Copyright 2002 Federal News Service, Inc.  
Federal News Service
April 9, 2002 Tuesday
SECTION: CAPITOL HILL HEARING

LENGTH: 26131 words

HEADLINE: HEARING OF THE HOUSE FINANCIAL SERVICES COMMITTEE
 
SUBJECT: H.R. 3763, THE CORPORATE AND AUDITING ACCOUNTABILITY, RESPONSIBILITY AND TRANSPARENCY ACT OF 2002 (DAY 3)
 
CHAIRED BY: REPRESENTATIVE MIKE FERGUSON (R-NJ)
 
LOCATION: 2128 RAYBURN HOUSE OFFICE BUILDING, WASHINGTON, D.C.

WITNESSES:
 
DAVID WALKER, COMPTROLLER GENERAL OF THE UNITED STATES, U.S. GENERAL ACCOUNTING OFFICE;
 
RICHARD C. BREEDEN, FORMER CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION, RICHARD C. BREEDEN & CO.;
 
DONALD C. LANGEVOORT, PROFESSOR, GEORGETOWN UNIVERSITY LAW CENTER;
 
DAMON SILVERS, ASSOCIATE GENERAL COUNSEL, AFL-CIO
 


BODY:
REP. MIKE FERGUSON (R-NJ): The committee is called to order.

Today the committee meets for the third day of hearings on H.R. 3763, the Corporate and Auditing Accountability, Responsibility and Transparency Act. Today's hearing is being held at the request of the minority. The chair now recognizes himself for a brief opening statement.

Good afternoon, welcome to the committee's third legislative hearing. Last December, this committee, which oversees the financial and capital markets, held the first congressional hearing on the Enron collapse and its impact on investors, employees and the financial markets. When the committee set out to investigate the Enron collapse we had several clear goals in mind.

First, we wanted to make sure the Congress knew how the biggest corporate collapse in American history occurred.

Second, we wanted to work towards restoring the confidence of investors in accounting, regulators and the rules governing our markets.

Third, we wanted to formulate an appropriate response that would ensure that the free market system and the regulatory system that underpins it, emerge stronger as a result of our work.

The American people deserve to know the facts directly and to hear them specifically from those most directly involved. I commend Chairman Oxley for working closely with major investigators, the Justice Department, the SEC, and Enron and Andersen's internal teams to achieve these goals. The introduction of the Corporate and Auditing Accountability, Responsibility and Transparency Act, or CAARTA, represents the culmination of this process. It has allowed us to move forward and investigate comprehensive and practical solutions that will undoubtedly strengthen the overall financial system.

The past few legislative hearings have been very constructive. We've heard from a diverse group of witnesses representing a broad spectrum of views regarding the securities market and the government's role in protecting investors. The distinct differences in the testimony from these individuals, including former SEC officials, and representatives from the securities industry, a leading consumer organization and the accounting industry, have confirmed that the committee has taken the necessary steps to improve the current regulatory system through CAARTA. CAARTA is clearly the product of a multitude of views and months of work by the committee to improve the public's confidence in the capital markets and to strengthen overall financial system in the most appropriate manner.

CAARTA is effective because it gets to the heart of these foundational issues that will prevent future Enron's without drowning businesses in a sea of red tape. It's important that this legislation avoids the temptation to overreact and legislate in a manner that will cripple the entire business community. In fact Federal Reserve Chairman, Allen Greenspan, has testified that the Enron collapse has already generated a significant shift in corporate transparency and responsibility. Highlighting the market's ability to self correct. Over legislating would be counterproductive and make it impossible for the markets to function properly.

Despite these concerns there is no dispute that Congress must be involved in some capacity to ensure that the free market will emerge stronger than ever. America needs a strong, vibrant and healthy accounting industry to keep companies financially sound and to provide investors with solid information. CAARTA was carefully crafted by members of Congress to provide our current system with this base, without overstepping our boundaries in a way that could ultimately have a negative impact on the world's strongest markets.

CAARTA rightfully establishes new firewalls and increased oversight to ensure independent reviews and avoid conflicts. It establishes a new public regulatory body under the SEC with strong oversight authority and prohibits firms from offering certain, controversial consulting services to companies they are also auditing. This legislation also requires accountants who audit financial statements of publicly traded companies to be federally certified by the public regulatory organization and highlights the concept of corporate responsibility by requiring companies to ensure their accountants are in good standing.

The oversight board has the authority to discipline individuals who violate securities laws or breach standards of ethics or independence. Investors of all types rely on accurate and accessible information to make their financial decisions. If the Enron debacle -- in the Enron debacle, thousands of investors were deprived much needed resources to make sound investment decisions. It's an outrage that any company would prohibit its employees from selling their stock within their retirement plans, while at the same time its executives were selling millions of dollars of stock because they were privy to more up to date information.

This legislation meets our responsibility to shareholders and employees of publicly traded companies who deserve to know more and know it in real time, about a company's financial well being. It also fittingly prohibits corporate executives from buying or selling company stock when 401(k) plan participants are unable to buy or sell securities. We have a moral obligation to ensure that safeguards are established to prevent the disasters of this magnitude in the future. CAARTA correctly holds corporate America more accountable to the employees and shareholders to restrict stricter accounting standards and tougher disclosure requirements. But legislating should not be the end of Congress's role in addressing these issues.

The collapse of Enron represents the combination of irresponsible actions on the part of decision makes with knowledge of the company's financial well-being, and a meltdown of the financial safeguards used to identify problems at a stage when corrective action might still be taken.

We must work directly with the private sector to instill a spirit of corporate responsibility by challenging America's business leaders to meet the highest standards of ethics and responsibilities to their employees and shareholders. There have been dozens of legislative measures introduced by both sides of the aisle to address these issues. It's time to put partisan squabbling aside and to move forward with practical solutions that will actually help.

These hearings have helped create -- have helped the committee assess the effectiveness of CAARTA in preventing future accounting and stock irregularities in publicly traded companies. However, in order to ensure that no questions are left unanswered, Chairman Oxley has agreed to this final hearing before we move forward with the consideration of CAARTA. I want to thank the witnesses for their attendance, and at this time I'd like to yield to the distinguished ranking member, the gentleman from New York, Mr. LaFalce.

REP. JOHN J. LAFALCE (D-NY): Thank you very much, Mr. Chairman.

Let me put this in perspective. In your opening statement you said that the chairman has agreed to this hearing. This is a hearing which we demanded as a matter of right under the rules of the House and the rules of the committee. The timing for it was set over the recess for 2:00 today, a day when the Congress does not begin voting until 6:30. If we didn't demand our rights we would have just receded to a markup on Thursday with but two days of hearings.

So you said it's time to put partisan squabbling aside. What does that mean, that we should just discuss and vote upon exclusively the bill that was prepared by the Republican staff to the chairman of the committee without Democratic input? That's not putting partisan squabbling aside, that's just saying succumb to our will. So let's kid ourselves or kid the public as to what's going on here.

The minority members of this committee wanted today's hearing out of the concern that we'd mark up legislation as soon as Thursday on issues facing our securities markets without giving adequate consideration to many aspects of the legislative proposals before us. There are money aspects of the legislative proposals before us on which no one has testified much less having had a diversity of testimony. And there have been significant developments.

On Monday you all read in the New York Times, the Washington Post, et cetera, about the role of investment banks that has been added to the Enron lawsuit. We have not explored that. That is certainly within the jurisdiction of our committee. It's an important issue to which we have given no consideration. Today you read in the New York Times and the Washington Post and the Wall Street Journal, et cetera, about the action of the attorney general of the state of New York with respect to securities firms who were violating their own rules flagrantly. Listing the allegations but he was able to obtain a court order.

Under any circumstance, though, these come within the jurisdiction and concern of our committee, and before we mark up legislation we should give attention to those issues. It's clear to me that this should not be the last hearing before we go to mark up. It seems to be there'd be a rush to judgment, and the judgment should be a very partisan one that is going along with the bill prepared by the majority staff of INITSIO.

There are consensus on certain things. There's a consensus that we need a new public oversight body for the accounting profession. But there is not a consensus on the attributes such a regulator must have to be credible and effective, and there has been no conversation between the Democrats and the Republicans, at least as far as I'm concerned, on this issue. For example, my bill explicitly establishes the powers and duties of the new regulator, while HR 3763 leaves these matters exclusively to the SEC rulemaking. Effectively, we leave these rules up for jump ball, totally up to the SEC. Now, certainly the SEC must make rules. They must have a certain amount of discretion. But I think given what we've seen, we aren't to have certain legislative powers that are clearly established. And that's a serious issue.

I think that the new regulator should have the authority to set quality standards rather than just enforcing industry standards. They should have disciplinary and investigative powers, and that's not in the chairman's mark, and it is in my bill. We need discussion of that issue. What should the legislation have? The legislation established includes disciplinary and investigative powers of the regulator body. Auditor independence: we've barely scratched the surface in considering that issue. We have not discussed the services that create conflicts for the auditor or measures to have the auditor the authority to determine the non-audit services the auditor should provide, other corporate governments' reforms that will enhance the functioning of the auditing committee and our inexplicable link to auditor independence

As the Enron collapse made clear, we also must ensure that the independent directors of our public companies are truly independent. Now, my bill includes these provisions. They deserve further discussion. They have not been discussed before our committee. The committee has given real consideration to the role of securities analysts in the Enron collapse. My bill will do more to reduce the conflicts that cause analysts to look the other way when companies present rosy but misleading pictures of financial wealth. As the New York State Attorney General said yesterday in bringing action against Merrill Lynch, such actions jeopardize the integrity of our securities marketplace, and we should examine that issue fully.

And finally, we must consider the need the enhance the ability of private litigants to enforce the securities laws, particularly with respect to aiding and abetting by accountants and other professionals. We restored the ability of the SEC to bring aiding and abetting actions in 1995 and we should consider restoring the ability of private litigants to do the same, and we have had no hearing devoted to that extremely important issue.

Further, I'm pleased to announce that today I introduced another bill, a bill that would give legislative substance and real teeth to meritorious portions of President Bush's 10 point plan on corporate disclosure and accountability. The Corporate Responsibility Act of 2002 requires discouragement of incentive compensation and certification of financial statements, and allows the SEC to administratively bar unfit officers and directors from serving in public companies.

There is much to be done. I look forward to working with Chairman Oxley and all the members in the committee to bring about a strong legislative response. I think we need additional time and hearings and consultations and conversations and compromise in order to bring that about, and I thank the chair.

REP. FERGUSON: Gentleman's time has expired.

The gentlelady from Illinois, Mrs. Biggert, recognized for an opening statement for five minutes.

REP. JUDY BIGGERT (R-IL): Thank you very much, Mr. Chairman.

Mr. Chairman, this morning hundreds of Andersen employees in my district rolled out of bed with a simple question on my minds, when I return home tonight will I still have a job? If I do make it through the day will my job be here at the end of the week or the month? Sadly for many of them the answer will likely be no. Through absolutely no fault of their own they will be looking for employment elsewhere. As Andersen finalizes plans to cut its workforce, my thoughts and prayers are with the more than 500 Andersen employees in my district, and the thousands more across the nation who had nothing whatsoever to do with the case at hand, but nonetheless are sharing the aftershocks.

We can debate privately or publicly, the end result of the actions taken over the past months, and how actions can lead to unintended consequences. As one Andersen employee from my district asked in a letter to me last week, if one out of 535 congressmen and senators gets in trouble, should you all be fired? The short answer is no, and it is true that to a certain extent we all lose public confidence when one member abuses his or her office. It is not right and it's not fair but it is what happens.

I think everyone can agree that change is moving in the accounting industry, and I think several good proposals are on the table. We must, however, strike the right downs to ensure that the decisions we make in the coming days will help solve the problems at hand without creating those unintended consequences down the road. HR 3761 is an important step in the right direction. With this legislation we will avoid any more blanket charges to groups of accountants, and instead punish the particular accountants at fault.

H.R. 3763 provides more immediate and closer scrutiny of the accounting profession in general and specific accountants in particular.

I should add that at the same time there is much more that the accounting industry must do. They should not wait for Congress to point them in the right direction. A good place to start is with the recommendations of former Federal Reserve Board chairman Paul Volcker. I commend the efforts that he has made to begin to restore some of the credibility that is much needed in the accounting profession. I look forward to hearing from the witnesses today and thank you very much. I yield back the balance of my time.

REP. FERGUSON: The gentle lady yields back. The gentleman from California, Mr. Sherman, is recognized for five minutes for an opening statement.

REP. BRAD SHERMAN (D-CA): Thank you, Mr. Chairman.

It's good that we're having these hearings. It's unfortunate who's not here. We have those very many organizations who don't get fees as investment bankers, but do control trillions of dollars of capital: professional investors, mutual funds, pension advisors who have been I think underrepresented in the overall process before Enron and even after Enron in giving us guidance as to what information they need and what steps need to be taken so that they can rely on that information.

CAARTA I think is a good bill, but it is less than the minimum we should do. And I know that -- I think our constituents will be unimpressed with those members of this committee who vote for the final passage of CAARTA, but vote against the amendments necessary to make it a strong enough and meaningful enough piece of legislation. Allen Greenspan is correct when he points out that there has been a shift in business culture, so that the greatest abuses of the past will not be repeated in the immediate future. But that is only the immediate future. The pressures that created the atmosphere of 2001 will return within a few years. The hottest executives at the hottest companies will be those reporting the hottest growth in their earnings and reporting the lowest liabilities. We need to legislate, not just rely upon what I fear is a short term change in the business culture.

There are three amendments I am certain to offer to this bill. The first is to tell the SEC they have to read the financial statements of the 2,000 largest companies every year, and then when they find something that is incomplete or confusing, they will demand that additional material be filed, the request or demand for additional information will be immediately public, the material filed in response would be immediately public and it would be immediately available to the public and this is an answer to the fact that an awful lot of what's in those Enron financial statements isn't false, it's just unintelligible. Not unintelligible to the uninitiated; unintelligible to anyone.

The SEC doesn't read the financial statements filed by the big companies. They only read the financial statements filed by the small companies. That's got to stop. And by the small companies I mean the IPAs.

Second, Arthur Andersen was one of the big give -- then big five that had its sales people, the people in charge of selling their services to Enron and collecting the fee, the engagement partner in final control of whether to sign the audit opinion. The other big four accounting firms, the other big five, put their quality and technical review people in charge of making that final decision. We should not leave it to the accounting firms to structure themselves any way they want. The people insulated from the sales decision need to -- and steeped in accounting literature need to make the final decision.

