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U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises,
joint with the
Subcommittee on Oversight and Investigations,
Committee on Financial Services,
Washington, DC.

    The subcommittees met, pursuant to call, at 10:50 a.m., in room 2128, Rayburn House Office Building, Hon. Richard H. Baker, [chairman of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises], and Hon. Sue W. Kelly, [chairwoman of the Subcommittee on Oversight and Investigations], presiding.

    Present from Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises: Chairman Baker; Representatives Shays, Paul, Bachus, Royce, Oxley, Shadegg, Weldon, Fossella, Miller, Ose, Toomey, Rogers, Kanjorski, Bentsen, Sandlin, J. Maloney of Connecticut, Hooley, Mascara, S. Jones of Ohio, LaFalce, Capuano, Sherman, Inslee, Moore, Ford, Lucas, Shows, Israel, Ross, and Hinojosa.

    Present from Subcommittee on Oversight and Investigations: Chairwoman Kelly; Representatives Cantor, Gutierrez, Schakowsky, W. Jones of North Carolina, Tiberi, and Clay.
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    Also Present: Representatives C. Maloney of New York, Jackson-Lee, and Sanders.

    Chairman BAKER. I would like to call this hearing to order.

    To begin our proceedings this morning, there are a couple of matters of business, procedural matters to which I would like to attend. The first is that by prior agreement with Mr. LaFalce and Mr. Kanjorski, each Chair and Ranking Member of the subcommittees and Full Committee will be recognized for opening statements of 5 minutes. Then each side will be given an additional 10 minutes for a delegation of opening statement time for whichever Members each side so chooses. By utilizing this method, we will still consume at least 45 minutes of subcommittee time before we begin discussion with the witnesses, so I think it very important that the subcommittees will adopt, without objection, this plan for proceeding.

    Any objection?

    Without objection, so ordered.

    In addition, we have two Members here present, Mr. Sanders, as well as Ms. Jackson-Lee from Texas, who will be recognized in regular order pursuant to recognition of all Members of the subcommittees for purposes of questions. Without objection, there is agreement on that matter.

    We are here today to examine and begin the process of understanding the most stunning business reversal in recent history. At one moment, an international corporation with a diversified portfolio enjoying an incredible run-up of stock prices, the darling of the financial press and analysts which, by the way, contributed to the view that Enron had indeed become the new model for the business of the future, indeed a new paradigm. One edition of Fortune Magazine called it the ''best place in America for an employee to work.'' Analysts gave increasingly creative praise while stock prices soared.
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    The corporate mission statement perhaps says it best, I take from page 53 of Enron Annual Report 2000: ''We are satisfied with nothing less than the very best in everything we do. We continue to raise the bar for everyone. The great fun here will be for all of us to discover just how good we really can be.''

    Enron even redefined fun. The sad fact, while having too much fun, it was really all too good to be true. Not only were investors and creditors left with lawsuits as their only assets, lifelong employees lost their jobs, retirement and savings, virtually left to start completely over in the midst of a national recession.

    While there were apparent indicators of potential difficulty to a few insiders, virtually all observers were shocked by a surprising statements of earnings expectations and then the incredibly fast demise of the huge enterprise. Now, in retrospect, it is clear, at least to me, that while Enron executives were having fun, it actually became a very large hedge fund, which just happened to own a power company. While that in itself does not warrant criticism, it was the extraordinary risk-taking by powerful executives which rarely added value, but simply accelerated the cash burn-off rate. Executives having Enron fun were apparently very costly.

    All the while, they were aggressive in the exercise of their own stock options, flipping acquisitions for quick sale. One executive sold a total of $353 million in the 3-year period preceding the failure. What did he know? When did he know it? And why didn't we? Again, referring to the mission statement of the corporation's annual report 2000, on communication: ''We have an obligation to communicate. Here we take time to talk with one another and to listen. We believe that information is meant to move and that information moves people.''
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    Apparently so. It moved this executive to sell $353 million worth of stock.

    Then we learned of the multiple special purpose enterprises, SPEs, as they are known, in which some executives apparently set up businesses which contracted with Enron, usually on exceptionally profitable terms. Everyone seemed to have their own place to go for self-dealing at great cost to employees and shareholders. Another concern, even though I must admit when times were good, single stock 401K seemed to be an advantageous thing to do when stock prices were soaring. Have you actually ever met a financial advisor who would tell you to have the most fun, be sure to put all your eggs in one basket?

    Some things are too risky, even for the purpose of having fun. We are here today to begin to grapple with just how all of this could happen. A lot of smart people with no conflicts of interest just missed it. Our task is to establish the facts, change the rules where needed, and assist the SEC in the pursuit of those who apparently have violated the law. This will not be fun, and it won't happen as quickly as Enron's demise. We will do this the old fashioned way, with a lot of hard work and a lot of time.

    In the end, our goal is to assure individual investors that there is real value in the marketplace, credibility and professional conduct and consequences for those who abuse the system. I wish to express my appreciation to Chairman Oxley and Ranking Member LaFalce for their significant interest in these matters, to Chairwoman Sue Kelly, who Chairs the Oversight and Investigation Subcommittee of Financial Services, who has graciously agreed to join with us in this hearing today, and use their subcommittee resources to take on important aspects of this inquiry, and to announce on our return in late January, and possibly early February, the subcommittees will continue a series of hearings to look at a number of elements.
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    One, this certainly rekindles prior subcommittee interest in the conduct of analysts and their role in this matter to evaluate the potential for an SRO for the CPA profession. A review of the 1933 and 1934 Securities Acts to determine where there are inadequacies, to examine Reg FD and its' failure to protect investors in this current debacle.

    And a special word to Mr. Kenneth Lay, the CEO of Enron who, after numerous requests by the subcommittees, sent a letter, which I do not have in my possession at the moment, but will be entered into the record at a later time, indicating that his appearance before a bankruptcy proceeding today obviated his ability to respond to the subcommittees' request. On the record, I wish to make it clear the subcommittees will have additional meetings should Mr. Lay's social obligations preclude his participation, the subcommittees also have the power to subpoena. At such time as we deem it appropriate, the subcommittees will take action to get the appropriate information from Mr. Lay and other executives of Enron.

    I do have a letter dated December 11th, which I will enter into the record at this time without objection.

    When we're finished, I hope we will establish a methodology in which all participants will understand when a corporation is just having too much fun, it won't result in the loss of personal fortunes for innocent third parties, investors, shareholders, and most importantly, innocent employees.

    At this time, I'd like to recognize Mr. Kanjorski for an opening statement.
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    Mr. KANJORSKI. Thank you, Mr. Chairman.

    Today's hearing will help us understand at least some of the factors that contributed to the downfall of Enron, a once mighty international conglomerate that recently filed the largest corporate bankruptcy in American history. Our hearing will also help us to discern whether Congress needs to take steps to restore the faith and trust of investors in the American dynamic capital markets.

    Although I have not yet arrived at any conclusions about the disturbing downfall of a corporate icon, I have already identified a number of concerns that I expect we will address during our investigations.

