated with the Selection of the
Public Company Accounting Oversight Board

Page 31 GAO- 03- 339 PCAOB Selection Process

Date (2002) Event

October 23 A Commissioner requests that the SEC Chairman schedule an open
meeting for the PCAOB vote. The Chairman schedules the open meeting for 2
p. m. on October 25.

Judge Webster agrees in the evening to be PCAOB chairman. Chief Accountant
leaves messages for Mr. Gradison and Mr. Goelzer regarding *exciting
news.* Mr. Gradison returns the call the following morning, and the Chief
Accountant informs him of his nomination. October 24 Chief Accountant and
the SEC Chairman recommend terms of office

for board members. Chief Accountant asks member of his staff to look again
into the U. S. Technologies filings and enforcement actions.

Chief Accountant informs Ms. Gillan of her nomination to the board. Also,
the SEC General Counsel does a verbal background check over the telephone.

SEC Chairman calls the Chairman of the Board of Governors of the Federal
Reserve System and informs him that Judge Webster has accepted the PCAOB
chairmanship. Later that day, the SEC Chairman provides the Chairman of
the Board of Governors of the Federal Reserve System and the Secretary of
the Treasury with the names of the four other nominees and asks them for
letters endorsing SEC*s selections to the PCAOB.

Office of the General Counsel completes search of Name Relationship Search
Index database for information on 17 finalists for the PCAOB. October 25
Staff from the Office of the Chief Accountant provides the Chief

Accountant with an overview of information collected on U. S.
Technologies.

Mr. Niemeier finds out that he has been selected for the PCAOB the morning
of the vote.

Commissioners see final slate and are formally told that vetting will
occur post- appointment. Also, PCAOB nominees find out for the first time
the names of their fellow board members.

Judge Webster, Ms. Gillan, Mr. Goelzer, Mr. Gradison, and Mr. Niemeier are
appointed to the PCAOB at the SEC open meeting. October 28 Judge Webster
telephones the SEC Chairman to inform him that law

enforcement officers had seized equipment and records at U. S.
Technologies*s offices.

Appendix I: Summary of Key Events Associated with the Selection of the
Public Company Accounting Oversight Board

Page 32 GAO- 03- 339 PCAOB Selection Process

Date (2002) Event

October 30 SEC press office receives an inquiry from The New York Times

seeking comment on the content of an article it plans to print the
following day concerning a criminal fraud investigation at U. S.
Technologies.

Office of the Chief Accountant looks into whether the SEC Division of
Corporation Finance reviewed the U. S. Technologies*s Form 8- K and Form
8- K/ A filings. October 31 Article in The New York Times alleges that
Judge Webster provided

the SEC Chairman with detailed information about his role in U. S.
Technologies when he met with him earlier in the month.

SEC Chairman and at least one other Commissioner independently contact the
SEC Office of the Inspector General to investigate these allegations.

Commission also asked the SEC Office of the General Counsel to conduct an
investigation into Judge Webster*s involvement with U. S. Technologies.
November 1 SEC General Counsel outlines for the Commission the specific
steps

his staff are taking to examine the backgrounds of each PCAOB appointee.
November 5 SEC Chairman resigns. November 6 SEC Office of the General
Counsel sends out vetting questionnaires

to PCAOB members with a deadline of November 15 for submission. November 8
Chief Accountant resigns. November 12 Judge Webster resigns as chairman of
the PCAOB. November 13 PCAOB holds planning meeting that includes Judge
Webster. November 14 Office of the General Counsel sends out supplemental

questionnaires to PCAOB members with a deadline of November 20 for
submissions. November 15 All questionnaires have been sent to CRM, the
contractor SEC hired

to conduct background investigations. November 20 Office of the General
Counsel sends Ms. Gillan*s and Messrs.

Niemeier*s, Gradison*s, and Goelzer*s supplemental questionnaires to CRM.
November 29 Article in The Wall Street Journal reports on the role played
by Arthur

Levitt in supporting Mr. Biggs. December 2 PCAOB holds its second planning
meeting that includes Judge

Webster. CRM briefs the Office of the General Counsel on its preliminary
findings and indicates that it will provide a more formal report on
December 12. December 31 CRM is to provide a final report on the
supplemental questionnaires

to the Office of the General Counsel by this date. a Stakeholders included
Members of Congress, the Chairman of the Board of Governors of the

Federal Reserve, the Secretary of the Treasury, industry groups, senior-
level SEC staff, selfregulatory organizations, witnesses from related
congressional hearings, and others.

Source: GAO analysis of SEC documents, relevant interviews, and other
information.

(250111)

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