Finally, Mr. Chairman, recently Arthur Andersen indicated that while it had offered over $700 million to settle, it was now cutting its offer to only $300 million because, oops, they don't have any capital. We need a minimum capital requirement for accounting firms of at least half a year's audit fees. Right now Arthur Andersen is saying they don't have any money to pay those damaged by their inaction, and we cannot tell accounting firms that they can go practice virtually without malpractice insurance, with virtually no capital and then if they make a mistake, the investors get nothing.

There are two other issues. One is that if we are going --

REP. FERGUSON: If the gentleman could just wrap up here?

REP. SHERMAN: Okay.

REP. FERGUSON: He's well past expired.

REP. SHERMAN: My time has expired. Let me simply say that those who don't learn from history are doomed to repeat it, and those who do not pass legislation triggered by recent history are doomed to see those same mistakes repeated.

REP. FERGUSON: The gentleman's time has expired. The chair recognizes the gentleman from Louisiana, the distinguished chairman of the Subcommittee on Capital Markets, Mr. Baker.

REP. RICHARD H. BAKER (R-LA): Thank you, Mr. Chairman.

I think in the aftermath of the demise of one of the largest corporations in American enterprise it would be inappropriate for us to rely on additional lengthy study or, worse yet, lengthy investigations with a failure to act. It would be really unacceptable consequences for the market, as well as individual investors. And if we start in good faith today and act quickly, I can suggest to you that the congressional process will require a very long and tortuous path before we all wind up in the rose garden to sign pins and exchange good wishes.

So moving quickly at this juncture is not ill advised. I think it's highly appropriate, especially in light of the fact the SEC, FASB, the GAO, the SROs and many other outside observers all have strongly held opinions about the directions we should be taking. Coming to the consensus of those elements will be enhanced by the legislative process and I think it entirely appropriate for us to proceed. I am particularly pleased of the panel of witnesses we have here today, to get their insights on the remedies appropriate in light of the consequences we face and to quickly implement not only their recommendations but the 10 point plan outlined by the president, which I think was responsive to our current difficult.

In fact, there are too many employees today watching every morning the fund balance in their 401(k)s erode. Where retirement plans were certain, now we're thinking about second careers. The consequences of this are enormous, not just for the individual employee but for capital formation itself. The enhanced volatility in market performance is directly related to the fear that there is an undisclosed liability or inappropriate revenue stream that is not creating a correct and accurate picture of true financial condition.

We all agree: disclosure, transparency and consequences for those who fail to comply by the rules. I think how we construct those rules are the difficult aspect. But as to the principles underlying the resolution of this terrible difficulty, I think we are in agreement and we should move forward. Thank you, Mr. Chairman.

REP. FERGUSON: The chair recognizes the gentleman from North Carolina, Mr. Watt, for an opening statement; five minutes.

REP. MELVIN L. WATT (D-NC): Thank you, Mr. Chairman.

I hope I don't take five minutes, but sometimes we don't know how long these things will take. During the consideration of the Gramm- Leach-Bliley Bill, I was accused of being one of the few members of the committee who actually read the bill. And I have to confess that I have made the same mistake again, this time over the break. I have actually been reading these bills and I want to start by saying something complimentary about the chairman's bill. It clearly moves in the right direction. It would be a substantial improvement over nothing and I think we should keep that in mind.

But I hope that this hearing today and the mark-up itself, if we are going immediately to a mark-up, will result in a deliberation about improvements or revisions that can be made to the bill to make it stronger. I think there are a number of instances in which I would prefer to have stronger language, stronger provisions. In a number of respects the chairman's bill punts just a whole panoply of issues to the Securities and Exchange Commission or other bodies.

Maybe some of that is necessary and desirable to get more information and input over time. But I think there are some basic principles that the legislative process has already agreed upon, or should agree upon to put into the bill before we punt the rest of it to the SEC for further study. And the way to get there can be one of two ways. We can either do it by discussions off the record, outside the context of a mark up or we can have a very, very protracted mark up because as many of you remember in the Gramm-Leach-Bliley process, there will be a number of amendments to be debated and concurred if we don't have the opportunity to put those amendments into the process, have some discussion about them before we get to the mark up, then I think this mark up's going to be a lot longer than perhaps is being contemplated at this point.

So one of the things I particularly feel strongly about is that there is a very important role for private litigants to enforce rights in this context. We can't give responsibility solely to the SEC and say you've got absolute authority to do this and if you don't do it then nobody is going to have the authority to do it, our whole accountability system in this country is based on the rights of individuals to hold corporations and other individuals accountable when they feel like they have been wronged. So at a minimum we need to put some of those provisions in the bill to provide for private litigants to protect their own rights. And that, I think, is a hallmark of the way our system should work.

I appreciate the gentleman bearing with me and I yield back the balance.

REP. FERGUSON: Gentleman has in fact used the balance of his time. The chair recognizes the gentle lady from Illinois, Ms. Schakowsky for an opening statement for five minutes.

REP. JANICE D. SCHAKOWSKY (D-IL): Thank you.

I want to thank the chairman and particularly Ranking Member LaFalce for assembling -- for his leadership in assembling these witnesses here today, that I think will make a very important contribution to the ultimate legislation. And I want to associate myself with the concern expressed by my colleague from Illinois for the Andersen employees who have, through no fault of their own, lost their jobs. And for this reason as well as many others it's important that we do act in order to prevent those kinds of loss and to protect industrials and pension holders from conflicts of interest and from corporate greed.

We all know that if not for Enron's collapse we would almost certainly not be considering these important matters today. I'm concerned that some want to characterize the Enron collapse as just a case of one bad actor in the market place. I disagree with that interpretation as I think do most people on this committee and that's why we are considering legislation because Enron's collapse does have systemic crisis. Corporate boards of directors, Wall Street analysts and the big five accounting firms all have an economic incentive to provide bias analysis of large profitable companies.

Enron used its political ties to persuade the government to carry out its business plan. Just take a look at California, President Bush, his regulators and congressional republicans who opposed price caps for consumers while Enron manipulated that market causing the energy crisis. Enron had incredible access to the White House. President Bush received over $736,000 throughout his career as an elected official. Vice President Cheney had at least six meetings with Enron officials while drafting the administration's national energy plan. Enron's economic and political power effectively muted people who were skeptical of the company's economic stability. Enron is not an isolated case and this is not only a business scandal but I'm afraid it is also a political scandal. The matter of the -- the fact of the matter is we do not have the laws and procedures in place to protect common investors. If we don't take swift action I have little doubt that corporate executives, greed and deception, will victimize more people. Simply relying on free market dogma will not suffice.

Employees and pension managers must be involved in corporate decision making. Boards that are dominated by corporate executives are inherently flawed. Enron's collapse had a significant impact on working families. In the case of Enron, hard working people lost their life savings while Enron's executives gained millions. It's estimated the Illinois State Pension Fund lost $25 million. That means that hard working teachers, police officers and fire fighters who work for the public good, may not be able to enjoy their hard earned retirement. And that I don't think is what public servants deserve for their future.

Of course I agree that we must proceed in a careful and deliberate manner but we must proceed. That's why I'm a proud co- sponsor of the Comprehensive Industrial Protection Act and I look forward to making sure that as we move to the mark up that critical provisions of that bill will be included in any measure that passes out of this committee. This legislation will help protect investors and workers in the future. I thank Congressman LaFalce for his efforts on this legislation. We have the responsibility to enact significant reforms.

I look forward to hearing the witnesses testimonies today and I yield back.

Thank you.

REP. FERGUSON: The gentlelady is expired.

The gentleman from Texas, Mr. Hinojosa, for five minutes for an opening statement.

REP. RUBEN HINOJOSA (D-TX): Thank you, Mr. Chairman.

I want to say that I come from Texas and I have traveled throughout my district and that is the first thing that our constituents want to know, just what are the members of the financial services going to do with regard to the losses that they have experienced and I'm looking forward to listening to the witnesses today so that as we go through the mark up, that we can make intelligent decisions, and come up with a national policy that is going to protect the -- not only the investors but protect employees of Andersen and companies like Andersen who have lost their jobs as a result of somebody at the top who made decisions that obviously were incorrect and very damaging.

I look forward to listening to the facts that the witnesses are going to present because I am very interested in both of the bills presented by Chairman Oxley and our ranking member that I think is much more comprehensive than one that is in my opinion going to be necessary to consider and give every opportunity to pass through this committee so that it can go down to the whole Congress and, Mr. LaFalce, I commend you for the comprehensiveness of the bill that you have given us to consider and I yield back the balance of my time.

REP. FERGUSON: Gentleman yields back.

The gentleman from New York, Mr. Israel, for five minutes for an opening statement.

REP. STEVE ISRAEL (D-NY): Thank you. Mr. Chairman.

I also spent a considerable amount of the last two-and-a-half weeks traveling throughout my district and hearing from constituents who routinely ask what we're going to do to ensure the integrity of investments. And I want to commend the Ranking Member, Mr. LaFalce, for the work that he's done on his bill. Also commend our chairman for his work and ultimately it's my hope to support legislation that has several features: Number one that provides the strongest oversight protections; Number two that facilitates transparency; Number three that ensures accountability and finally that ensures an even standard among investors and management.

I look forward to working with my colleagues on the committee to these ends and I yield back the balance of my time.

REP. FERGUSON: Gentleman yields back. The chair sees no other members seeking time for an opening statement. The committee will now hear testimony from our panel of witnesses. We thank the witnesses for their patience and for their presence here today. They are from the chair's left to right, the Honorable David Walker, Comptroller General of the United States, U.S. General Accounting Office. The Honorable Richard Breeden, Former Chairman of the SEC, now with Richard C., Breeden & Company. Professor Donald Langevoort from Georgetown University Law Center and Mr. Damon Silvers, Associate General Counsel of the AFL-CIO.

Mr. Walker, you're invited to give your testimony. You have five minutes. Thank you for being here.

MR. DAVID WALKER: Thank you, Mr. Chairman, members of the committee.

With your permission I'd like the entire statement to be entered into the record.

REP. FERGUSON: Without objection, so ordered.

MR. WALKER: Thank you. I will now summarize that statement.

I appreciate the opportunity to share my perspectives on the range of issues emulating from the sudden and largely unexpected bankruptcy of Enron Corporation and financial related activities relating to several other large corporations. As the committee knows, GAO has conducted an extensive amount of work dealing with the accounting profession and has issued a number of reports over a variety of years. More recently, in order to assist the Congress in framing needed reforms, on February 25th, 2002, we convened a forum on corporate governance, transparency and accountability to discuss a variety of systemic issues. On March 5, 2002, I issued highlights to the forum meeting, which Mr. Chairman, I'd make available for the record if you so desire.

As you requested, my comments today will primarily focus on oversight of the accounting profession and related auditor independence and corporate governance raised by Enron's failure.

The issues raised by Enron's failure are multi faceted, involving many different problems and players with various roles and responsibilities. In that respect, needed changes to the governance role should vary depending upon the specific nature and magnitude of the problem.

Specifically, the government's role can change from direct intervention to encouraging certain non governmental and private sector entities to take certain steps designed to enhance trust and better protect the public interest.

With regard to the possibility of a new oversight body, the issues of fragmentation, ineffective communication and limitations of discipline surrounding the accounting profession's self regulatory system strongly suggest that the current self regulatory is not adequate in effectively protecting the public's interest, particularly in the auditing area. We believe these are structural weaknesses that require Congressional action. Specifically, we believe that the Congress should create an independent statutory federal government body to oversee financial audits of public companies. The functions of the new independent body should include: establishing professional standards, dealing with auditing standards including standards for at the station review engagements, independent standards and quality control standards for both public accounting firms and key members of those firms who audit public companies.

Secondly, inspecting public accounting firms for compliance with applicable professional records and standards and investigating and disciplining public accounting firms and/or individual auditors of public accounting firms who do not comply with applicable professional standards. This new body should be independent from but should closely coordinate with the SEC in connection with matters of mutual interest. There are alternative models which we would be more than happy to discuss if you so desire.

In addition, we believe that the issues concerning accounting standard setting can best be addressed by the SEC working more closely with the FASB rather than putting that function under the new body. The new body should be created by statute as an independent federal government body. The new body should have resources of funding independent from the accounting profession. For accountability, we believe the new body should report annually to the Congress and the public on a full range of its activities including setting professional standards, inspections of public accounting firms and related disciplinary activities, that Congress may wish to have GAO review and report on the performance of new body after the first years of its operations and periodically thereafter.

We believe that the effectiveness of both the directors and committees including their working relationship with management of public companies can be enhanced by the SEC working with the stock exchanges to enhance certain other listing requirements for public companies.

We also believe that the issue surrounding the financial reporting model can effectively be addressed by the SEC in conjunction with FASB without statutorily changing the standard setting process. However, we do believe that more active and ongoing interaction between the SEC and the FASB is needed in order to facilitate a mutual understanding of priorities for standard setting, realistic goals for achieving expectations and timely actions when expectations are not met.

Over the last decade, securities markets have experienced unprecedented growth and change. At the same time, the SEC has been faced with an ever increasing workload and ongoing human capital challenges, most notably high staff turnover and numerous staff vacancies. We believe that it's important for the SEC to be provided with the necessary resources to effectively discharge its current and any increased responsibilities that the Congress may wish to give it.

And finally, we believe the SEC should be directed to report annually to the Congress on its -- on certain matters that I outlined in my testimony.

In closing Mr. Chairman, and members of the committee, the United States has the largest and most respected capital markets in the world. Our capital markets have long enjoyed a reputation of integrity that promotes investor confidence. However, this long standing reputation is now being challenged by certain parties.

Today, I've discussed our suggestions to assist the Congress in crafting needed reforms. We strongly believe that an independent federal government body created by statute to regulate audits of public companies is needed in order to better protect the public's interest.

However, currently we do not believe that it is necessary of appropriate for the government to assume direct responsibility for other key areas such as general accepted accounting principles or corporate governance requirements. We do however believe that Congress should provide the SEC with direction to address certain related issues.

In the end, no matter what system exists, bad actors will do bad things with bad results. We must however strive to take steps to minimize the number of such situations and to hold any violators of the system fully accountable for their actions.

Thank you, Mr. Chairman.

REP. FERGUSON: Thank you, Mr. Walker. I would ask the witnesses to do your best to say within the five minute time constraint, something that we all appear to have enough difficulty doing on our own. Thanks very much.

Mr. Breeden, five minutes.

MR. RICHARD C. BREEDEN: Thank you, Mr. Chairman, ranking member LaFalce, members of the committee.

It's a great pleasure to have the opportunity to testify before you today at your request to discuss the provisions of H.R. 3763 and 3818 as well as to address various issues raised by the committee arising out of the tragic and disturbing events at Enron.