    First, I would like to learn more about the serious financial harm done to thousands of Enron employees and the many others who owned Enron stock. Some press reports suggest that the company rules blocked rank-and-file employees from selling Enron stock in their 401K retirement plans in the days and weeks following the announcement that Enron had overstated its earnings by $583 million in the past 4 years. Those hardworking Americans had to watch helplessly as their savings shrank without any recourse while Enron's executives could apparently sell their stock options and avoid the financial pain. That is wrong.

    Second, I have concerns about whether the accounting industry experiences any conflicts of interest in serving its customers. In recent years, many have noted that an accounting firms' consulting fees from one company may exceed its auditing receipts from the same company. This practice calls into question whether shareholders can rely on earnings reports and other indicators of the company's health and its future stock price. In order to provide transparency for investors, auditors should actively work to limit potential conflicts.
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    Third, we return today to the issue of analyst independence, a topic we have closely studied this last year. From our past hearings, we have learned that an analyst working for a firm that handles investment banking for a company the analyst covers could receive a more favorable rating to attract new business. I am therefore interested in learning why of the 15 analysts covering Enron on the day following the failed merger with Dynegy, only one had a ''sell'' rating on the company stock. These ratings misled investors.

    Finally, in hindsight, it appears that the Enron board of directors failed to serve Enron's shareholders. Several news stories have detailed how gifts, contributions and other activities may have compromised some members of Enron's board. I expect that, as time goes on, we will learn that Enron is not the only company where these questions arise. Members of a corporate board must retain their independence and hold management accountable.

    In closing, Mr. Chairman, I typically prefer private sector regulation to Federal regulation. But if the private sector fails in its responsibilities and creates a vacuum, then the Federal Government has a duty to protect its citizens by addressing the market failure. More Americans than ever have their savings invested in the stock market, and we have an obligation to protect them from the conflicts of interest we are investigating in the Enron collapse.

    Chairman BAKER. Thank you, Mr. Kanjorski.

    At this time, I recognize the Chairwoman of the Oversight and Investigations Subcommittee, Mrs. Kelly.
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    Mrs. KELLY. I want to thank Chairman Baker and Ranking Members Kanjorski and Gutierrez for agreeing to hold this joint hearing on the recent collapse of Enron and its impact on investors and the financial markets. In this hearing, I hope we can all gain a better understanding of why Enron collapsed so quickly, and why Enron's public filings and Andersen's audit reviews failed until it was much too late to give any indication of the problems they were experiencing.

    Transparency is the goal of the disclosures a company is required to make, and a fundamental necessity to a properly functioning open market. Unfortunately, the disclosures made by Enron did not give any indication of the problems they were experiencing until October 16th. News reports have had many different versions of what may or may not have happened.

    I've read about a partnership that hid the level of leverage the company had incurred, mistakes and misstatements that may have occurred in the audits, certain Brazilian investments that also may have contributed to Enron's fall.

    What is clear is that people have been hurt by the collapse of Enron, from the thousands of investors whose retirement and other investment savings have been devastated to the thousands of employees who now find themselves without a job and with a jeopardized pension plan.

    We have on our hands what appears to be the largest bankruptcy ever, which could have far-reaching implications for our economy. We have the duty and the responsibility to ensure that safeguards are in place to prevent a disaster of this magnitude from ever being repeated. We must determine when the accountants, executives and regulators knew what was happening, what they did to rectify the problems. While it would be impossible to ever have in place a system that would prevent failures in the future, we always must try to improve on the current system of disclosures and enforcement that is the responsibility of the SEC.
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    Enron's collapse underscores how important it is for Congress to act immediately to pass the netting provisions of the bankruptcy bill which have already passed the House numerous times.

    For the record, Mr. Chairman, I would like to ask unanimous consent to have a letter signed by seven financial regulators who support the netting provision made part of the record. This legislation would reduce the uncertainty for financial market participants about the disposition of their contracts in the event one of their counterparts becomes insolvent. In this letter, the financial regulators state that ''failure to enact, these financial contract netting provisions would unnecessarily place the financial system at greater risk.''

    Chairman Oxley has been working on this. I want to add my strong support for enacting these needed provisions before we adjourn this year. I want to thank all the witnesses for taking time out of their busy schedules to share their views with us, and I look forward to discussing these issues with them.

    I yield back the balance of my time, and I do thank those Members of my subcommittee who are here today.

    Chairman BAKER. Thank you very much, Mrs. Kelly. We certainly appreciate your cooperation and assistance in this important matter.

    The Ranking Member, Mr. Gutierrez.

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    Mr. GUTIERREZ. Good morning Chairman Baker, Chairwoman Kelly and the Ranking Member Mr. Kanjorski, and I want to thank Mr. LaFalce for joining us also here this morning, and for holding this hearing.

    We are gathered here today because of a series of unfortunate events that culminated on December 2nd with the filing for bankruptcy of Enron. In Houston alone, Enron has laid off more than 4,500 of its 7,500 employees as part of a corporate restructuring program. The victims of this catastrophe, Enron's employees, have been left wondering how bankruptcy will affect their severance pay, health insurance, and financial futures. For the vast majority of them, the spectacular collapse of their company causes a financial and personal tragedy. Many feel betrayed and angry. Sadly, many workers didn't even know they were about the lose their jobs. They just came in one day to work, and were simply given 30 minutes to pack up their belongings and leave.

    In addition to the layoffs, a great number of Enron employees lost, in a matter of months, almost all the value of the stocks they owned, which plunged into levels below one dollar. Enron employees may have lost 70 to 90 percent of their retirement funds, which translates into more than $1 billion. Many of Enron's employees had invested all of their 401K funds into Enron stock. And why shouldn't they? Just months ago, Enron was the country's seventh-largest company in terms of reported revenue, I say reported revenue. Enron was a fast-rising star that had turned the dreary business of energy trading into one of the world's vastest corporate empires. It reported quarterly revenues of nearly $47 billion.

    The Enron case brings to the fore an issue that has long worried pension and benefits experts: a retirement plan hugely dependent on the health of the company that provides it. Although the Employee Retirement Security Act of 1974 states that an employer with a traditional pension plan cannot invest more than 10 percent of the plan's assets in the employer's stocks, traditional pension plans are rapidly falling out of favor, with the newer 401Ks replacing them. Currently, there are no limits yet on how much an employee's pension plan may be comprised of the employer's stock, nor are there any caps on investments in employer stock with employer-contributed funds.
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    Enron's own stock accounted for more than 60 percent of the assets in the $2.1 billion defined benefit 401K plan several months ago. It is widely known that some companies have even higher levels, creating an even worse scenario should these companies fail. Indeed, these amounts are situated well beyond what would be described as prudent diversification.

    The dangers of over-concentrating company stock in a 401K plan have been made vividly clear by Enron Corporation's debacle. But despite the perils, millions of American workers have little choice but to bet their retirement savings, as well as their jobs, on the fortunes of their employers.

    However, Enron is hardly alone in its high exposure to its own stock. Almost 120 of the largest U.S. companies, as represented by the Committee on Investment of Employee Benefit Assets, have seen their own stock rise to an average one-third of plan assets.

    Hardest hit will be Enron's 21,000 workers. For 3 weeks, starting in late October, all Enron retirement plan participants were locked into their current allocation when the firm decided to go ahead with a switch to new plan administrators. Enron's stock lost 35 percent of its value during the freeze, but the workers' pain was not shared by top executives. According to press reports, many of them cashed in millions of dollars worth of Enron stock while the employees were locked into those stocks.

    For instance, Enron Chairman, Mr. Kenneth Lay, who refused to come before these subcommittees, alone took $23 million of Enron stock and sold it in the year 2001, a year in which the price of the stock plummeted from $82 to 26 cents a share, while the employees were stuck with the stock.
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    The only mistake these employees have committed was being loyal to their company and wanting their own small, but well-deserved, share of the riches Enron executives habitually pocketed during their years at the company. Of Enron's 21,000 employees, the approximate 12,000 who participated in the Enron 401K plan now have virtually nothing.

    Another source of problems is the companies that make their own matching contributions in stocks, and usually place restrictions on the trading of these shares by the employees. Generally, workers cannot sell their shares until they are near the age of retirement, making them captive investors.

    Enron prevented its workers from selling the shares they had accumulated until they reached the age of 50. Although this did not save the stock from collapse, it did major harm to the employees. It's alarming to consider that Enron is not alone in such a requirement. Other big companies lock workers into their 401K company shares until a certain age. We all know that you are not supposed to put all your eggs in one basket.

    Mr. Chairman, to conclude, I would like to touch on an issue that I think is key to this affair. Under my perspective, transparency of information must be enforced in publicly-traded firms, such as Enron.

    Transparency in financial reporting plays an essential role in making financial markets fundamentally efficient. This is absolutely necessary if we want to have healthy markets.

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    Last, Mr. Chairman, we should give them what Members of Congress have. I can pick up the phone and today I can change my 401K, we all can, as Members of Congress. All of our employees can make one simple phone call and we can change our investment strategy at an instant. The employees of America should have the same right and the same prerogatives that Members of Congress and Federal employees have.

    Thank you very much, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Gutierrez.

    The Chairman of the Full Financial Services Committee, Chairman Oxley.

    Mr. OXLEY. Thank you, Mr. Chairman. Thank you for chairing this subcommittee hearing, as well as Chairwoman Kelly. Today, we'll begin the subcommittees' investigation of the facts and circumstances surrounding the largest corporate failure in history. Today, we will hear about the dramatic collapse of Enron Corporation, once the seventh largest company in the United States, riding high as recently as 6 months ago. The company has since lost more than 99 percent of its market capitalization, and now trades below $1.

    Until all the facts are known, it is prudent for these subcommittees to avoid reaching sweeping conclusions about the causes and persons responsible for Enron's collapse. But that does not mean we should refrain from asking the difficult questions that demand answers.

    We will ask the difficult questions. We will delve thoroughly into the facts and circumstances surrounding Enron's collapse. And we will get answers.
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    This subcommittee, and the Subcommittees on Capital Markets and Oversight, will vigorously pursue this matter to ensure that the Congress, and the American public, know who to hold accountable.

    We need to learn whether millions of investors were intentionally misled by Enron's financial engineering and reluctance to disclose information.

    We need to learn why financial statements that provided less than a complete picture of Enron's financial situation were certified.

    We need to learn why almost all of the securities analysts following Enron failed to warn investors, and why exactly half of them continued to rate the company a ''buy'' or a ''strong buy'' even after it had plunged below $1.

    We need to learn whether the current reporting and financial disclosure system needs to be overhauled.

    We need to learn why the accounting rules permit companies to keep important information off their balance sheets.

    Above all, we need to reduce the likelihood that this will happen again.

    The effects have been devastating, as one might expect, when a $75 billion company files for bankruptcy. Hit hardest by the meltdown, of course, were Enron's employees. Thousands have already lost their jobs, and more will undoubtedly follow. And the 11,000 employees who participated in the company's 401K plan have seen their retirement savings practically eliminated.
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    In addition, beyond the impact on Enron employees themselves, Enron's collapse has drained the investment savings of investors across the country who put their retirement and other investments into mutual funds, pension funds, and other vehicles that invested in Enron. Thankfully, at this point, there does not seem to be a systemic threat to the financial markets as a result of Enron's collapse, but the damage the collapse has done to the financial position of thousands of Americans will be very difficult to quantify.

    Some may use Enron's bankruptcy as a vehicle to make big Government arguments against electricity markets. But it wasn't the electricity consumer who was hurt by Enron's fall, it was their workers and investors.

    Furthermore, Congress must pass the netting provisions of the bankruptcy reform legislation. Enron and its subsidiaries were party to tens, if not hundreds of thousands, of different financial contracts. The identification of these contracts and verification that they are eligible for netting will require vast expenditures of time and money and divert the attention of Enron and the court from the task of reorganizing. Meanwhile, creditors will remain uncertain as to the enforceability of their contracts and the ultimate status of their claims against Enron.

    Let's eliminate the uncertainty, the waste of valuable court time and estate funds, and allow institutions to eliminate exposure more thoroughly.

    We are pleased to welcome the distinguished Chief Accountant of the Securities & Exchange Commission, Bob Herdman, to discuss the reporting and financial disclosure system mandated by the Federal Securities laws. I'm particularly pleased that Mr. Herdman is here today, because the central issues that the Enron collapse raises are issues of investor protection and accounting rules, about which there are few better experts than the Chief Accountant of the Commission on which to opine.
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    Mr. Herdman, welcome to the subommittees for your first appearance since you've been appointed.

    I would like to remind the Members of the subcommittees that Enron, as well as Arthur Andersen, are the subjects of a formal investigation by the SEC, so Mr. Herdman will not be able to provide any specific information about those investigations, and I'd ask the Members to please phrase your questions accordingly.

    On the second panel, we will hear from the Chief Executive of Arthur Andersen, Joseph Berardino, who serves as Enron's auditor. We welcome back Chuck Hill to the subcommittees to discuss the performance of Wall Street research analysts in this matter. Finally, we will hear from the AFL-CIO on the impact to investors.

    Unfortunately, Enron's Chief Executive, Kenneth Lay, was not able to testify before the subcommittees today. Mr. Chairman, you entered the letter into the record. He is participating in the first hearing of creditors in the bankruptcy proceeding.

    I want to assure the Members of these subcommittees, as well as the public, that I am confident Mr. Lay, and Enron, will provide answers to us and to the public as the subcommittees continue their investigation into this matter.

    Mr. Chairman, I yield back the balance of my time.

    Chairman BAKER. Thank you very much, Mr. Chairman.
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    Ranking Member of Financial Institutions, Mr. LaFalce.

    Mr. LAFALCE. Thank you very much, Mr. Baker. Thank you also for acceding to my request to have a representative of the employees, Mr. Trumka, testify at today's hearing. He's also a 1974 graduate of Villanova Law School, and I had the pleasure of graduating from the same law school just a few years earlier.

    Enron is a wake-up call. Enron gives us a very important glimpse of what is necessary to hold our markets together. The integrity, the adequacy, the clarity of information provided by public companies to the public. When the adequacy and accuracy of that information is compromised, devastation can and does occur, devastation to large and small investors alike. And how many more Enrons are out there? And what are the systemic factors that made this collapse and may make other future collapses possible?