I had the great privilege of serving as chairman of the Securities and Exchange Commission back when dinosaurs roamed the earth and it was an era in which we were successful in passing several major pieces of legislation both when I was in the White House, the Savings and Loan Reform Legislation and the Market Reform Act and Securities Enforcement Remedies Enhancement Act of 1990. And both in our legislation and the work of the commission in that era, I had the great pleasure of working with both sides of the aisle in Congress. It's been a great tradition in the area of financial services regulation and particularly in the areas governed by the SEC of bipartisanship and it's a good thing to see you working together to try and address these problems.

It's important that tradition of bipartisan cooperation remain the prevailing spirit in this area.

At the outset, I'd like to congratulate all the members and the staff of the committee for the fine work you've done in developing legislative proposals to respond to the weaknesses in our current system that this situation has brought to light. Both bills contain many sensible provisions that should enhance our extremely good system and make it more resistant to problems in the future.

Both bills follow generally similar principles and demonstrate many areas of common agreement. This is particularly apparent in the provisions of both bills concerning a new approach to oversight for the accounting profession, enhancements to the quality and the speed of disclosure and enhancing healthy practices in corporate governance. While H.R. 3818 goes beyond the provisions of H.R. 3763 in a number of areas, it appears clear to me that there is good common ground in the two bills and plenty of room to craft a bill that is reasoned and measured. And certainly the president has shown leadership in this area as well and with presidential leadership and both Houses -- both Houses of Congress and both parties considering these issues there is plenty of room to try and craft a bill that would reflect a consensus approach to these issues.

Of course some have said the market has already fixed all the problems of Enron and with that I respectfully disagree. There's no question the market has reacted to the events at Enron, boards of directors and audit committees are more sensitive and wary about conflicts and overstatements of income. Many people have learned more about SPEs than they ever thought they would learn in their life in recent weeks and I doubt if many boards will be suspending corporate codes of conduct and conflict standards any time soon.

Hopefully auditors at other firms realize both the importance of sharing concerns with the audit committee rather than keeping silence about major issues and alternatives. And investors and exacting a price from companies where they perceive a higher level of accounting risk and lower levels of transparency. These are all very healthy and welcome developments.

While improvements have been made, market responses can be short lived and many memories can be too short. Unfortunately, companies that don't need the reforms often adopt the better practices. But companies that pose the greatest risk to investors may not change their policies at all. There are many issues involved in the Enron Andersen case that cannot be solved entirely by the market and there is not any reason we should be reluctant to admit where our system has weaknesses we should address.

The system for oversight and discipline of the performance of audit firms and their personnel is one area that would benefit from legislative change. Our previous system of peer review and self regulation have certain types of issues through the public oversight board did not work. The SEC needs at least some additional resources to allow it to handle the volume of financial fraud cases it should be pursuing as well as providing more frequent review of filings by high cap and widely held issuers. Legal standards today for disciplining accountants and their firms for audit failures are subject to more litigation than is desirable. Certain enhanced types of remedies such as stronger officer and director bars and disgorgement authority to recover profits on sales of stock by insiders prior to a bankruptcy, would be desirable.

Standards need to be set regarding consulting services by audit firms for audit clients and the system for developing and interpreting accounting principles through the FASB needs to be improved. These and other modest steps can complement market disciplines and help restore balance and confidence to our system. None of these steps need involve excessive regulation or interference with healthy market developments. In drafting a specific bill we should not stake all on trying to do too much and we should not allow ourselves to do too little.

We have to make sure, for starters, that existing law is vigorously enforced because much of the Enron Andersen case involves violations of existing laws. Beyond that, you've identified a number of reasoned and careful steps that will enhance the qualities of the existing system. I wouldn't talk to my response to a number of questions from the committee and I'd be happy to discuss any of those questions further, and I'd only like to very, very briefly summarize my views on the establishment of a new oversight body for the accounting profession. Both those contain provisions concerning establishment of a new oversight body.

In my testimony, I urge you not to create a new governmental body but rather to reinforce the role of the SEC in dealing with such issues. Whatever body is created and whatever its exact mission, any such group should be a private sector entity, with oversight by the SEC. We should not repeat now the mistake that was made when the CFTC was created that set us on a course of endless competition of jurisdiction between government bodies with closely parallel missions. The SEC is there, it has the history, the culture, the tradition and the tools for dealing with these kind of problems and it should be the body that then provides oversight to an effective, self regulatory organization along the lines of the NASD or the New York Stock Exchange. There, these organizations have strong staffs, a good record of promoting healthy ethics and law enforcement while not creating additional government bodies.

Again, thank you very much for having me and I commend the strong efforts of both parties to date, in seeking to build legislation that can command broad based support. Our disclosure and accounting system has stayed viable over the years because we've not been afraid to learn from major problems and to change some of the rules of the game. In my judgment, this case demands a reasoned and measured response but a response nonetheless.

Thank you.

REP. FERGUSON: Thank you very much.

Professor Langevoort, recognized for five minutes for an opening statement.

MR. DONALD C. LANGEVOORT: Thank you, Mr. Chairman, and let me try to be very brief.

The last few months have brought public attention to bear on the seriousness of a problem. That economic forces have increased the temptation and techniques many companies' executives face to be dishonest to the investing public and that these temptations and techniques have translated into an unacceptable level of corporate fraud, mismanagement and concealment.

My invitation here today is not to address all the possible reforms that could come from this but rather touch on private securities litigation as one touchstone for reform and I will try to be very brief by focusing my oral remarks, as opposed to my written testimony, on the two reforms that I consider most important, and indeed whose merits to me are beyond doubt.

First, restoring a system in which those who aid and abet securities fraud, become liable to the victims. When the Supreme Court in 1994, eliminated aiding and abetting in private rights of action, it didn't do so on policy grounds or through careful legal reasoning. Rather it said, as a matter of statutory construction, that job is for Congress not the courts. I urge you today to take up the court's invitation and respond accordingly. It is very difficult to argue that somebody who provides substantial assistance to a securities fraud, shouldn't have to compensate the victim. Common law has, for centuries, imposed that liability.

Congress has recognized that aiding and abetting is a federal crime and in 1995 gave the SEC specific authority to proceed in that direction. It's clearly wrongful. Why then wouldn't you make the aider and abettor compensate the victim? The answer we are told, is fear of litigation abuse. That these kinds of claims can be abused. Now I have to confess I am one of those people who takes litigation abuse seriously. I think Congress, in 1995, was -- acted appropriately in addressing the issue, even if I don't agree with all the specific outcomes. But litigation abuse and its fear is no excuse for saying that somebody who provides the brains, the talent, often the motivation, behind a fraud should avoid responsibilities to the victims simply because their appearance is not made visible to the investing public. And sadly, that's the state of the law that we have today.

Those to whom the fraud is not attributed, who are not identified to the investing public, have grounds to avoid liability. It seems to me, clear that we ought to change that rule, in the name of commonsense, without regard to debate about the statistics of whether the incidents of private securities litigation have gone up or down. It simply makes sense to impose liability on those people.

Secondly, the other reform I want to address in my oral testimony is redressing the rather foolish Statute of Limitations that we have today for private securities actions. The Supreme Court, once again, gave us this rule. Again as a matter of since Congress hadn't done anything about it since 1934, who are we to impose a different standard. The result is that we have in private securities litigation, a rule that was adopted in 1934, before Rule 10(b)(5) existed, before class actions existed, before the depth of our securities markets and its breadth could scarcely have been imagined. It's silly to assume a rule adopted then, should be the rule adopted today, simply by a result of history.

That rule, that actions have to be brought within one year after notice (hint ?), is much too short today to develop a complex, well grounded law suit. And even worse, the rule that if somebody can hide the fraud for three years, they get away completely, simply as a result of their success, is also something that makes no sense in our highly complicated, highly complex financial situation.

Now, I make no claims that these two reforms or the others that I address in my written testimony, would prevent the next Enron, would change things dramatically. But they are very important first steps. Very important pieces of puzzle that we ought to take as we begin to address the problem.

Thank you.

REP. FERGUSON: Thank you very much.

Mr. Silvers, five minutes for your testimony. Thank you for being here.

MR. DAMON SILVERS: Thank you and good afternoon, Mr. Chairman and ranking member LaFalce.

On behalf of the AFL-CIO's 65 member unions and our 13 million working family members, want to thank the committee for the opportunity to appear here today. The collapse of Enron and similar events at Global Crossing, Waste Management and other public companies are a window into a set of pervasive conflicts of interest that defeat the purposes of corporate governance and threaten the retirement security of America's working families.

This committee has heard in prior hearings, from those who would still have you belief what Enron used to preach in this town. That unregulated markets will solve all problems if they're just left alone. Now that maybe the view from the K Street offices of the people who do the heavy lifting for the audit firms here in Washington. But it is not how things look for thousands of working families in Houston and Portland, Oregon and Rochester, New York and clearly in Chicago, who have lost their jobs or their retirement savings and their health care because they believed what they were told. Told by the employers, by their employer's accountants and the analysts that interpreted the accountants numbers.

H.R. 3818, the aptly named Comprehensive Investor Protection Act of 2002 is the most comprehensive legislation introduced in this Congress in response to the conflicts of interest in the capital markets and in the boardrooms of America's public companies. Let me briefly review the areas where Congress needs to act to protect investors. The provisions of H.R. 3818 that respond to that need and the key differences between H.R. 3818 and H.R. 3763, which the chairman discussed in his opening remarks.

First, public company boards need strong, independent directors. So investors need complete disclosure of all the ties that exist between the board members, the company and company management. H.R. 3818 requires just that, while H.R. 3673 has no such requirement. This higher standard of independence should be the relevant standard for measuring the independence of company auditor and compensation committees. Furthermore, shareholders should have access to management's proxy, not just for shareholder proposals on a handful of subjects, but for director candidates, independent director candidates. We urge these corporate governance provisions be added to any reform package this committee takes up.

The second area in need of reform is the practice of public accounting. Here again H.R. 3818 takes the right approach to auditor independence by giving the SEC the authority to ban a wide range of consulting by auditors and requiring that the audit committee or the full board of directors of a company approve in advance the provision of consulting services by the company's audit firm that are still allowed by the SEC. In contrast, H.R. 3673 bars only certain types of consulting and would allow that the sorts of consulting that led to the most egregious abuses at Enron by Arthur Andersen to continue.

The next issue is auditor oversight. Former SEC Chair Arthur Levitt has outlined in testimony before the Senate Governmental Affairs Committee what we believe are the key characteristics of a much needed auditor oversight body. Members independent of the big five, full investigative and disciplinary powers and independent funding. H.R. 3818 creates a public accounting regulatory board that meets these tests. H.R. 3763's provisions do not meet these tests.

Then there are the Wall Street analysts. H.R. 3818 requires the SEC to ban analysts compensation tied to investment banking performance. The majority's bill goes no farther than requiring a study. All these reforms though are of little benefit if there is no enforcement. The ranking member's bill provides both adequate resources to fund pay parity for the SEC and to expand the commission's oversight and enforcement activity. The majority's bill has no such provision.

Finally, I want to address the ultimate accountability measures available to shareholders: recourse to the courts. As Professor Langevoort has mentioned, the restoration of investors' right to sue those who aid and abet securities fraud is a vital and important step that must be taken immediately. And I would add in addition to the statute of limitations issue that the restoration of joint and several liability is critical in cases where the wrongdoers start filing for bankruptcy. These provisions are included in H.R. 3818 and not in the majority's bill.

In conclusion, H.R. 3818 gets at the heart of the problem of conflicts of interest, where as H.R. 3763, the majority's bill, leaves untouched these central conflicts of interest; conflicts of interest that brought us Enron and will no doubt continue to cause losses to workers' retirement savings if not addressed. At the heart of what happened at Enron are systemic solutions to systemic problems that need systemic solutions. These solutions will no doubt offend powerful interests, but they will protect America's working families. H.R. 3818 contains within it these necessary solutions and has the AFL-CIO's strong support.

The AFL-CIO is grateful for the opportunity to share our views with the committee on these bills and welcomes the opportunity to continue to work with the committee as you move forward in addressing these important issues.

Thank you.

REP. FERGUSON: Thank you very much to all of our witnesses.

We appreciate your presence here and your lending of your insights and expertise into some of the very important matters before the committee, particularly regarding this legislation. We're now going to begin our question period. Each member will be allotted five minutes to ask questions of the witnesses. I'd like to begin the question period by yielding to the distinguished chairman of the Capital Markets Subcommittee, Mr. Baker.

REP. BAKER: Thank you, Mr. Chairman, for that courtesy. I do appreciate it very much.

Mr. Walker, I noted in your written testimony reference to the fact that the audit client should be -- clearly an understanding that he has a primary responsibility to the shareholders. I recall having read in the earlier report also another line which indicated it should be made statutorily clear that the financial statement is the property of the shareholder. In testimony before this committee, Mr. Berardino, the former CEO of Andersen, in response to a question from me indicated that the financial statement was the property of management and the shareholder, which I thought flew in the face of Accounting 101 in the audit committee's engagement of the audit team is to prepare an accurate and true picture of financial condition for the shareholder.

Although the financial data must be arrived at in consultation with management to understand the true operations of the business plan, management should not be involved in the alteration, manipulation or intimidation of the preparation of the numbers as the audit team sees them in light of this responsibility. Is that an accurate reflection of your understanding?

MR. WALKER: My understanding, Mr. Baker, is that first the board of directors work for the shareholders.

Secondly, under current literature, management is responsible for the financial statements but the financial statements are for shareholders and other stakeholders. And I personally believe that one of the real keys that has to be focused on here is determining who is the client and who are the parties who are representing the client. I would argue that when you're talking about an audit and you're talking about related financial reporting associated with that audit, that the client is the -- or should be the shareholders and other stakeholders who are relying upon that information.

But their representative should be the audit committee, which should be an independent body, a part of the board, and that the audit committee should be responsible for hiring the auditors. The audit committee should assume additional responsibility above and beyond what it has right now, in order to ensure that there is a convergence of interest between the board, who is supposed to be working for the shareholders, and the independent auditors who should be working for the shareholders, but in addition to that have a broader public interest.

REP. BAKER: If I may, let me take that as a long "yes" because I have a follow up. There is inherently a conflict between the management's interest to enhance stock performance, thereby enhancing their own remuneration perhaps at the expense of the shareholder in unfortunate cases. To disincentivize that type of manipulative conduct in relation to the preparation of the statement, would it be advisable for us to consider making the CEO personally responsible and liable for the accurate preparation of the financial statement? I know there is clearly a responsibility, but do we need to make that more clear?

And I'll jump to the next one while you're rolling that one around, because I'd like Mr. Breeden to comment as well, to go perhaps further. It has been represented that there are cases in which management, through collusive efforts of many, have enhanced appearances of the corporation to increase the value of stock, exercise no cost options granted as a part of their employment arrangement and then subsequently have a restatement of earnings, so that the shareholder takes the net effective loss and the executive remains enriched through that manipulative process.

For example, in that case should we authorize the SEC to make enquiries into matters of that sort and be given the rules and authority to take appropriate action, including discouragement. So that if there's a downturn as a result of manipulative bookkeeping, that there are consequences for the corporate executive? I make these comments in light of Chairman Greenspan's remarks and others, who have encouraged us to find ways to disincentivize short term earnings pressures and long term corporate asset growth. Would either of you comment, please?

MR. WALKER: Well, first there are several things in my testimony where I talk about things that I think the SEC should be required to look into in order to provide better checks and balances to better protect not only the shareholders' interests but the public's interest. That includes the composition of the board. That includes the composition of key committees on the board, and that includes trying to provide additional transparency and checks and balances against the kind of actions you're talking about.

Right now management does have a responsibility to sign a management representation letter, in conjunction with an audit and they are supposed to make certain assertions that to the best of their knowledge and belief, among other things that certain things are true. I think that could be an area that you may want to have whichever body that you decide should be responsible for the auditing area for better protecting the public interest to take a look at that and determine whether or not additional steps should be necessary.

MR. BREEDEN: Congressman, it's nice to see you. I would only add, number one, on your question of the financials themselves -- financial statements have to be prepared by management. The starting point is -- the only correction to what you said, the auditors are not engaged to prepare the financials. That is management's duty and responsibility. The auditors are there then to check those financials and test them and that check and balance system is at the heart of how we go about preparing financial reports. I think absolutely CEOs should be responsible for what's in the financial statements. I think they are legally today already. The system today, however, provides also full indemnification from the company as well as insurance if they have any liability. So you have liability --

REP. BAKER: Mr. Chairman, with your due diligence, I know my time's expired. I just want to emphasize that one point. In the event there's an allegation against the corporate CEO for misrepresentation of material elements of the preparation of the finances, the corporate attorney defends the CEO, where the shareholder has to fund the personal litigation expense out of their pocket.

My point is should there be a downside where it is defined after appropriate inquiry that the manipulation that did in fact occur, there was a loss occurred, should not the CEO then, out of his own pocket, have some liability which does not now today exist?

MR. BREEDEN: I think your point of there being a downside is important. I think the president's messages have emphasized that challenge. Its remarks have emphasized that. My own testimony suggests that we do need to do more in the discouragement area. I'm particularly worried about the situation where an executive may be selling, in Gary Winnick's case in Global Crossing, $750 million worth of stock on the even of bankruptcy, and whether or not you should trigger it by a restatement I think Congress should consider whether stock fails within a certain period of time of the company going into bankruptcy, whether the profits from those sales by senior officers shouldn't be recaptured into the bankruptcy estate.

REP. BAKER: I have much more but I'm way out of time. Thank you very much.

REP. CANTOR: The chair thanks the gentleman.

The chair now recognized ranking member LaFalce.

REP. LAFALCE: Thank you very much.

Today I introduced a bill to give legislative teeth to a number of the recommendations that President Bush called for. Number one, just with respect to discouragement of bonuses and other incentive compensation of either false or misleading statements or other misconduct. Number two, requiring the CEO and CFO to personally vouch for and certify to the veracity and fairness of their company's public disclosures, including their financial statements, and certification that certain internal control procedures are in place.

And third, enhancing the ability of the SEC to bring an enforcement case prohibiting a person from acting as an officer of director of a public company by lowering the standard. Right now the standard is substantial on fitness. We would simply eliminate the world substantial.

It may be unfair to ask you to comment on a bill that you have not been asked to testify on at this juncture, but it would be fair, I think, to ask you to submit a letter to the committee giving your views on that bill once you have had time to consider it, hopefully before markup on Thursday.

(Laughter.)

Okay, now to go on. Mr. Walker, you have indicated, I believe, correct me if I'm wrong, that the new oversight body for the auditing profession is necessary, that it should have the authority to establish professional standards for the auditors of public companies, that this new regulatory organization should be able to set independence standards, that the new regulator should be able to charge annual fees to public companies as a means of financing itself.

Is that basically correct?

MR. WALKER: Our recommendation --

REP. LAFALCE: And you find those provisions in HR 3818, I would assume, and not in the other bill.

MR. WALKER: I would find --

REP. LAFALCE: But wherever they're found, you would --

MR. WALKER: Some of the provisions are on 3818.

REP. LAFALCE: Right, okay. Good. All right. Now, why do you think they're important.

MR. WALKER: Well, my personal view is that we should not have direct government intervention unless we believe that it's called for. And if there are other bodies or parties where a government could encourage them to take the right steps we should first try to do that, and if they fail to do it, then consider direct and government intervention. I think the area where direct government intervention is necessary is in the auditing area. I do not believe that you're going to achieve the objective of best protecting the public interest without more direct government involvement dealing with independent setting for auditors of public companies, the quality assurance procedures associated with those auditors, the disciplinary process associated with those funds and the individual members, and certain other matters laid out in our testimony.

REP. LAFALCE: Good. I appreciate that because I think that there is -- both Mr. Oxley and I believe that we do need a new auditing body. The question is what powers should it have? It certainly should have at least those powers and maybe some more. That's something that, as Mr. Breeden suggested, is subject to compromise. We could talk a lot. But another question is too, who should be on that board? And that's a very important question. And I have said that the SEC should appoint them from lists that were submitted from certain types of organizations such as pension plans of private employees, pension plans of public employees, et cetera. Otherwise you might have a situation where you have Mr. Pitt appointing a board that Mr. Boucher would look at and say this is so bad I'm resigning, which is exactly what happened.

So do you have any thoughts as to the type of individual that should be on that board? Do we leave it totally to the discretion of the SEC, or do we put some language in the legislation which tries to make sure that the individuals on that board will be interested first and foremost, and exclusively, in the protection of investors?

MR. WALKER: My personal view is that there should be some standards for the individuals who would be appointed to the board. I would note in your bill, Mr. LaFalce, there's one provision in there that I think may raise a constitutionality issue, and that is --

REP. LAFALCE: I'll take that one out, whatever it is.

MR. WALKER: Yes, that's right.

(Laughter.)

And in the interest of self-interest, it's the one that talks about the comptroller general being part of the appointment process.

REP. LAFALCE: Oh, yes.

MR. WALKER: The comptroller general can make recommendations about --

REP. LAFALCE: You don't want it, you don't get it, you're out.

MR. WALKER: Yeah. Recommendations are okay --

(Cross talk.)

REP. LAFALCE: Okay.

MR. WALKER: -- make decisions.

REP. LAFALCE: Mr. Breeden, you described two concerns with the non-audit services that auditors currently provide to audit clients. One, specific services that create conflicts for the auditor, and two, the volume of non-audit fees in relation to audit fees. Does either bill address it adequately, more adequately, are both inadequate, do you have a preferable -- a preferred approach other than the approach in either of the two bills?

MR. BREEDEN: Congressman, I think both bills have made a very good start to looking at what is -- I tried to, in my usual excessively wordy way, tried to, in my testimony, show that there are some real complexities in this issue, and it's hard to just say no consulting at all because things like tax services are not pure audit but would rob the audit of its vitality if you took them away.

REP. LAFALCE: Which I specifically say should not be done.

MR. BREEDEN: And neither bill takes tax services away, although some of the proposals in the marketplace have done that, and I think they would do significant damage if you went that far. Consulting on internal controls is, I think, something I used to do in the three years I spent at Coopers and Lybrand, and I think that contributes to the quality of audits. So I think that we need to identify any cases where the auditors are, in essence, auditing themselves. If they have built a data system that is the system used for financial reporting, if they are doing something in the consultant side that their own auditors are supposed to go and audit, it's unreasonable to expect that they will give the same level of diligence that they would if an independent person had done that.

(Cross talk.)

REP. LAFALCE: That's true, we need to go beyond that --

REP. CANTOR: Gentleman's time has expired.

REP. LAFALCE: Mr. Walker wanted to --

MR. WALKER: Real quickly, Mr. Chairman, could I real quickly on that?

REP. CANTOR: Okay.

MR. WALKER: In my testimony we recommended the committee consider a principles and safeguards-based approach that we've already promulgated for federal entities and entities that receive federal funds. As you know, Mr. LaFalce, the GAO actually promulgates auditing standards for federal entities and entities that receive federal funds, and we believe that that guidance would be helpful in considering what should be done with regard to public companies.

Thank you.

REP. CANTOR: The chair thanks the gentleman.

At this time the chair would like to just address for a moment, Mr. Breeden. I take it you're familiar with Chairman Greenspan's remarks when he addressed this committee several months ago, and while he was here he expressed a concern that Congress could go too far in over-regulating the capital markets in response to the issues at hand. Can you comment on that and what do you make of those concerns?

MR. BREEDEN: Well, I think anytime you have a scandal of this kind that has touched so many people and caused such widespread losses. And between the losses to investors in Enron and the losses to Andersen employees and so on there's an enormous amount of damage here and so I think Chairman Greenspan was, as many others have done, was noting a concern that Congress be careful in responding to events that naturally cause outrage on the part of good people everywhere, that we not go too far in fashioning legislative responses. And I tried to -- and I agree with that sentiment.

At the same time I also believe that there are some areas that have been exposed in this overall situation that will benefit from legislative changes that we not do too much but we not do too little.

And I think actually that Mr. Oxley's legislation together with Mr. LaFalce's legislation, both goals here, attempt to and one goes farther than the other, but maybe something in between is an area where people can coalesce around. It's important not to go too far but I think there are some areas where real change needs to be made.

REP. CANTOR: Mr. Walker, do you respond to those concerns?

MR. WALKER: Yes. As I said in my statement I think that you should only have direct government intervention where you believe that the problem cannot be effectively addressed by other parties. And in that regard well we say the greatest deed is, is in the area of the auditing area. And what we're recommending is that there be a qualified, independent and adequately resourced body to be able to assume those responsibilities rather than the Congress trying to get into the details, trying to make those decisions through legislation. I think that's critical in order to make sure that you don't overreact, that you have a balancing of interest.

As you know, Chairman Greenspan has also said that he believes that additional action is necessary in certain areas, such as in the auditing area and has expressed some concerns about current accounting and reporting with regard to certain types of compensation arrangements.

REP. CANTOR: Thank you.

If I could try Mr. Silvers for a moment. In 2000, former SEC Chair Levitt, proposed order independence rules targeting 10 consulting services for prohibition. The final SEC rule prohibited seven of these services. Another was dropped because it was deemed unworkable. The Oxley Bill bans the other two. The LaFalce Bill bans all 10. Again, seven are already prohibited under the current rules. Isn't this provision redundant?

MR. SILVERS: Is -- I'm sorry, sir, which provision do you think is redundant?

REP. CANTOR: The Oxley Bill bans the other two but the LaFalce Bill comes in and bans all 10 while seven are already prohibited by the rules as they exist now.

MR. SILVERS: My understanding from reading the bills, Mr. Chairman, is that the -- that Mr. LaFalce's Bill provides that the commission with the authority to take a look at a practice such as that which occurred at Enron, where Arthur Andersen participated in structuring SPEs and then came back. And it's -- in part it did so I believe under the rubric of tax consulting. Certainly they could have done so under the rubric of tax consulting. They structured the SPEs and then they came back and audited those same SPEs and they generated a $5 million fee for doing so.

The challenge of this conflict of interest is, is that the commission needs to have the authority to draw these fine lines and the chairman's bill simply does not give the commission the clear authority and direction to do that. Mr. LaFalce's bill does that. The difference frankly is, is that under the chairman's bill, if a firm was to feel that it made sense for them economically to go and do what Arthur Andersen did at Enron, there really would be no reason per se under the chairman's bill that they couldn't do that. Whereas, Mr. LaFalce's bill clearly directs the commission to promulgate rules that would prevent that conduct. I don't believe that that distinction is by any means redundant, as you would suggest.

REP. CANTOR: Mr. Breeden, if I could turn to you in attempts to elicit a response again to the question about the potential redundancy in one of the bills that attempts to address the rules that are already in place.

MR. BREEDEN: Mr. Chairman, I have not looked in detail at the language of the commission's current rules compared to the bill to see whether they're completely overlapping or whether there are gaps their, I could do so afterwards, but I -- and send you a letter about it, but I really haven't done so and I can't tell you whether they're fully redundant or not.

REP. CANTOR: It would be appreciated, thank you.

REP. LAFALCE: Would the gentleman like me to give an answer?

REP. CANTOR: Sure.

REP. LAFALCE: Even when they're not fully redundant at all because there were caveats within the rule. Number two, if the worst sin is redundancy, that is, codification inter law regulations, I will accept that sin.

REP. FERGUSON: The chair thanks the gentleman.

The chair now recognizes Mr. Kanjorski.

REP. PAUL E. KANJORSKI (D-PA): Thank you, Mr. Chairman.

All of the testimony and the pending bills make certain presumptions that, one we know the full extent of the Enron disaster and also that -- obviously in regard to the accounting firm, the $25 million in auditing fees and $27 million in consulting fees, whether these were overcharges, whether the work performed was unethical or improper and if it was in any regard, to what extent. Had you -- are you -- any of you aware of any studies that have analyzed what work was done? How competent the work was and whether or not in fact any of it was improperly done?

Yes.

MR. WALKER: I'm not aware of a study. I am aware of the fact that Arthur Andersen at least was performing certain internal audit services that would be banned under both of these bills and -- which I think is noteworthy.

MR. BREEDEN: Congressman, I'm not aware of any studies but $52 million in fees combined for audit and consulting is an enormous fee. That would put Enron's payments to Andersen clearly would have had to have been among the top of not only Andersen's clients but probably of any accounting firm's clients.

MR. SILVERS: Mr. Kanjorski, I would make two points in response to your question. One is the conflict that I alluded to in response to the chairman's question as discussed on page five of the Powers Report and then gone into some detail later on in the report in terms of the specific conflicts that were at work here. And I would add that prior to the appearance of the Powers Report that both Andersen and Enron made some efforts to conceal from Congress and several different committees, including this one, the extent of those conflicts. But the Powers Report itself documented it quite adequately.

I would also say that although that fee is very large, it's very interesting that the multiple of the consulting fee in relationship to the audit fee at Enron, was not even close to the high end. I would -- there have been several surveys of the ratios that the SEC's recent disclosure have divulged to us of these ratios and other major public companies which I would be happy to provide to the committee. I would just note one sticks in my mind which was Motorola which had a board overlap with Enron until very recently and Motorola was 16 to one the ration of audit -- of consulting fees to audit fees.

REP. KANJORSKI: The consulting fees were 16 times more than the audit?