    Today, we will get but a small glimpse of that. But when our committee returns in January, we must, and I'm confident we will, conduct a comprehensive review of all of the policy issues this debacle raises, including at least the following:

    First, earnings management or earnings manipulation. To what extent did Enron's management bend or break accounting conventions to distort their financial condition? And most important, is this practice widespread? And are there more Enrons out there?

    Second, corporate governance. The board of directors, and particularly the audit committee and the compensation committee, have a fiduciary responsibility to the shareholders. Did they meet that responsibility in this case? Are audit committees in corporate America meeting their responsibilities to vigorously review the financial statements of companies and hold management accountable to the standards of the law, as well as sound business practices? And what reforms should the SEC, SROs, and this Congress consider?
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    Related party transactions: What was the nature of the related party transactions in what was basically a publicly-traded hedge fund? Were those transactions proper? Were they properly disclosed to investors and to the board of investors?

    Accounting and auditing: Are the accounting standards, as they apply to a company of this type, too difficult to apply, and do such rules incentivize companies to exploit unintended loopholes? To what extent, if any, should we rely on the accounting industry to protect shareholders and assure that companies disclose the true nature of their financial conditions, or the desire to keep clients affect accountants' ability to conduct their audit objectively and their willingness to bring accounting irregularities to the attention of management, the board of directors, and the SEC?

    Analysts and market expectations: It's clear that the Enron collapse was in large part due to a crisis in confidence throughout the market after Enron made material adjustments to the financial statements. Should financial analysts have known by their own critical analysis of the company's financial statements at their regular meetings with management that something was fundamentally wrong?

    Data analysts, whose firms have significant business with Enron, maintained a favorable rating even after it became clear that the company was in serious trouble. It would be useful, in fact, I think imperative, for our subcommittees to hear testimony from independent research analysts not affiliated with investment banks, and then with research analysts from investment banks to compare their ratings on Enron at different points in time over the last several years.
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    For it is my understanding that there were some independent analysts issuing negative recommendations on Enron. What did they know that others did not and should have known? We need to understand the quality and objectivity of their research and how well such analysts communicated with investors.

    Employee pension plans: People didn't have money in their 401Ks, they had their lives in the 401Ks. Were they encouraged to invest in those 401Ks by management to buttress the stock? Did management tell them what they knew, or did management tell them what they thought was necessary to stabilize the price of the stock? What laws exist under ERISA? Is it possible for a company to say ''we will contribute matching moneys only if you invest in our stock,'' as opposed to others? If that's true, should the law be changed?

    Lastly, the sufficiency of regulation. Has the SEC fulfilled its oversight obligation in this case? Is the current framework of self-regulation adequate? Does the SEC have sufficient resources to effectively fulfill its oversight responsibility, whatever it perceives its oversight responsibilities to be? There was a day when people had virtually all their money in a bank, in a thrift, in a credit union, and we mandated that the Federal Reserve, the FDIC, the OTS, the OCC basically live with those institutions examining the books. But today, people have most of their wealth in publicly-traded companies. And there is very little governmental oversight, if any at all. Should this change?

    Mr. Chairman, I look forward to pursuing all these questions very aggressively in the future. Thank you.

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    Chairman BAKER. Thank you, Mr. LaFalce.

    For the record, Mrs. Kelly had a letter that she wished to have introduced in the record relative to contract netting. Without objection, it is included.

    Chairman BAKER. I have two charts distributed to Members. I just realized the charts are mine relative to Enron's stock value over time, and the trading record of those documents I've had distributed to the Members, and are also being made part of the record without objection.

    Chairman BAKER. At this point, we will begin to recognize Members on each side for opening statements to be limited to no longer than 2 minutes with 5 Members per side. The first I have on my recognition list is Mr. Shays for 2 minutes.

    Mr. Shays.

    [No response.]

    Chairman BAKER. The next I have is Mr. Paul. This is by time of arrival. Mr. Paul, no statement?

    [No response.]

    Mr. Fossella, we're on a roll here.

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    [No response.]

    Chairman BAKER. Mr. Ose.

    [No response.]

    Chairman BAKER. Mr. Toomey.

    Mr. TOOMEY. Thank you, Mr. Chairman. It appears that the complex nature of the large volume and some question reporting of numerous transactions introduced uncertainties, significant uncertainties as to the leverage and the nature of the risks, even the solvency of Enron, and the market responded. It responded severely, shutting off credit, allowing Enron to collapse with breathtaking speed. But I would remind my colleagues that we tolerate another kind of uncertainty, that is the legal uncertainty that credit exposures could be properly netted and resolved according to the documents under our Bankruptcy Code.

    I want to join with some of my colleagues who have emphasized the importance of passing the netting bill. I introduced a bill that would make the necessary changes to the bankruptcy code, and we should do that this year.

    I would just briefly like to make one other point. Several of my colleagues have strongly criticized the practices that cost employees of Enron to lose large sums of the money that they invested in Enron stock. I share that criticism generally. But I would remind all of us that we contribute to that very problem in some respects when you consider that last year, we passed a bill that forbids people of ordinary means from engaging in the very transactions which could have allowed them to hedge their exposure. Retail swaps would allow people to preserve the value of their retirement savings, and these subcommittees and the Federal Government should not continue to restrict the use of these vital risk management tools only to institutions and to the very rich, as we do today.
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    With that, I yield the balance of my time.

    Chairman BAKER. Thank you, Mr. Toomey.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman. This hearing today will begin the process of unraveling the reasons for the collapse of the Enron Corporation. While the impact of Enron's collapse will be felt in many quarters, not the least of which is Houston, where thousands of employees have lost their jobs, and apparently their savings, this hearing will focus on the failure of the company's corporate governance structure to properly oversee management, along with serious questions regarding the performance of Enron's outside auditor. The subcommittees need to begin to understand whether the fall of Enron from its perch, as one of the largest public corporations in the United States, with its market capitalization at $75 billion, and stock trading at $84 a share a year ago, to bankruptcy and the stock at about 25 cents today was a failure wholly inside the company with its outside advisors within the financial market, or our regulatory and legal structure.

    As a Houstonian, this is not just a failure within the marketplace, but also a tremendous loss to our community. Thousands of employees have been laid off just before Christmas into a down economy. Their savings and pensions wiped out. Our city has lost not just a corporate icon, but a corporate partner in civic affairs, a company which transformed the Nation's energy markets from a State-regulated structure into an innovative efficient marketplace, collapsed under its own weight, apparently due not to the new trading markets that it helped create and nurture, but apparently because of old economy corporate mistakes.
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    While it is doubtful in my mind that Enron will survive, the energy marketplace it helped to found will, and it is telling that throughout its fall, those markets still have remained steady and calm. The scope of our hearing today must determine whether Enron's management knowingly violated securities laws regarding disclosure or whether those laws allowed for the company to limit disclosure of certain financing structures which have the effect of understating liabilities and overstating assets and revenues. We must determine whether the corporate governance structure of Enron broke down or whether the laws providing for outside directors of public companies are flawed. We must determine whether Enron's auditors properly stated its financial condition or ignored warning signs to the detriment of investors and employees.

    The increasing volume of corporate earnings restatements, not just Enron, should be alarming to the investing public, capital markets and the Congress. Are the disclosure laws lacking in providing investors and regulators with accurate data regarding a company's true financial condition?

    Is Enron an anomaly or a preface of the things to come at the end of the roaring 1990s and its period of so-called ''irrational exuberance,'' and I hope we have many more hearings on this and the pension effects of this. And I ask unanimous consent to present my whole statement for the record.

    Chairman BAKER. And don't forget to yield back the balance of your time.

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    Chairman BAKER. Mr. Shays has returned. Mr. Shays.

    Mr. SHAYS. Thank you, Mr. Chairman. I want to associate my remarks with the remarks of the Full Committee, your remarks and Mrs. Kelly's. They express my views quite well. I would then yield to my colleague, Mr. Ose.

    Mr. OSE. Thank you, Mr. Shays.

    Mr. Chairman, if I might, I do have a couple of questions before I make a statement. There was a comment about the defined benefit plan at Enron, which was another means by which people could protect their retirements. We've checked that out through the Pension Benefit Guarantee Corporation and those assets are guaranteed by the Pension Benefit Guarantee Corporation. That's the defined benefit plan.

    I appreciate the gentleman from Connecticut yielding. My particular interest has to do with the special purpose entities and the rules that govern them. I read the various statements. As near as I can tell, that 3 percent threshold is considered on the basis of each separate transaction rather than in aggregate. I'm hopeful that in the course of these hearings, we'll get into that a little bit further.

    I yield back the balance of Mr. Shays' time.

    Chairman BAKER. Thank you very much, both you gentlemen.
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    Ms. JONES. Thank you, Mr. Chairman. Good morning to Chairmen Baker and Kelly, Ranking Members Kanjorski, Gutierrez, and LaFalce. I'm glad to have an opportunity to give a brief opening statement this morning. We are here to find out, as best we can, within the public view, what happened with Enron. I would suggest Chairpersons and Members that our efforts must run deeper than that, and that is to find out not just what happened, but how did it happen and where did our regulation policies and opportunities to oversee this particular public company went wrong. Never before in our recent memory has a company's stock fallen so quickly. I'm concerned about the loss of jobs and the possibility of pension loss that will come as a result of the loss of dollars from people's investments.

    I'm as concerned about Enron as I am concerned about a company called LTV still in the City of Cleveland in bankruptcy with 3200 employees being laid off and the steel workers stand on Capitol Hill today saying to the Congress, ''pass some legislation that would help us and save our industry and give us some legacy fees.''

    So today, as Members of Congress, we're asked to do a number of things, and one of those would be to look at some of the agencies and organizations that are responsible for providing oversight over the accounting methods of this company and what people have to rely upon when they make investments. I trust that at the end of the day, we will be able to move forward and say that we're doing all within our power as Members of Congress to provide oversight, to provide regulation, and give insight and protection to the American public that uses Enron and any other company to do their investments and save for the future.

    I yield the balance of my time, Mr. Chairman.
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    Chairman BAKER. Thank you very much. I thank the gentlelady.

    Mr. Bachus.

    Mr. BACHUS. I thank the Chairman. I commend you and Chairwoman Kelly for holding this important hearing. We have very transparent and strong capital markets so when a failure of this magnitude comes, it takes all of us by surprise. I think it's important that, as opposed to pointing fingers or rushing to judgment, that we take a hard look at this and study it, and not really rush to conclusions until we've done that. In studying what happened, I want to first commend Arthur Andersen for bringing their CEO today. I wish that Enron had done the same thing. The fact that Arthur Andersen's Mr. Berardino is here, I congratulate Arthur Andersen. I wish Enron had done the same thing. It would have made it easier for us.

    I would like to focus on three real quick things. First of all, we know that Enron was at one time a very successful company. They were willing to take risks, they had creative business planning, aggressive expansion. That contributed to their growth. Obviously, on the flip side, that contributed to their demise because they grew too fast, got into areas they didn't understand.

    Second, quite apart from the accounting, whether they complied with accounting rules, we know that this company, I think this is part of the bottom line, had a history of not being forthcoming about their business operations. I just want to give you one quote that I think shows this. This is from the former CFO of Enron, Andrew Fastow. He told Fortune Magazine in March, 7 months before he was forced out, ''We don't want anyone to know what's on our books. We don't want to tell anyone where we're making money.'' Obviously, we didn't need to wait till today to find that out. Their lack of transparency was a significant contributor to what happened. We owe it to the shareholders, to the pension holders, to get to the bottom of this, and I feel under your leadership, Chairman and Mrs. Kelly, and with the help of our witnesses, we'll begin to do that.
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    Thank you.

    Chairman BAKER. Thank you very much, Mr. Bachus.

    Mr. Mascara.

    Mr. MASCARA. Thank you, Mr. Chairman. Thank you for calling these hearings. What I'd like to say in my 2 minutes is to pose some questions that hopefully I'll have an opportunity to do later, but if not, they'll be on the record.

    One is whether the SEC approves the prospecti filed by Enron on the various SPE filings in an attempt to ascertain whether complete financial disclosure was revealed. The other is, given that the SEC representative here, the CEO cannot disclose, according to his statement anyway, that I read—is that information that has to deal with this investigation? And if not, apparently we're not going to get many answers today—is whether a grand jury should be formed and empaneled to investigate this economic calamity.

    Regarding the pensions, I'm looking for answers. Whether the large number of Enron employees who had 401K pension plans and Enron stock, why they could not sell their stock. We call it down here a thrift plan, open season. And at the same time, the management people were cashing in their 401Ks. And now that Enron has declared bankruptcy, does the bankruptcy law provide any special protection to employees in the pension plan. I understand that before Enron declared bankruptcy, the stocks in these 401Ks were traded, and whether the SEC required that the accounting firms involved complied with all of the FASB, Financial Accounting Board Standards.
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    Those are some of the questions that I need to have answered, and hopefully I'll have an opportunity to ask those questions. If not, I would hope that the respective firms and the SEC involved will provide those answers to me.

    Thank you, Mr. Chairman, I yield back.

    Chairman BAKER. Thank you, Mr. Mascara.

    Mr. Miller.

    Mr. MILLER. Thank you, Mr. Chairman.

    To be honest, I'm less interested in what we have to say and more interested in listening to what the witnesses have to say. I'm personally going to focus on questions following that. I would yield back my time.

    Chairman BAKER. Thank you very much, Mr. Miller.

    Mr. Sherman.