MR. SILVERS: Precisely

REP. KANJORSKI: So maybe Andersen undercharged, is that --

(Laughter.)

MR. SILVERS: -- perhaps you could raise that with them?

REP. KANJORSKI: -- well no. The reason for that question of course is I -- obviously the Congress is going to act. Whenever anything happens in our society we either pass a law or form a commission and obviously we're not going to be able to form a commission so we're going to pass a law. But I'm more worried about the unintended consequences of what we maybe passing.

I'm not absolutely certain that the Congress has the clarity of either the Enron problem and if it represents and endemic problem, just how endemic that problem is. And whether or not we're in a position to move this legislation through as quickly as we seem to be doing or shall we take more deliberative time.

Do any of you see some great risks to our economic system if we take a couple of more months in resolving this problem or do we have to just do this before Memorial Day because it fits into the political schedule?

MR. SILVERS: I'm the only person willing to take a risk on this proposition --(laughter).

Obviously I think the people that I represent here would like Congress very much to take action in this session. I defer to the wisdom of the committee as to what precise calendar that requires. It seems to me that the more important question is, are you going to take the right action or not. And I think that, Mr. Kanjorski, your questions get at one issue in which I'm not sure that this committee's heading in the right direction. It would be better to take the time to get it right than to do something that won't protect America's working families against a future Enron.

REP. KANJORSKI: I tend to agree, Chairman.

That question is structured on the idea that we have 17,000 plus public corporations. It would seem to me they don't all fall into Enron and anything we do will cost additional expenses to those corporations and to the government to police the activity we're doing and I'm just worried, are we going to do what sometimes we've done in other actions in Congress, just ignore the cost and the burden to struggling companies that have to get equity, have to get out there, haven't done anything but will have to comply with all these rules and regulations at great expense to the company and ultimately to the shareholders and maybe actually put their success in jeopardy. Has anybody looked at that?

What I'm thinking about is whether or not we should put a tier operation in and look at the top 1,000 corporations, 5,000 corporations. But all 17,000 -- I mean we did that with banks when we did CRA and to a large extent, it was my experience that we put unusual burdens on small community banks to get through the legal work and expense to comply with CRA. And that we end up because sometimes I'm visited banks that were spending a sixth of their income on legal and accounting fees to prove compliance with CRA -- little banks that couldn't exist outside their community so anything they were doing, they were complying with CRA.

REP. CANTOR: Would the gentleman -- would Mr. Walker answer the question and then the gentleman's time has expired.

REP. KANJORSKI: Thank you.

MR. WALKER: Thank you. I think in the final analysis, it's better to get it right rather than do it fast but I think there is a need for some expeditious attention to the critical areas, especially in the auditing area. Obviously as you know, Mr. Kanjorski, that this is the beginning of the legislative process on this side of the Hill and the Senate has to act as well as there's a lot of things that have to happen before this will get finalized.

We do recommend though in our approach that it's important to have qualified independent and adequately resourced bodies deal with a lot of the details. The Congress may want to ask for those bodies to look at certain issues and to make sure, for example that in the area of independence that they consider are principles and safeguard based approaches, they can look at certain services in particular as to whether or not they should be allowed and under what circumstances.

But I think if you take that approach where you're making sure you've got a qualified independent adequately resourced body, you're providing that body with the power to do what needs to be done, you're providing it some guidance but not getting too detailed with regard to how much you're prescribing legislatively. That might be a reasonable balance because after all markets evolve over time so what you say today that may not be appropriate, there could be something else tomorrow and so some other body has to be able to be empowered to deal with that.

REP. KANJORSKI: Thank you, Mr. Walker.

MR. WALKER: Thank you, Mr. Chairman.

REP. CANTOR: The chair recognizes Mr. Rogers from Michigan.

REP. MIKE ROGERS (R-MI): Thank you very much, Mr. Chairman.

I'm going to take maybe just a bit of a different direction. One of the concerns I have is in this whole episode that we be in Congress have been certainly in a hurry to find a villain and I'm not sure we've exactly identified the crime yet. And I was hoping to ask the chairman, Mr. Breeden, I mean one of the things I'm concerned about is that we're trying to treat this with a pill rather than laser surgery. And I'm not so sure that laser surgery isn't the order of the day here.

We have a real possibility here to cause some real problems for lots of folks -- UAW members and you name it out there, families who are investing more and more in 401(k) plans all across the United States and just sometimes just questioning the company's accounting practices by official entity can be devastating to the stock of that particular company.

We haven't done any investor in the United States any good if we do that maliciously or at least without good intent. I want you to please help me to please understand how we can make the corrective actions I think we all know we have to make here certainly for transparency without jeopardizing investor confidence in those families out there who are working very hard every day. They send their money into their mutual funds knowing that that is what they're retire on and they're really counting on all of us -- those here in Congress as well as you, auditors, regulators and those in the business community to make sure that there is honesty and true brokering going out there in those companies.

MR. BREEDEN: Congressman, I think both you and Congressman Kanjorski raised similar in a way concerns and good points. And one of the best things we've been able to accomplish over the last couple of decades is to foster a broader participation in our capital market and as my colleague here from the AFL-CIO points out, we have working men and women through pension plans, we have investors through mutual funds and directly to the tens of millions and that's been a wonderful accomplishment. And so we have as a nation a great deal at stake in protecting the confidence those people have that our markets work with honesty and integrity and that they can believe the numbers they look at and that they make investment decisions on and that this is a huge system with 17,000 public companies and in fixing a couple of things are apparent.

Number one, we have to be careful that we don't go too far, we don't fall under the law of unintended consequences and we try to fix one problem and we create another one, that we don't go too broadly and create excessive costs as the Congressman was mentioning in CRA which is a very real risk. We need to start with what we have which is the world's finest system. It is not perfect. It has some flaws. No system designed by human beings and run by human beings is ever going to be perfect but I genuinely believe notwithstanding Enron, that the U.S. accounting disclosure system is the best in the world and so let's not throw the baby out with the bath water. Let's start with what we have and then look to see how can we build on that. And if there are gaps here and there that we need to address then let's do it.

And I think that -- now on the question of investor confidence, I don't there's -- I'm not aware of situations where anyone has maliciously questioned people's financials but certainly the market itself should raise questions about companies that have very aggressive accounting practices. We certainly have seen that post Enron with aggressive selling against Tyco and other stocks that are perceived to have some accounting issues. And I think those market disciplines are very healthy, in fact I wish we had more of them. Not that people should do it based on rumor or fear. But that a healthy skepticism at looking hard at what numbers companies are reporting and making sure that investors do their homework to worry about the risks that they may be undertaking.

So this whole area is one in which it's extremely complex. We have to be extremely careful that we don't get things out of balance. But at the same time, I think it is clear that we can do things to speed up disclosure and make disclosure more comprehensive. For 40 percent of the assets of the Enron to be hidden off the books was unacceptable. That is disclosure and it's a joke. It shouldn't have happened.

The parties responsible should have known that there was way -- whether or not it was proper accounting it was lousy disclosure. And so we need to look starting at the commission but also here at Congress, are there things we can do to make disclosure faster and make it more comprehensive? Can we have better information about executive stock sales?

That's very important to individual investors across the country. They know enough to know they may not understand an SPE but they know if the CEO is bailing out of the stock that they don't want to be investing themselves at the very same moment the top guys are getting out. So speeding up those disclosures which are today fairly slow is another healthy thing. Making sure that auditors don't sell their integrity and we can't station an SEC enforcement agent at the shoulder of every accounting professional, but at the top trying to make sure that the system encourages quality auditing and that the firms themselves realize how important their public trust is and the strong efforts they themselves need to make to do the job.

There are a lot of things where I think we can make some improvements that are consistent with our traditions and consistent with our system and make it a little better.

REP. CANTOR: The chair thanks the gentleman.

The chair recognizes Ms. Maloney.

REP. CAROLYN B. MALONEY (D-NY): I thank the chairman and the ranking member and all the panelists and I am sure that you're aware that today Andersen announced that they are laying off 7,000 of their employees and that this represents a quarter of their total employees.

And furthermore, the long term viability of the company is truly in question. And as I've said many times before, the overwhelming majority of the professionals in the industry are hard working and honest and have a great respect for the title Certified Public Accountant.

I am concerned, quite frankly, about some of these employees, many of whom are my constituents. And I'd like to ask Mr. Breeden, from what you known, do you think it's appropriate for the Justice Department to have targeted the whole of Andersen or should we allow the Volcker plan to go forward and have it put in place and go after a limited number of employees known to have been involved in the Enron audit? Do you have feelings on this.

MR. BREEDEN: Congresswoman, thank you.

The Andersen situation is a very sad one. It's certainly one that is regrettable on many different plains and I certainly hope that anything possible, that Paul Volcker or anyone else can do to stabilize the firm and allow it to survive and then worry in the future about rebuilding, I wish it every possible success. On the other hand, we used to have debates when I was in the White House and working on financial services, about whether banks were too big to fail and I don't believe Arthur Andersen is too big to fail and I don't believe any of the other big four -- remaining four, are too big to fail and if they ever got that notion in their head that they somehow have carried their monopoly on auditing and the oligarchy that exists in competition in this world, that no one could bring an action against them if they broke the law, that that would be a mistake.

We went through Watergate to prove that the President of the United States is not above the law and I think that the general counsel and CEO of Arthur Andersen are also not above the law. And I don't take a position on whether or not the Justice Department has the -- we can only know when a trial takes place and we see what evidence the Justice Department has, but in my experience working with the Department of Justice in law enforcement over many years, they don't indict people or firms capriciously. They do it on the basis of a very sober and careful calculation of whether they have the evidence of wrong doing and it's a responsible act.

I think some of the people worrying about the consequences for Andersen should be asking the question about isn't it sad that Andersen's management engaged in the acts that led to the permanent injunction in Waste Management. That Andersen's management tolerated massive destruction of documents on the eve of government investigation. A chimpanzee could know that the documents at Enron were going to be subpoenaed high and low by every government agency and private litigants all over the place. And that if you destroy documents, you may be affecting the rights of the University of California to recover against Enron executives or others and that in that context, destroying documents is wrong.

It's a tough issue because nobody likes to see what's happening to other people at Andersen and yet Andersen finds itself where it is, largely through its own actions.

REP. MALONEY: You mentioned earlier, Mr. Breeden, that we should have faster and fuller disclosure. And one area that really isn't disclosed now, except by consent or individual choice, is the code of ethics for the board of directors or the code of ethics for firms. Do you think it would be helpful if the code of ethics was printed in the annual report and if the board of directors took the unusual step of over writing the code of ethics of their board, that it be reported to the SEC and printed in the annual report? As you know, in Enron, as reported in press accounts, the board of directors voted to overturn their own code of ethics to allow their CFO, Mr. Fastow, to head the special SPEs.

So I was wondering when you call for full disclosure, would this be an area that you think might be helpful to the investor, to the general public?

MR. BREEDEN: Yes, Congressman. I think very much so. In fact, in both testimony on the Senate side and in this testimony, I did say I believe that any time a board acts to suspend the corporate code of ethics that not only publication in the annual report is way too slow. They should have to file an 8k, do it within 10 days anyway. But almost immediate disclosure should be made. I think that corporate codes of ethics should be at least posted on their Web site. It might add quite a few pages to the annual report, but somewhere it should be noted. And I did call for disclosure in the proxy statement or in some other vehicle for the board to set forth its policies on conflicts among senior executives.

The conflicts in Enron, at the CFO level, were among the most dangerous possible things that a corporation could do, because the outside auditors and the audit committee and full board all are looking at numbers provided by CFO and so if the CFO has got a personal financial reason to give distorted number, it can defeat simultaneously the ability of the board, the audit committee, and the outside auditors to check up on that. It's the one vital spot where it's the hub in the spokes of the wheel, so any conflicts involving a CFO should be, in my judgment, prohibited under state law and there should be required to be immediate disclosure if a company goes down that road. Which hopefully they will not.

REP. CANTOR: The gentlelady's time has expired.

The chair now recognizes Chairman Baker.

REP. BAKER: Thank you, Mr. Chairman.

REP. CANTOR: For inquiry purposes, he was assuming the time in the chair, he was here before I was, so this is on his own time, Mr. Chairman.

REP. BAKER: Thank you very much for clarifying. Don't want to misrepresent my account here.

In the earlier round, Mr. Breeden, we talked about disgorgement and insider trading prohibitions, bailing out on stock the night before the bankruptcy filing. We talked about clarity in the liability for the CEO for the preparation of the financials. There are other elements that I think I'd like to get your comment on. One is the subject of a cooling off period where the auditor is the principal engaged as an outside auditor for company X, on retirement immediately goes to work for that company as the chief financial officer. There are prohibitions which apply to members of Congress for example, and what we can do post congressional life. Do you look at that in a devisable way? Is that something we should consider?

MR. BREEDEN: Yes, sir. I believe that you should. I remember back in my days at the commission we had the then infamous Lincoln Savings collapse. An awful lot of people were hurt in that and that was another case where the CFO that was in place at Lincoln Savings had come over from the outside auditor, which means the people who audit his work the very next year are all the people who used to be his subordinates at the audit firm and so without knowing exactly how it should be done, I think cooling off periods are healthy and is something that would probably make sense.

REP. BAKER: Well, as to structure on all of these, and I've got a couple more I want to touch, it's my thought to authorize mandate that the SEC to study and implement rules governing these points raised by the Congress as a policy matter. I think it may be very difficult and take us years to confect a plan that is enforceable and not disruptive to markets if we do the specifics. But at least to have a goal within six months, a year, for the SEC and staff to determine the most appropriate manner for prohibiting whatever is a reasonable corporate practice -- unreasonable corporate practice. All the committee in their ability to do their work, provision for independent counsel. In other words, not having to rely on internal corporate officials to do the work for the audit committee.

It's difficult if you have a CFO who's conflicted, but if you're really trying to do the job on the audit committee and you're asking the guys who are employed by the corporation, isn't that equally troubling?

MR. BREEDEN: Well, I serve on three other committees and I chair two of them and I can't imagine anybody telling us, and I don't think it's just me, I can't imagine anyone saying to an audit committee that they can't hire outside counsel. The board can do what it wants. The problem is that -- and it's a little bit of a chicken and an egg situation -- I mean one of the problems in both Waste Management and Enron was that the auditors never said "boo" to the audit committee. They knew there were problems and didn't bring the audit committee into the loop, so they were in many respects, oblivious or appeared to be ignorant of many of the issues that might have caused them to go out and hire outside counsel, but they have to know that they need it.

REP. BAKER: That was my point. Is that rather than making it a permissible activity to do it, is that a mandatory obligation to construct your audit analysis based on outside counsel?