    Mr. SHERMAN. Thank you. I'm interested in the pension plan issues where workers invest their entire work life and their retirement savings in the same basket, but I would point out that we in this Congress are very much promoting the ESOP concept which encourages the same thing, but with an additional element, and that is worker control. And I think ERISA should require in a pension plan diversification or worker control, if the workers are over invested in the stock of their employer.
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    I am a CPA and I am particularly interested in the accounting issues. Fundamentally, responsibility rests with Enron management which engaged in highly complex and questionable transactions and then misstated them in their financial statements. But we need to see whether Generally Accepted Auditing Standards were sufficient to allow the accounts, the outside auditors to know what the facts were and whether the auditors applied those standards correctly. And if the auditors did know the facts, then we need to look at whether Generally Accepted Accounting Principles serve were employed, and if so, whether they need to be changed. I'm particularly interested in these special purpose entities which seem a wonderful way to enrich management through self-dealing and conflict of interest, plus a method of manipulating financial statements. The only legitimate use that I'm familiar with for SPEs is to shift risk from the public shareholders to a special purpose entity. But you hardly shift risk when the chief asset of the SPE is stock in the company that they are supposedly ensuring or protecting against risk.

    Also, I have to wonder whether the 3 percent independent equity rule is sufficient. It seems to beg for manipulation with insufficient risk protection for the company. I think we have a bit of an analogy here—wrap it up?—and that is we may discover not only that the auditors did not apply the accounting standards correctly, but that the company actually came very close to complying with those standards and that it is the standards that need to be changed even more than making sure that we had adherence, what I think will worry us most as we discover that Enron, had they just been a little different, could have complied with all the technical rules and still gone down the drain.

    I yield back.

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    Chairman BAKER. Thank you, Mr. Sherman.

    Mr. Weldon.

    Mr. WELDON. Thank you, Mr. Chairman. I want to thank you and the Ranking Member and all those involved in putting this very important hearing together. This failure of this company has shaken the American confidence in our investment system and I feel very strongly that we will need to, either through a self-regulating process or a legislative process, make changes in the way accounting practices and stock analysts operate in the United States. I would like to particularly associate myself with the remarks made by Mr. Gutierrez. I think we will seriously need to consider modifying ERISA legislation to prohibit the situation that we had with Enron. It's tragic enough that these employees had been laid off, but the fact that their entire retirement savings was wiped out, is totally unacceptable.

    I yield back.

    Chairman BAKER. Thank you, Mr. Weldon.

    Our last participant opening statement is Mr. Sanders for 2 minutes.

    Mr. SANDERS. Thank you, Mr. Chairman. Thank you for holding this hearing. It seems to me that Enron's collapse raises several very important issues, some of which have already been discussed by my colleagues. Clearly, we must protect employees from seeing their retirement funds ripped off and their life savings go down the tubes. We've got to look at this in terms of the implications on the privatization of Social Security as some would have us do, and also understand that other companies around this country in different ways are ripping off the retirement plans and the pensions of their workers.
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    Second of all, we want to examine the role of accounting firms like Arthur Andersen. As many know, Andersen recently settled a suit brought against them by the SEC for $7 million as a result of a failed audit at Waste Management Incorporated. The question arises, what was Arthur Andersen doing when Enron was cooking its books. How much confidence should the American people have in companies like Andersen?

    But the third issue, Mr. Chairman, that has not yet been raised, it seems to me perhaps to be the most important. That is the role of big money in the political process and the need for real campaign finance reform. Since 1992, Enron has contributed over $5 million to Republicans and Democrats. During the last 2 years, Enron has spent $4 million lobbying Congress and the White House. The Chairman of Enron, Kenneth Lay, his wife contributed close to $800,000 to the Republican party since 1988. During the 2000 presidential campaign, Enron made available its fleet of corporate jets for political travel by candidate Bush.

    What did Enron get in return for their campaign contributions from the Federal Government? Amazingly enough, as far as I understand, Mr. Chairman, they are still in line today for a $254 million tax rebate if the Republican House version of the Economic Stimulus Bill becomes law. Thank you Enron, for all the good work you are doing, and you're going to get a check for $254 million from the American people. Clearly, that's an outrage.

    Several months ago, the Bush Administration refused to assist California and other States cope with severe energy crises.

    Chairman BAKER. If you can begin to wrap up, Mr. Sanders.
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    Mr. SANDERS. Costing consumers tens of millions of dollars. There is no question but Enron, through their political contributions and influence, has had an enormous impact on energy policy and the way this Government does business. That's wrong and it's got to be changed.

    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Sanders.

    For the record, I have several documents relating to political contributions by the Enron Corporation to Republicans and Democrats. I will admit those for the record as well, just to keep balance in the hearing record. Thank you, Mr. Sanders.

    At this time, I would like to finally turn to our esteemed witness on our first panel, Mr. Robert K. Herdman, Chief Accountant of the Securities & Exchange Commission, your first appearance before these subommittees, Mr. Herdman. I am very pleased to learn of your acceptance of this position. Your reputation for good work is outstanding, and we are pleased to hear your comments. Welcome.


    Mr. HERDMAN. Chairman Oxley, Chairman Baker, Chairwoman Kelly, Ranking Members LaFalce, Kanjorski and Gutierrez, Members of the subcommittees, thank you for the opportunity to testify today on behalf of the Commission regarding recent events relating to Enron. Your letter of invitation asked me to address the regulatory matters and accounting issues that have been publicly raised by Enron's collapse. My written testimony does address those matters. I ask that it be included in the record.
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    As you know, the SEC is investigating the Enron matter. The Commission appreciates the subcommittees' recognition of the non-public nature of its investigation, and as Chairman Oxley alluded to, the Commission also asks that in light of its ongoing investigation, the subcommittees understand our reluctance to address specific issues relating to compliance with the Federal Securities Laws at this time.

    If I might add, the reason for this, as I understand it from my General Counsel, Mr. Becker, behind me, is that if there is public disclosure about the particulars of an investigation, while it's still in process, that runs the risk of appearing to prejudice the outcome and it might, in fact, jeopardize the investigation. But let me assure you that at the conclusion of this investigation, we will deal swiftly and completely with any wrongdoing and wrongdoers to ensure full protection of investor interests. I want to assure the subcommittees that the Commission shares your grave concern over these events.

    The sudden collapse of a Fortune Ten company gives pause to all of us who care about financial reporting and the tragic consequences of these events for Enron investors, including the many Enron employees whose retirement savings have been decimated, simultaneously with losing their jobs, is a sober reminder to all of us of the importance of reliable and transparent financial reporting. It is axiomatic that confidence in our markets begins with the quality and transparency of the financial information available to help investors decide whether, when and where to invest their hard-earned dollars. The goal of the Federal Securities Laws is to promote honest, efficient markets and informed investment decisions through full and fair disclosure of all material facts.

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    The SEC is tasked with ensuring that markets are transparent and hospitable to all investors. Congress wisely, in the Federal Securities Laws, adopted the philosophy that investors have the right to be fully informed of all material facts, and choose markets that are free from fraudulent, deceptive and manipulative conduct.

    Transparency in financial reporting, that is the extent to which financial information about a company is visible and understandable to investors and other market participants, plays a fundamental role in making our markets the most efficient, liquid and resilient in the world. Transparency enables investors, creditors, and the markets to evaluate any publicly owned entity. Transparency helps investors make better decisions and by doing so, it increases confidence in the fairness of markets. It is critical that all public companies provide an understandable, comprehensive, and reliable portrayal of their financial condition and performance. If the information in financial reports is transparent, then no one is surprised by unknown transactions or events.

    It also is critical that auditors, standard setters, audit committee members and the SEC perform our respective roles with respect to financial statements. My written statement includes information on the accounting standards setting process that exists in our country, the self-regulatory process in the accounting profession, and the role of the SEC in reviewing filings.

    As you know, last month Enron disclosed several errors in its' previously issued financial statements and announced its intention to restate its financial statements dating back to 1997. As the subcommittees have requested, my written statement provides an explanation of the accounting and auditing literature and several of the issues discussed in Enron's recent filing. Specifically these deal with restating previously issued financial statements account for special purpose entities or SPEs, and the $1.2 billion reduction in shareholders' equity.
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    Also at the request of Members of the subcommittees, my written statement explains the mark-to-market accounting applied to contracts for the purchase or sale of energy contracts. As I said at the outset, the Commission will move expeditiously in its investigation in the Enron matter and will take appropriate actions.

    Regardless of the outcome of the issues surrounding the Enron situation, the SEC is working to improve and modernize our financial disclosure system. Our goals are to make financial statements more transparent, easier to understand, to foster private sector standard setting that deals appropriately with current and immediate needs, and to work with the accounting profession to ensure comprehensive and effective self-regulation.

    Chairman Pitt's op-ed piece in the Wall Street Journal yesterday outlined these and other of the Commission's planned improvements to our current reporting and financial disclosure system. We believe these are extremely important initiatives that will constitute much of the Commission's work in the coming weeks and months. And I am pleased to advise you that today the Commission is issuing cautionary advice regarding the need for corporations to make full and fair disclosure about what we're calling ''critical accounting policies.'' As we continue to move forward, the Commission looks forward to working closely with the Congress on these and other issues of importance to the investing public.

    Thank you for the opportunity to appear today. I'm happy to try to respond to any questions Members of the subcommittees may have.

    Chairman BAKER. Thank you, Mr. Herdman.
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    The Committee will return next month to review practices which have been initiated in the last session. There has been ongoing staff work and research effort and efforts to come to closure with my staff on recommendations which should be forthcoming early next year. I hope we will be initiating a similar process with regard to at least consideration of the SRO approach with regard to the CPA industry, or whatever might be the appropriate recommendation from the SEC to consider.

    Although the current body of law, in my view, would seem to be adequate, I think the complexity of modern business structures may have surpassed the rules we currently have in place, which would then lead us to a discussion of a rewrite of the 33–34 codes, which would be a long-term, obviously extensive process. The short term issue for me, though, is without regard to a fact finding in the matter of Enron, does current law provide sufficient penalty and what is the nature of the penalty for self-dealing either inaccurate disclosure or withholding disclosure or violation of meeting the duty of care standard or your fiduciary responsibility.

    Can you tell us without making a statement as to a finding relative to the performance of Enron officials not related to the question. If someone were found to violate those standards, what would be the penalties available to the Commission today in pursuit of bringing someone to responsible justice?

    Mr. HERDMAN. Mr. Baker, I'm aware that the Commission has a wide range of sanctions that it can impose against companies, and in certain cases against individuals. I really have to defer the discussion of the specifics, because that is not my area of expertise.
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    Chairman BAKER. We've got a couple more and we may get back to this, but let me just save that for the record, and at an appropriate time, to keep us moving, perhaps a response pursuant to the hearing would be helpful.

    With regard to regulation in the current environment, it seems an element that works for compliance is simply not to disclose if there is a question in your mind if you can do it properly as opposed to an affirmative responsibility in the law to make disclosure of material elements without having to make the judgment. If it's material, you disclose it. Had we had that standard, in fact, would that have helped with the transparency concerns and the current concern.

    Mr. HERDMAN. I really can't speculate about how things might have affected the particular matters with respect to Enron. The entire question of moving to a system of current disclosure with affirmative obligations to disclose is one of the important parts of our program to improve financial reporting coming up——

    Chairman BAKER. Let me characterize it this way. A statutory or regulatory requirement for affirmative disclosure certainly would not have made the matter more difficult. It possibly could have helped.

    Mr. HERDMAN. Certainly.

    Chairman BAKER. With regard to the adequacy of current disclosures, and they are extraordinarily sophisticated, in trying to wade through the financial statement of Enron, well, it put me in my place. I don't know—is there anybody within the SEC that really goes through, from A to Z, the entire document on their own without outside help who can read these things and understand what business risks are presented? Or have we gotten information that's so convoluted that a person in good faith, who is reasonably educated still is rather lost. Make me feel better, please.
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    Mr. HERDMAN. I assure you that we have on the staff of the Commission people who are quite expert in these matters and do go through documents filed with us from A to Z. Having said that, I won't deny that at times that can be a daunting task, because financial statements today are very complicated.

    Chairman BAKER. Let me ask it this way. If you had had the time and the staff available and someone in the casual review of the data currently required under law to be disclosed, could they have determined that financial reversals were in the future from the current disclosure format, or do we need to be looking at a different way of making relevant information more understandable?

    Mr. HERDMAN. Without commenting on Enron here, Mr. Chairman, I think most financial statements today are not designed to provide information about the future. However, our rules for disclosure and management's discussion and analysis does require a certain forward looking focus particularly with respect to matters that have occurred in the past that might not be reasonably expected to occur in the future.

    Chairman BAKER. For example, we're going to buy a waterworks company in England—I'm just making up something here—and we don't know much about waterworks and we're going to spend a lot of money, that's a material thing, it doesn't necessarily mean it's adverse, but disclosures of where you might be going in business judgment could have been helpful to people trying to understand the scope of business which a hedge fund-like business might engage in.
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    Mr. HERDMAN. Disclosure is designed to provide transparency.

    Chairman BAKER. Lastly, because I've exhausted my time, with regard to pro forma reporting, as opposed to cap standards, will there be recommendations, further recommendations with regard to revision of the pro forma methods of accounting or reporting as opposed to the current Generally Accepted Accounting Principles?

    Mr. HERDMAN. At the present time, I'm hopeful and expect that the cautionary advice that the Commission issued just several weeks ago will take care of any abusive practices that have existed in the past.

    Chairman BAKER. Let's assume we're going forward without looking historically. There would be pro forma reporting, which would have led to a misunderstanding in the marketplace. Under current rule, given your recent advisory, what would be the consequences for a corporation or a CFO issuing those pro forma advisories that were found to be inappropriate?

    Mr. HERDMAN. I can't generalize, but if such disclosures are made in a way that violates the anti-fraud provisions of the Securities Laws, then I expect that there will be vigorous enforcement action taken.

    Chairman BAKER. I can surmise, given the sensitivity of the response to the current environment, you feel adequately armed to respond to inappropriate conduct in current circumstance once you have made a factual determination of wrongdoing?
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    Mr. HERDMAN. I believe that that's correct. I'm not sure that I can speak for the entire Commission.

    Chairman BAKER. We want to make sure you have the tools you need to do the job that's ahead of you. If that is not the case on further reflection, please advise the subcommittees as to areas of concern that you can identify that may warrant the subcommittees' assistance.

    Mr. HERDMAN. We will certainly do that.

    Chairman BAKER. Thank you very much, Mr. Herdman.

    Mr. Kanjorski.