MR. BREEDEN: Well, I wouldn't require going to -- I mean I just think we have enough make work acts for lawyers, but I wouldn't require it, but I think certainly as a matter of good corporate practice and maybe through listing standards, it's something that can be encouraged. Certainly, any audit committee has to have the right to speak to independent counsel and independent financial advisers, if they believe they need the advice.

REP. BAKER: And lastly, with regard to stock option plans. Shouldn't that require shareholder approval?

MR. BREEDEN: I believe so.

REP. BAKER: And there's one other piece of work that I complement you on. In 1992 there was a report issued by the SEC and it also supports the statement of Chairman Pitt before the committee just before the Easter recess, relative to reporting to the SEC by the GSEs. As I recall it, your work at that time indicated it was advisable policy for the GSEs to file as all other Fortune 500 companies do, in compliance with SEC standards. Is that still your view?

MR. BREEDEN: Congressman, I don't remember that specific report. I seem to remember getting the tar beat out of me by folks at the time over that issue. I haven't looked at it since then so, with respect, I'd just stay out of that little hornet's nest.

REP. BAKER: If you believe this hadn't gone away, I can assure you that the report contains that information because I have the briefs myself.

MR. BREEDEN: Well, one of the great things about being in the private sector as opposed to being in government service is you can duck a few of the fastballs that you have to go ahead and stand at the plate when you're in government.

REP. BAKER: Well, I commend you for your bravery while on duty. Thank you.

MR. BREEDEN: Thank you.

REP. CANTOR: Thank you. The chair now recognizes the gentleman from North Carolina, Mr. Watt.

REP. WATT: Thank you, Mr. Chairman.

I want to start by applauding the testimony of Professor Langevoort. I may not be pronouncing his name right. His testimony has kind of gone unnoticed in the question and answer period, but he should know that as far as I'm concerned, it is among the most important testimony that has been given here today. I think I went there in my opening statement when I emphasized the importance of allowing individuals to hold people accountable and corporations accountable in addition to government bodies. And your testimony seems to me to be consistent with that.

First of all, we've got to reestablish the right -- the legal standard that makes other parties have legal liability to anybody, and then we've got to give individual people who are damaged by those activities the right to take up their own private litigation and enforce those rights. And in some cases that may result in less government bureaucracy. I keep having trouble convincing my Republican counterparts of that, but they may come around. The problem is that the -- and I'm certainly going to try to pursue this in the course of this mock up. The problem I've already identified, however, is that the rules of germaneness in the legislative context are about as -- are probably more rigorous than the rules of relevance in the evidentiary context.

And if we start with the chairman's bill, I'm not sure we can craft an amendment that gets that on the table for discussion and debate. So I'm not going to spend a lot of time asking you questions about it. But I did want you to know that what you said did not go unnoticed by at least one member of this committee.

MR. LANGEVOORT: Thank you, and I was actually happy not to get all the fastballs.

REP. WATT: Right. Now I want to go to another issue that I'm trying to resolve or reconcile the differences between Mr. Walker and Mr. Breeden, and try to figure out with one of them I agree with more. As I understand it, Mr. Breeden -- no, I'm sorry. As I understand it, Mr. Walker thinks that we ought to have another federal board of some kind in addition to FASB and the SEC; we ought to have some third agency. And as I understand Mr. Breeden's testimony, he rigorously disagrees with that. I would like for the two of you to try to reconcile, if they are reconcilable, your views on that issue. I tend, I think, to come down more on Mr. Breeden's side than Mr. Walker's side, I believe.

It is coincidental that right across the hall here we are -- I'm on Judiciary also, as you may have gathered by my legal bent here -- we are debating whether to break up the INS into about five or six different parts on the theory that if you break it up and then you -- it'll all of a sudden become more efficient, even if you keep the same people and the same rules and regulations and everything. It seems to me that one approach we might be using is trying to make the SEC and FASB more efficient, rather than creating another institution in the process. So let me hear from Mr. Walker first and then I'll -- I won't ask another question; I'll give Mr. Breeden equal time to defend his position.

MR. WALKER: Mr. Watt, right now you have one federal government entity involved and that's the Securities and Exchange Commission. As you know, the FASB is not a federal government entity; it is a self- regulatory organization.

REP. WATT: Well, wouldn't this bill put those kind of agencies kind of under the jurisdiction and supervision of the SEC?

MR. WALKER: What we were proposing at GAO is that the SEC has more than enough to say grace over right now. Some can debate --

REP. WATT: Well, one way to solve that is to have some more people.

MR. WALKER: Well, that's one issue.

But I guess what I'm saying, Mr. Watt, is that what we're saying is number one, the area of most acute need for intervention is in the auditing area. The SEC is already overtaxed as it relates to enforcing the securities laws and dealing with significant accounting and reporting issues that have to be dealt with. There are many people on this committee and others in Congress who believe that the CFTC ought to be merged with the SEC.

So the point is that there's a lot of things that the SEC has to do right now. Our view is what's important is that you could have an independent entity within the SEC. You could have a body within the SEC that would have presidential appointees with Senate confirmation, who have the authority to make final decisions with regard to certain auditing activities but would allow them to be able to coordinate as appropriate with the SEC on accounting issues and on the securities regulation. We think that's possible to be able to do that.

But one of the concerns that we have is the auditing area is the one that we think there is the most need, and there needs to be appropriate accountability to Congress and we don't know that you get adequate accountability to Congress unless you have the parties responsible and reportable to Congress. Furthermore, we question whether or not the SEC can effectively discharge these additional responsibilities because it's having difficulty already with what it has.

REP. CANTOR: The gentleman's time has expired. Thank you.

MR. BREEDEN: Mr. Chairman, if I could have the liberty of responding to this, because I think it really is a pivotal issue and --

REP. CANTOR: Without objection.

MR. BREEDEN: Thank you very much. I, of course, have boundless regard for GAO and its analytic capabilities. This is a matter that is a matter of principle and philosophy, I suppose, but I could not feel more strongly about it. And, Mr. Watt, I appreciate your asking the question and giving me a chance to give you my side of things.

For about 68 years now the SEC has been the federal agency with responsibility for overseeing the accounting profession. It has a long history. It has a long culture and a long tradition of being able to put the public interest first, to have an effective enforcement program. I don't think there's any wrongdoer out there, be it corporate, individual or a partnership, that the SEC in its history wouldn't tackle. It has built up a long history there without fear or favor of any person, irrespective of party, irrespective of any other factor.

And to say that, well, that's very nice but they're awfully busy doing some other things. We should put it aside and start all over again and build a brand new agency that has no history, no culture, no existing staff, nothing. We're going to start from the beginning and build it all up and 10 or 15 years from now it will have experience and culture and tradition and we're going to hope that at that time it's going to do a better job than the agency that for 68 years has done a great job for America's investors.

Now, the commission is starved for resources and has been under- funded since 1934, and I would -- I appreciated at the time I was chairman the efforts of many members of Congress to expand its staff so that we could keep pace with growth in the markets, and that's an ongoing problem today. But I really think that there is not a need for another federal agency. Now, I agree with a great deal of what Mr. Walker has said in terms of the importance of integrity and independence and good powers, and all of those things can be in a body like the NAFD that would be a subsidiary private sector organization out doing a lot of work, doing a lot of enforcement, bring all those fine qualities to bear, but reporting up through the existing government agencies so we don't lose the benefit of nearly 70 years of public service.

REP. CANTOR: Thank you.

Thank you. The chair now recognizes Mr. Bentsen.

REP. KEN BENTSEN (D-TX): Thank you, Mr. Chairman.

Let me thank my colleague from North Carolina, because I wanted to be the devil's advocate on that, but he's much more eloquent than I am and I agree with his line of reasoning and I think it is problematic. I think, Mr. Breeden, you were right on point that what we're talking about doing now is starting over from scratch to create a new agency, and I -- and John is correct, redundancy is not necessarily a sin. But what I keep coming back to is, doesn't the commission already have a tremendous amount of authority in this area, and perhaps the commission should be under some attack for not necessarily exercising that authority, and perhaps the commission can argue that they've been underfunded and haven't had the resources.

But it seems to me -- I mean, I've always been under the impression that the commission had this authority. You yourself stated that, in fact, audited financials are, in fact -- the financials themselves are prepared by the public company as a function under the 34 Act, and then audited and given a blessing by the auditor. But in fact, they are all compelled by securities law in the first place, and it's the commission that governs securities law. And so I think that your point is right on -- your reasoning is right on point.

I furthermore think that now we're talking about, in the GAO, and I don't think John's bill goes this way or Mike's bill goes this way necessarily, the idea of registration of auditing firms with this new authority, and the next question is, which I've asked the federal panels is, are we going to have to have qualified opinions with an audit that's given -- for each audit that's given, that it meets certain standards? And do we know exactly where we're going in setting the standards?

And let me ask -- I want to move on to some other points. Everyone talks about the need of a division of labor between audit and non-audit services, and I don't disagree with that, but we have a number of lists that our out there what ought to be precluded or prohibited and what ought not to be prohibited. Are we better off trying to write in the statute what services can be provided and what services can't be provided, or are we better off providing the commission, if that's the route we go, or whoever the ultimate authority is, and again, I would argue that it's the commission, with the same with authority that we've done in banking law, for instance, that says something that is -- you know, that creates the appearance of a conflict, and leave it up to the rule-making bodies to determine what's appropriate and not appropriate?

Would we be better off than providing the list? Either one or all?

MR. BREEDEN: Congressman, I think he question of what is a permissible service is a very important one, certainly at a minimum, if it were left to an agency there'd have some guidelines and standards of what should the policy be here, and I think Congress has an important role to play in trying to answer that. You know, in my mind, if Arthur Andersen had not done one penny worth of consulting work for Enron, the exact same problem would have happened. We are, in part, discussing a red herring here, because the audit fee that Andersen was collecting from Enron was more than big enough to corrupt the behavior and create all the pressure, whether or not they were also, on top of that, getting consulting fees.

And so let's don't kid ourselves that if we force people to get out of all consulting these pressures on independence are not going to go away. In some ways they get worse because if you've said that the entire firm is dependent on nothing but the audit fee, then the CFO who can threaten to take away the audit fee has even more leverage over the auditor than not. So on the other hand we want the public to understand that audit opinions can't be bought, and the sheer -- and the audit relationship ought to be the primary focus, and as one of the other witnesses point out, I mean we have now seen some cases where companies are -- have many multiples for consulting fees as the audit fee.

So what should the policy be? And if Congress sets out standards, whether it's conflict or specific types of risk, yes, then you give the job of drawing loans to an agency.

REP. BENTSEN: Let me -- my time is running out and I want to follow up with two other points. One is, Mr. Breeden --

REP. CANTOR: Is Mr. Walker --

REP. BENTSEN: Well, it --

REP. CANTOR: The gentleman's time is expiring.

REP. BENTSEN: Well, no, I don't think it's expired because it's on the --

REP. CANTOR: I said is expiring. Yes, you are correct.

REP. BENTSEN: Okay. I'd like to hear from Mr. Walker, but I do want to ask one other thing of Mr. Breeden.

An issue was raised with respect to Enron that goes back to some of the law and rule changes in the '80s with respect to insider trading as we know it, not sales by insiders. And while discussions could -- sort of the Chinese Wall that was established between underwriting and sales and trading. And some have raised the question that the unintended consequence of that was that deals that were being structured -- primarily private placement deals that were being structured for Enron that had the effect of deluding stock value and taking debt of balance sheet while putting -- while increasing the leverage of the company, have -- had the brokerage side known that, they may well not have had made a market in their public securities. Is that an unintended consequence, and is there a way to address that in going back to that '80s law or is that just something we have to live with?

MR. BREEDEN: The whole idea of Chinese Walls is to deliberately deprive certain parts of an organization of information that is possessed by other parts. And so assuming that that information is valuable, that's almost always the case, for example, that the investment banking side of a firm might know than a tender offer is going to happen or that there might be an LBO going to happen, something's going to happen to change the capital structure that would cause your brokers to either recommend the stock or not recommend it, and you consciously and deliberately say we cannot allow that information to be used because only the customers of that firm would have that information, it's not out in the broad marketplace.

So I think Chinese Walls aren't perfect, and they do have the effect that you mentioned, in particular, cases, but they also prevent, essentially, institutionalized insider trading that would happen if knowledge from the banking side can filter over into one group of brokers but not everybody else in the rest of the marketplace.

REP. BENTSEN: But under --

REP. CANTOR: The gentleman's time has expired.

REP. BENTSEN: -- and under things such as Reg. F.D. (ph) and others, when deals are being structured that are increasingly leveraging the company to the detriment of the public shareholders, should the underwriting side be duty bound to disclose that? And I understand the original intent, why you put the Chinese Wall, it would make perfect sense, but now you have the reverse effect occurring. Or is that just an unintended consequence we have to live with?

REP. CANTOR: Mr. Breeden, if you can extradite your answer, the gentleman's time has expired.

MR. BREEDEN: Always a problem. I guess I would just say I think that's worth taking a look at in the context of what we've seen in this case, and see if there aren't ways we can mitigate those negative effects.

REP. BENTSEN: Thank you.

Thank you, Mr. Chairman.

REP. CANTOR: The chair now recognizes Mr. Sherman.

REP. SHERMAN: Mr. Chairman, thank you.

Let me make sure I anger virtually everyone in the room with at least a couple of quick points. First, as we praise the SEC, let us remember that that is the government agency responsible for our capital markets, and we've just had the largest capital markets failure in history. And while we focus on an accounting industry that is about to go down from the big five down to the big four, we should remember that we could have an SEC rule that no one firm can audit more than 15 percent of the publicly reporting issuers, and force the breakup of the big four and do something that has kind of a catchy title, the big eight. To us old guys that has a catchy title. And I don't have time for all responses but I hope our panel would respond on whether only four accounting firms auditing publicly traded companies is a good idea for our capital markets.

It has been pointed out that management prepares these financial statements and the auditor just expresses an opinion on them. We should point out that what auditors do is demand changes to those financial statements, which management can implement or not implement. The reason I make this point is that there's been a lot of talk of criminalizing speech, that is to say prohibiting the, quote, "undue influence of management on the auditors" and what worries me is that that is just pejorative vagueness for talking. And that if we are going to criminalize some discussions between auditors and management we ought to figure out how financial statements are going to be created or who's going to decide which talking is necessary and which is criminal.

Shifting to a question to the -- Mr. Lange -- to Donald and to Damon, you folks have pointed out the importance of private litigation which is the only economic incentive auditors have to do a good job and to stand up to that other economic incentive they have to do whatever Ken Lay wants them to do, but one concern I have is, back in those old days these accounting firms were general partnerships. Everybody was liable for whatever the accounting firm was liable for all -- multi-thousands of partners and an awful lot of assets. Now they're all limited liability companies.

Does it make any sense to allow law suits against accounting firms unless we have a requirement that they have malpractice insurance or malpractice reserves or some other capital, and should that capital requirement be set at one-half a year's audit fees or at some other level?

MR. LANGEVOORT: Certainly you need to address the question of whether there is money. I think we have yet to learn what the protective shield of limited liability partnership or limited liability company is. But you're absolutely right. If the deterrent effect is going to be there, there has to be some way of reaching the wealth generated by performing the services and capturing that.

REP. SHERMAN: I'm not so much thinking of this as a hammer that's going to take away the house of every partner of Arthur Andersen, so much as a compensation fund. If we're going to tell people they can sue because they've been harmed, they ought to be able to recover something and I would point out that the amount being offered by Arthur Andersen now, is just six years fees to one client.

MR. LANGEVOORT: I don't disagree with that but I would keep the club and the hammer there too.

REP. SHERMAN: Shifting to the scope of service. There's discussion of making a laundry list perhaps 10 items that auditors are not allowed to do but the main impetus for this is to say, well maybe $25 million in fees is a necessary evil if you're going to have privately paid for audits but to owe $52 million is way too much. Do we need just a laundry list of services not to be provided or do we need a rule that says your total non audit fee, cannot exceed say, 50 percent, 100 percent of your total audit fee. The ratio was commented on by I believe, Mr. Silvers. Should there be a requirement that that ratio not exceed 50 percent or 100 percent?

MR. SILVERS: I think that the issue here really is, as you mentioned with the laundry list that it's possible to evade the intention which is to end the conflict by the changing practices within the market place. Our view is, is that what you need here is a -- and I believe one of the witnesses -- one of my co-panelists spoke to this earlier, you need a statutory mandate to the commission. To -- that in general bars consulting services, allows for consulting services that are intrinsic to the audit function, all right. And gives the commission the discretion to sort out as the market place and practices change, which are which.

REP. SHERMAN: But if say tax services are an integral part of the traditional accounting function or auditing function, is it acceptable to have a million dollar audit fee and a three million dollar tax fee?

MR. SILVERS: Well, I think there's two answers to that. One as I said earlier there are tax services and there are tax services.

Right, there's preparing the audit then there's structuring a partnership designed to keep everything off the books. What -- they're very different and that's why you need the commission the have this discretion. But to answer your question directly, the question of the ratio.

It seems to me that if we've got the general rule right and the SEC is complying with the intent of Congress here, that you would never see a situation in which audit firms exceeded by multiples, right, consulting fee. Audit fees conceded by multiples, consulting fees, thus the kind of measure you're suggesting might be, I think what Mr. LaFalce referred to, as a helpful redundancy. I think though that what really is critically here is that the commission be given both the discretion and the clear direction --

REP. SHERMAN: I would point out that the commission has had the discretion for the last 50 plus years.

I believe my time has expired.

REP. CANTOR: I thank the gentleman. The chair now recognizes Mr. LaFalce.

REP. LAFALCE: I thank the chair very much.

Mr. Silvers, we have not really spent too much time considering the issue of mandatory rotation of auditors. And I might say that all my accounting provisions or auditing provisions were discussed at great length with the former chief accountant of the SEC, Mr. Lynn Turner. As you know in my bill I would say that you could have an audit for a four year period and it cold be renewed. It could be renewed basically if you've got the good housekeeping seal of approval of the SEC for an additional four year period. But then that would be it.

I think that might well ensure four -- eight years of good audits and then another auditor could come in and say what a great job the previous auditor did or point out where there's need for improvement. Now what are your thoughts on that concept? It seems to me that that concept is even more important or at least equally as important as the separation of the auditing and non auditing functions.

MR. SILVERS: Yes, I would very much agree with your characterization of that language. I think that -- and the AFL-CIO has proposed a rule making petition to the SEC that the SEC put such a requirement in place by rule making. I think that the critical issue here again goes to the -- what Chairman Breeden was talking about which is, the sort of confluence of forces that are at work to compromise the audit, all right. One of the most important is the sense of cash flows in perpetuity that come from keeping a client happy. And the way in which there is a kind of melding of the audit firm and the staff of the people they are auditing. I think that Chairman Baker made some reference to his concern about that earlier in this hearing. Both the firm rotation and the prohibition on individuals flipping over that Chairman Baker alluded to would get at that.

REP. LAFALCE: The prohibition, and flipping over, cooling off period is a provision of my bill.

MR. SILVERS: I'd left that to you to say.

REP. LAFALCE: Okay, good and you favor that. Let me just ask the other gentlemen on the issue of the cooling off period. I have a two year time period wherein the chief auditors of a particular company could not then be employed by that company. Would you favor that, Mr. Walker, Mr. Breeden?

MR. WALKER: I think the issue of cooling off needs to be looked at. Some changes are necessary. I think you have to recognize that there are ways to potentially get around that. While you may not be able -- while it's not appropriate for them to serve in a CFO position some of the things that Chairman Breeden has talked about, you also can hire people as consultants and they're not employees and the question is, what are they doing? So I think you have to recognize and look at it on substance over form and make sure that you accomplish in the objective.

MR. BREEDEN: Congressman, as I said earlier I think that cooling off is an important principle without looking at the specifics of how to do it. For example, I would let a company hire someone from their audit team to come in and have another position in the company for two years without being a CFO. I think the real risk comes when the CFO is dealing with his own former -- his or her own former staff over at the audit team and I --

REP. LAFALCE: Let's not kid ourselves, some accounting firms have a policy of encouraging early retirement, creating the incentives for early retirement so that you do become the CFO of the company that you've been auditing, and you cement the relationship, the tie between the firm -- auditing firm. And we've got to deal with that problem some way. Now we can always point out while this 'I' is not dotted right or that 't' is not dotted right, but there is a fundamental problem and let's cure the problem that if we do it imperfectly, well then we could correct it. But let's deal with the very imperfect problem that exists. Let me go on now because I have so many other questions that I want to ask.

Mr. Langevoort, you've been neglected. I don't want to neglect you any more because Mr. Watt was talking about what he considers to be so important but that's one of the most important provisions of our bill. We specifically would give legislative sanction to aiding and abetting liability for accountants and other professionals and we specifically alter the statute of limitations.

Now, there's been some confusion. Everybody says, "You ought not to change the 1995 Securities Reform Act or the 1998 Securities Reform Act." Do either of those provisions change the 1995 or 1998 Securities Reform Act?

MR. LANGEVOORT: No, and thank you for the softball question.

(Laughter.)

REP. LAFALCE: You see, everybody here is under the impression that we -- undoing what was done in '95 and '98.

MR. LANGEVOORT: We -- these two changes would carry out things that predate the '95 legislation that the SEC has endorsed previously. They are compelling as a matter of public policy.

REP. LAFALCE: And yet witness after witness from industry comes in and says, "Oh, you can't do this because you'd be undoing the '95 and '98 legislation." They really don't know that it has nothing to do with the '95 and '98 legislation.

REP. CANTOR: The gentleman's time has expired and the chair is going to yield himself time for an additional round of questions.

Mr. Breeden, I'd like to ask you on the question of rotating audit, do you feel that there will be an increased quality of audit if a company is required under all circumstances to replace its auditors if Mr. LaFalce says every four or every eight years. Do you really feel there will be an increase in quality of audits given the subsequent increase in expense the company will incur?

MR. BREEDEN: Mr. Chairman, as I -- in my testimony I said that I don't personally favor a mandatory rotation because I think rotation in some cases would be at a benefit and in other cases would be a disadvantage. In a very complex company it takes a number of years to get up to speed and really understand where the risks in that company are and if you rotate -- and in particular if you rotate every four or five years I think you would have periods of time blackout periods almost where the auditors are getting up to speed. That could be overcome. People could spend more money to (tow ?) more people at getting up to speed faster. But in general I think that is something as a requirement that goes farther than we need.

What I would like to see us do is to move more to a system where auditors are for a three or four year period, not for a one year period. And that at the end of that time the audit committee has to go out for proposal and at least hear what the other firms propose and how they would structure the audit and how many hours they think should be involved.

And then let's leave it to the audit committee to make a decision on whether that firm should be retained or whether you should vote it.

REP. CANTOR: I'd respond and ask you what value would it be for there to be an imposition in to require going out for bid again under all circumstances because that too does take time? And obviously someone participating in response to a bid will not have the knowledge of the company the way that an existing auditor will have. And is that the best way that we really gain some safeguards there?

MR. BREEDEN: I'm not sure I understand the question. You're saying what value is there in going out for proposal?

REP. CANTOR: Just for going out --

MR. BREEDEN: Well, I wouldn't require that as a matter of legislation but I think as a matter of audit committee good practice that every few years you should put your periscope up above the surface of the ocean and take a look around and see what other options are out there.

I think the audit committee -- I wrote on this subject in the journal a week or so ago. And the audit committee needs to become more active than has been traditional. And we've been moving in that direction for the last 10 or 20 years. We keep -- through the exchanges they keep encouraging better literacy, higher quality membership on audit committees. They are positioned to be a check and balance on the CFO. But we can't expect audit committees to attract people and you want them to have the responsibility and yet put them in a straight jacket and say well the law itself tells you what you have to do and not do. So I would leave some of these questions to the audit committee.

REP. CANTOR: Thank you. The chair now recognizes Mr. LaFalce.

REP. LAFALCE: Thank you, very much. I do think that there are a number of threshold questions that are important. First of all, we ought not lose sight of the fact that it's more than accounting and auditing that we have to be concerned about. We had problems with corporate officers, we had problems with boards of directors, we had problems with the auditing firms, we had problems with the rating agencies, we had problems with the securities and their analysis, we had problems with the law firms and commonly an awful lot of others too.

What I'm fearful of is that I'm not fearful that we're going to over react. Industry is too strong, too powerful, too influential. Let's not kid ourselves. It's going to be tough to get anything at all past that's meaningful, that's more than cosmetic. Our problem is not over reacting. Our problem is under reacting coming in with a cosmetic. And let's not kid ourselves. If we don't understand that we do not understand the governmental process as it really works as opposed to you know, how it's supposed to work.

I want to go into some differences between the bill and I really -- it's not a question of his bill, my bill or anything like that. But I want these issues to be addressed. I'd like there to be dialogue between us. There's been no dialogue. So that we -- before we have a mark up. I make a publicly call for an opportunity to have dialogue, private dialogue on these issues, that we could come to some compromise on them. But I would like at least some public comment now on some things that are knew to the extent that you have knowledge. And you probably don't have too much knowledge other than newspaper knowledge but please can we just talk about it.

The law suit against Enron has been expanded to include a number of the investment banks. About 10 or so. What's the theory of liability there? It's not just lending. I think it's more than lending. There's some type of active participation. Is it more than aiding and abetting? And then also some people think that aiding and abetting in an action brought by the SEC simply requires a show of negligence and I think the standard is substantially higher than that. I'd like some substantiation on that.

And then also the Attorney General of the state of New York has obtained a court order. I'm not exactly sure what the order says or does but it was against Merrill Lynch apparently and again speaking now from what I know about it from the newspaper, for making recommendations that are contrary to opinions that were expressed by an overwhelming of the analysts of the firms in their e-mail conversations not revealing that. Who wants to swing at that one?

MR. LANGEVOORT: Let me start with -- I think with the first question. With respect to the pending law suit against a variety of participants in Enron. I've not read the 500 and whatever page complaints. I can't address the specifics.

Going back to my testimony, the uphill battle plaintiff is in trying to trace a way in which the investment banker's involvement was more than just behind the scenes assistance. It tries to do that by saying the investment banks used their analysts conduits to speak directly to the market. That's more than assistance. There may have been some participation in preparation of documentation that made it into the hands of the investing public. Those are all possibilities but I guess my bottom line concern is that's really an unfair burden to put on the plaintiff. What you're really complaining about is that the bankers were the brains in some respect behind all of this.

Secondly, with respect to aiding and abetting --

REP. LAFALCE: One of the difficulties I have is we haven't examined that before our committee. We haven't examined what the nature of the law is that would cover -- what the nature of the law should be to cover them and that could be -- could be a large part of the problem. I don't say that it is.

MR. SILVERS: Can I -- Congressman, I'm not familiar with the complaint obviously as has been amended. But I am a little familiar with some of the transactions that may be part of the complaint.

There have been -- because there's been litigation both in the Bankruptcy Court and in the Southern District of New York around some of these banking transactions. And essentially what some of that litigation seems to show, and there are judicial opinions backing up what I'm about to say, is that in at least the case of J.P. Morgan Chase that company engaged in what was treated as a market derivatives transaction, but in effect was a loan to Enron because it was a loan paired with two energy derivatives contracts which essentially cancelled each other out.

And in one case they both ran through J.P. Morgan Chase subsidiaries based on the island of Jersey off the United Kingdom, which is an offshore bank haven. And the result of that transaction was that Enron got a billion dollar loan that didn't show up on Enron's balance sheet.

REP. LAFALCE: The whole issue of derivatives and the regulation of derivatives is very important because the industry officials that engage in derivatives have said, "Well, these are counter-parties who are so sophisticated that there need not be any type of regulation," for them at least. And yet there are innocent people who are not parties to those actions that can suffer serious consequences, and that's an issue smack dab before the jurisdiction of our committee, which we haven't bumped into.

REP. CANTOR: If the gentleman will expedite his answer. The gentleman's time has expired. Well, we're going to take another round.

MR. LANGEVOORT: Just to conclude, that transaction -- unless some particular facts have arisen that -- where Chase directly communicated that transaction to Enron investors, that transaction will not be litigable because of this aiding and abetting issue. But nonetheless, as you point out, real people were very badly hurt here. I spent some time with some of them in Houston on Friday and those people have no -- if it's merely aiding and abetting, those people have no cause of action. Ironically enough, Chase Manhattan Bank though is acting on their behalf on the creditors committee of Enron in depriving those same people of their severance money while they see if they can bob and weave out of the liability generated by these transactions. It's really scandalous, frankly.

REP. LAFALCE: Mr. Chairman, I know my time has expired, but Mr. Langevoort didn't respond -- didn't have an opportunity to respond to the question of the standards that have to be met in aiding and abetting liability, whether it's negligence or something considerably greater than negligence.

MR. LANGEVOORT: Congress made absolutely clear when it restored the SEC's aiding and abetting authority that intentional misconduct was the standard, and that is clearly the law with respect to aiding and abetting generally.

REP. LAFALCE: And therefore if we extend aiding and abetting liability to private litigation, we would adopt the same standard and so you'd have to prove intent.

MR. LANGEVOORT: The bill 3818 would mirror the standard for intent in private security --

(Cross talk.)

REP. LAFALCE: It need not, but it does.

MR. LANGEVOORT: That is correct.

REP. LAFALCE: Yes.

MR. LANGEVOORT: Correct.

REP. LAFALCE: Thank you.

REP. CANTOR: The chair yields to himself. Just time for an additional question. Mr. Breeden, in your written testimony you unequivocally state that you would not support any steps to restore joint and several liability, aiding and abetting liability and other measures. Can you speak just very briefly to the adequacy of the remedies available under the '95 Act?

MR. BREEDEN: The '95 Act, and it was discussed earlier. I guess the only thing I would add to the '95 Act was this same issue of whether aiding and abetting should be -- whether Central Bank of Denver should be overturned was before the Congress in the '95 Act. The Congress in that legislation could have done so and it didn't. The absence of action rather than the actuality of action was part of what Congress ended up doing there.

My own view is that we have struck a balance in the private litigation area and there will always be cases that will cause us to say we should give more rights of action, but there are -- also that opens the door in my opinion and I respect the differences from others on this point. But I believe it does open the door to abusive litigation and the costs of that are very, very real; not only to the economy and to businesses, but to shareholders too who pay the ultimate cost of that whole process. So --

REP. LAFALCE: Mr. Chairman, if I could just follow up with a question of Mr. Breeden on that point?

REP. CANTOR: Yes, sir, and if you could -- I mean --

(Cross talk.)

REP. CANTOR: Maybe he could just finish his response and I'll yield back to you because we've got plenty more time.

REP. LAFALCE: Sure, sure.

MR. BREEDEN: I guess my view would be twofold: one, in the context of this legislation of trying to do something positive and meaningful to respond to the Enron situation. I think if we re-fight the battle of litigation reform all over as part of it, I think it will make the chances of doing anything constructive here much lower and therefore I would not like to see that happen, because I think there are some improvements that should be made and there are a lot of good things in your bill that ought to be done.

Secondly, even if it weren't a question of tactics and timing, I don't substantively favor the expansion of the private rights as has been described.

REP. CANTOR: Thank you very much. The chair now recognizes Mr. LaFalce.

REP. LAFALCE: Mr. Breeden, I just don't know how any person, unless they have a philosophic disposition that says individuals should not be able to go into a court of law to obtain redress for a wrong, can say that if an individual or a firm has intentionally aided and abetted in false or misleading statements that they should not be able to be held liable. You know, it is absolutely beyond the capacity of the SEC on its own to go after all those instances when it's done. They've got a paltry record on this in the past. The FTC, which has the ability to go into court -- and you can't go into court if you're an individual -- has come before Congress and said restore the right of an individual who's been aggrieved, because it is wildly beyond our capacity to bring lawsuits where lawsuits are necessary to be brought.

Mr. Breeden, I understand the philosophic mind that just wants to cut back. For example, the mind of this administration. They want a terrorism insurance bill, but only if it's coupled with the cutback of an individual's right to go after individuals who may have participated in that terrorism and caused injury. Well, having said that, let me just say that that's one issue where you and I have profound differences on and I hope that the Congress, at least this committee, will be given the opportunity to consider that issue and not confuse it with undoing the 1995 or the 1998 legislation which simply did not address those issues.

And I will not be offering the joint and several. I will be offering the aiding and abetting and I will be offering the statute of limitations and I'll be offering them separately so that we can have discrete issues before us.

Now, going back to the issue of mandatory rotation. Mr. Silvers, you favor it. I don't know that you have an opinion one way or the other, Mr. Langevoort. Mr. Breeden, you've said you've opposed it. Mr. Walker, you said you certainly think it should be on the table for study. That fair enough?

MR. WALKER: We're saying two things. One, we think more does need to be done on mandatory -- on rotation of key personnel on the engagement, and that the other issue should be study. I have some personal concerns about mandatory rotation --

REP. LAFALCE: Well, you know, I brought this up with Mr. Len Turner, the former chief accountant who favors mandatory rotation, and he said to me -- "Let me tell ya," he says, "I used to be at one of the big five," he says, "and mandatory rotation of the chief partner just doesn't work." He says, "No partner is going to go in and replace another partner and blow the whistle on the other partner and say everything he did was wrong." He says it doesn't work.

He says, "If you're going to get to the heart of it, you're going to have to go to mandatory rotation."

Now, he may be right but he may be wrong. But my recommendation in the bill is not without significant authoritative support. But let's assume we shouldn't do that.

Now, Mr. Breeden, you've said, well, what we ought to do is have audit committees. Consider hiring audit firms for maybe a three or four year period, and then consider other audit firms too who maybe submit proposals. Well, the only thing is if we don't mandate that, how do we get the bad guys rather than the good guys? Won't we have a situation where the good guys are the ones who are going to do that, and the bad guys are the exact ones who won't do it voluntarily? That's the problem with voluntarism. Now, you could have the SEC do it, but look at -- you've sang the praises of the SEC. The problem is the SEC has deferred almost 100 per cent over the years to the SROs. They've had almost no watchdog role over the SROs, whether it's the securities industry and most especially the accounting industry. They have been silent.

MR. BREEDEN: Congressman, on the issue of rotation, while I don't personally favor mandatory rotation, it's an extreme step and I don't think we're necessarily sure that applied to 17,000 companies in this country that it would be a good idea. On the other hand, my idea of having a three or four year engagement could lend itself to having a statute that said that beyond say one initial term and two renewals, that specific standards and findings might have to be made by the audit committee in order to pick the incumbent and keep going.

You could encourage, and the commission itself could encourage through proxy rules, the audit committee -- require the audit committee to say why after a dozen years or so, but some pick some number, why they didn't consider -- did they consider rotation, and if so, why didn't they do it? There are ways you can put a little pressure on to make sure that people do look hard at the question, would it serve the shareholders' interests to rotate?

REP. LAFALCE: Yes. Mr. Walker.

MR. WALKER: First, for the interest of full and fair disclosure, I am a CPA and I have practiced for a number of years. Number two, I've been with two of the big five firms, and so I know how things work. Number three, I think if you look at the issue of rotation of the key personnel, right now the rules aren't adequate. You can have an individual or a person who's serving as engagement manager, then engagement partner, then the second partner. So they can end up being on the engagement for many, many years in a row --

REP. LAFALCE: And will the SEC be having the power to change that since their existence hasn't?

MR. BREEDEN: Congressman, I think this an excellent issue though, that points why the proposal of both Mr. Oxley and yourself, both bills, call for a body here to be created that would begin to resolve some of these issues. And I think you have put your finger on this as one of the number of --

REP. LAFALCE: That's why I wanted to have this hearing, because we haven't discussed this issue. And I would love to discuss it and I would love to reach a compromise short of legislatively mandating rotation if it's a good compromise.

MR. BREEDEN: One of the things --

REP. CANTOR: The gentleman's time has expired and Mr. Sherman is in wait.

MR. WALKER: One quick thing, Mr. Chairman, please.

I think one of the things you have to be concerned about is if you're looking at the public interest, in looking at the public interest I think you have to be concerned with how many firms are there that can perform the service? I think the number of firms does matter. Number two --

REP. LAFALCE: Well, that's an important issue too. Now, aren't there a lot of auditing and accounting firms below the big five that really could do much more work than they presently do --

MR. WALKER: They could do more work except when you're dealing with highly complex and global enterprises in which they're not going to be able to do more work.

REP. LAFALCE: But lots and lots of the publicly traded companies, what are there, about 17,000 --

MR. WALKER: They don't fit those criteria.

REP. LAFALCE: Yeah, they can do it. We've got to be able to encourage -- I had a chairman of an accounting firm in my office today saying I favor mandatory rotation, it's the only way we're going to be able to get a piece of the action.

MR. WALKER: Well, I understood. It depends on what you said. But number one, the number of firms is important that are qualified to do the work. Number two, that they be quality firms with quality -- internal quality assurance procedures. And number three, the quality of the people. One of the concerns that I have about mandatory rotation is that could end up putting more pressure on price. And the last thing you want to do is to create a further commoditization of the audit business, especially if you're going to end up taking away a lot of non-audit services. Because in the end, you've got to have a viable economic model. And if you don't have a viable economic model you're going to -- not going to attract and retain quality people and --

REP. LAFALCE: It's in comparison to what you save in market capitalization --

REP. CANTOR: The gentleman's time has expired, and the chair is going to recognize Mr. Sherman.

REP. SHERMAN: Thank you, Mr. Chairman, for giving me a chance to combine my third, fourth and fifth round questions into one block.

One of the witnesses mentioned Jersey Island, and of course we've also seen a lot of Enron activity in the Cayman Islands. I commend this committee and the ranking member and the chair for having these hearings on Enron and responding. But the ways and means committee is strangely silent. There are two sets of accounting games that were played by Enron; one to cheat the shareholders, the other to cheat the United States government and all taxpayers.

Now, the first is a little bit more apparent because the victims are there, the employees, everyone who had stock in Enron, and every stockholder in every company in the country, because I'm convinced the market would be several hundred points higher if everybody didn't have to factor into their investment decisions, the fact that the company that they invest in has a number of risks including the risk that they might be the next Enron.

The hidden cost and victims of the accounting games, the trips to Cayman Islands have had nothing to do with snorkeling, are on the taxpayers, the citizens of the country, everybody who depends on government, on efforts to combat world terrorism, and it's not just Enron, but hundreds of companies that have each established dozens of subsidiaries in the Cayman Islands, in Jersey Islands, in Barbados, in the other tax savings, and I would call upon our sister committee to be as vigorous as this committee has done. We have to defend investors, they have to defend citizens.

But shifting to other responsibility in the scope of the outside auditor, the whole problem arises because financial reporting is the only game where the umpire is played by one of the teams. And that means under the current system, if you say no we won't give you an unqualified opinion, you're not just giving up this year's audit fee, you're giving up this year's consulting fee. And you're not just giving up this year's auditing and consulting fee, but those fees could continue for 10 or 20 or 30 years into the future.

Now, one thing that I don't think will solve the problem right away, and I used to work for one of what we call the "little six" accounting firms, as long as investors, as they have, always demanded from the big companies they buy their stock in that are widely traded, the "big five," "big eight," "big four" firm beady auditor. I don't know a way to break that up just with rotation. I think you'd end up rotating among the big four, which may have some advantages and disadvantages. I think if you want smaller firms we'd have to break up the firms we've got now because I don't think Holaf (sp) is going to be able to stand up, or Seedman, (sp) and say we audited General Motors or we audited even Pacific Gas and Electric, and you should buy their stock, or at least rely on our financial statements on whether to decide to buy their stock.

You should then focus though, on that financial relationship that an accounting firm has with its clients. And one thing Mr. Silvers and I were talking about is the non-audit fee. And the question is whether you can just list a number of different services and say, okay, from time to time we'll change the list and we'll prevent the client from having too much clout with the accountant because we'll always have a list of prohibited services or limited services that prevent the client's total fee package from being too important to the accounting form.

And I wonder whether that's even possible without the backstop that I've suggested, Mr. Silvers referred to it as a perhaps useful redundancy, and that is -- and I'd like the other members of the panel to comment.

Is there any way you could list some services but not other services, and not have a situation where the client's total fees to the accountant might possibly be as large or larger than the audit fee? Can we do this by enumeration or must we do it by ratio?

REP. CANTOR: Yes.

MR. WALKER: My personal view is, and as is our testimony that GAO's view is, that you may want to have certain principles that you say that under no circumstances can the auditor violate certain principles which we articulate and note out.

Secondly, you may want to have certain safeguards that, you know, you make to make sure that people aren't auditing their own work, either firms or people within the firm, if you will. And -- but that you should delegate to, in an independent, qualified, authoritative body, being able to make the tough decisions on what should and shouldn't be allowed, based upon changing market forces.

I thin it's difficult to establish any particular level to say that merely because non audit fees exceed a certain number that there's a per se problem.

REP. SHERMAN: Sir, if I can interrupt, let's say it was thought to be acceptable that an accounting firm also provide executive recruitment, you're not auditing your own work except to the extent that --

REP. CANTOR: The gentleman's time has expired. If we can expedite the answer.

REP. SHERMAN: I didn't even get through to the question, so I withdraw.

REP. CANTOR: The gentleman may proceed.

REP. SHERMAN: Whatever the allowable service is, say executive recruitment, if it makes sense to allow a little bit of it, can you allow so much of it that the accounting firm is receiving more from those services than from the auditing fee?

MR. WALKER: Under the approach that we've taken, under general accepted governmental auditing standards, which is outlined in my testimony, we say that there are certain things that you can't do, irrespective of how much is involved. There are other things that you should be able to do but certain safeguards must be met, and we do not propose any dollar limit if you will. We think that the audit committee should end up being more actively involved in reviewing certain types of services, approving those services, but merely because the amount involved in and of itself wouldn't be dispositive.

REP. SHERMAN: I believe my time has expired.

REP. CANTOR: Thank you.

REP. LAFALCE: Yes, I just wanted to thank the panel very, very much. I think this has been very constructive and helpful. I just wish there were more members from both sides of the aisle who could have listened to the issues that were discussed by both of you. Also, Mr. Breeden, I do want to say that it was a pleasure working with you in the Bush Administration when representatives of the administration used to talk with Democratic Members of the House. That is not the case. I used to virtually live with representatives from the Treasury Department and from the White House in those days.

Maybe because we were in the majority then and they used to talk with us. That's why I developed such a close working relationship, not only with you but with the president himself and so many of his Cabinet officials. That's missing in Bush II and it's a sad -- I'm sad that it's missing.

Thank you.

MR. BREEDEN: Congressman, can I only say and just respond and say it was a great pleasure working with you then and all the members -- some of the members who are still on the committee here that -- I really think the savings and loan legislation was an opportunity. A great challenge faced by the country and you played a tremendous leadership role then and it was a great pleasure. I've never forgotten working with you.

REP. LAFALCE: Well, let me say this, that one of the difficulties -- probably in my judgment the biggest difficulty is that there was a cut back in examiners and in regulators for our savings and loan in the mid 1980s. I think that was the single greatest contributing factor. In the beginning of 2001, when our committee assumed jurisdiction, I pointed out that the biggest shortcoming in government today, was the inadequacy of resources at the SEC and I called, at the beginning of 2001, for not a 2 percent or 3 percent increase, but a 200 percent or 300 percent increase in the resources of the SEC. I was at least figuratively laughed at in calling for such a huge increase. Now that Enron has happened, at least the president has called for a 6 percent increase in his budget. But that's not good enough.

REP. CANTOR: The chair would also like to express his thanks to members of the panel and for your indulgence and patience.

The committee now stands adjourned.

END

LOAD-DATE: April 11, 2002