    Mr. KANJORSKI. Mr. Herdman, looking over the overall policy, is it your belief, as a professional accountant of the SEC, that we have sufficient transparency or as the sophistication and possible manipulation of disclosure statements by corporations becomes so fuzzy as to really not constitute true transparency.

    Mr. HERDMAN. Congressman, I think that our capital markets are clearly the best in the world, and our accounting and financial reporting are widely acclaimed as the best in the world as well.

    Mr. KANJORSKI. So is it your interpretation that this is a singular occurrence that occurred because of economic situations, or did this occur because of stock being artificially bid up and played because of an over accentuation of revenues and the hiding of debt?
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    Mr. HERDMAN. I really can't say at this point what has led to Enron's demise with any certainty. That's something that we certainly hope to learn as part of our investigation. As that progresses, as we learn things, we'll be looking to see whether there are indications that there may be other problems out there.

    Mr. KANJORSKI. Are there other Enrons out there or do you feel this is a unique situation?

    Mr. HERDMAN. I think at this point, it is premature for me to answer that question one way or the other.

    Mr. KANJORSKI. I may assume there may be other Enrons out there?

    Mr. HERDMAN. There may be.

    Mr. KANJORSKI. What is the SEC doing to determine whether that's the case, and how will you disclose that to the public or to the Congress?

    Mr. HERDMAN. Well, when problems are found in a particular industry, the staff of the Division of Corporation Finance, which does review filings, makes it a practice to take a look at the filings made by other companies in that industry and proceeds, if there are indications of non-compliance with Generally Accepted Accounting Principles, unclear disclosures, and so forth, enters into a common process back and forth with the registrant. If there's not a satisfactory resolution of those matters, and if the staff of the Division of Corporation Finance believes that it's warranted, there are instances where a referral is made to the Division of Enforcement for follow-up by them.
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    Mr. KANJORSKI. With regard to the special purpose entities, is this a widely used methodology in large corporations, specifically to avoid disclosure of the true nature and condition of the main corporation?

    Mr. HERDMAN. It's not an uncommon practice, Congressman, for special purpose entities to be engaged. While special purpose entity transactions have the effect of excluding certain things from a corporation's financial statements, there are a number of very valid reasons why corporations do enter into them, including the fact that they often offer the potential for reduced interest costs as well as certain tax advantages in some instances.

    Mr. KANJORSKI. So from your general overall view of the occurrence here at Enron, you would say that the investing public doesn't have to have a fear that this may be endemic to the system, but this is just a unique, separate situation that just happened?

    Mr. HERDMAN. I don't think any of us can say that at this point, Congressman. I think that the Enron situation raises questions about an entire system of financial reporting and confidence in that system.

    Mr. KANJORSKI. I notice, as I looked at the Chairman's chart of Enron Insider Trading, you can almost see a picture that the insiders were getting out at the absolute top point, and they did it in several instances. They took their life rafts and got out about 6 months ahead of when the ship was finally going down. Are you looking at insider trading to be an indicator that there may be something that the insiders are aware of that the investing public isn't aware of?
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    Mr. HERDMAN. With respect to Enron, I can't comment obviously. With respect to whether that's a procedure that might be useful, that's something that we would consider. I don't have any personal knowledge of whether that's an accepted practice today among the staff of the commission.

    Mr. KANJORSKI. I'm just trying to see what we can do as a Committee in the Congress to make sure there aren't other innocent investors out there in the public. Should they be somewhat alarmed when they start seeing the insiders getting out in large bulk? They may not want to go in. Obviously, the analysts didn't bring this to anybody's attention. The accountants didn't bring this to anybody's attention and the SEC didn't bring it to anybody's attention. So there are a lot of babes in the woods out there that own stock, and they are trading in these securities thinking that they were a very secure corporation, and all the insiders are handing out life jackets.

    Mr. HERDMAN. I think the question of whether shareholders should pay particular attention to trading by insiders is an interesting one, but frankly, Congressman, that's outside of my area of expertise, really to comment.

    Mr. KANJORSKI. Do you clearly by the disclosures made on insider dealing disperse that information to the general public sufficiently?

    Mr. HERDMAN. I can't answer your question.

    Mr. KANJORSKI. If I were on a boat and I saw some water on the floorboards and I saw the captain and the crew jump off the boat real fast, normally at sea I think I'd grab a life jacket and jump too, because they must know something I don't know. It seems to me in stock transactions it's somewhat similar. And if it isn't, if we're not getting that disclosure out there, the fact that the captain and crew are jumping overboard, then we've got to find a vehicle to alert people.
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    Mr. HERDMAN. I am aware that there are requirements for disclosure determined by insiders, and that information is made public.

    Mr. KANJORSKI. I yield back my time.

    Chairman BAKER. Thank you, Mr. Kanjorski. I'm sure those dispositions were purely coincidental and in time will prove there was no relationship.

    Mrs. Kelly.

    Mrs. KELLY. Thank you, Mr. Chairman.

    Mr. Herdman, I'm interested in the mark-to-market accounting standards that energy traders are given. It's a sophisticated kind of thing. A lot of people who invest are not really, I think, aware of what's going on there. I wonder, given the difficulties in ascribing a value to some of these transactions with this policy, don't you think it's led to some misleading information that's been provided to investors? I'm not asking specifically about this, but investors in general?

    Mr. HERDMAN. I don't know that there's any evidence to indicate that mark-to-market accounting has led to misleading information to investors. The broker-dealers in this country have used mark-to-market accounting to account for their activities for many, many years. They have sophisticated financial instruments that aren't quoted on exchanges that need to be accounted for at market value. And so estimates need to be made of value in order to accomplish the mark-to-market process. Energy trading contracts can be and are very, very complicated and they sometimes go on for periods of time as I understand it that go beyond the period of time where there are quotes, either for purposes of forward contracts, or broker-dealer type contracts, and therefore they require that a model be developed that takes into account recency of other transactions and mechanics such as that, leading to an estimate of fair value.
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    That really is the difficult part of it. It's fairly easy to mark-to-market a financial instrument that is traded on the New York Stock Exchange. Even I can calculate that. But the calculation of the market value of a third year contract to supply electricity requires a great deal of specialized expertise.

    Mrs. KELLY. Is the SEC looking into changing any of these rules with regard to the energy policies, the energy companies?

    Mr. HERDMAN. As I said at this time, Chairwoman, we haven't seen any indication that the mark-to-market accounting has caused problems for companies within the energy industry. If we do, we would certainly expect that there might be a need to tighten up the accounting rules here.

    Mrs. KELLY. Do you think that the investors and transparency would be helped if the SEC and the FASB clarified the principles of mark-to-market accounting?

    Mr. HERDMAN. I think the principles of mark-to-market accounting are quite clear in the accounting literature that exists today, and the circumstances under which it should be done.

    Mrs. KELLY. Yes, you said earlier that this was a bit murky with regard to energy.

    Mr. HERDMAN. What's not rigid in the accounting rules today is a specified methodology for how to calculate the market values.
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    Mrs. KELLY. And perhaps you might be looking into that.

    Mr. HERDMAN. That's a possibility.

    Mrs. KELLY. I also understand that FASB has been reviewing standards related to the consolidation of the financial statements by parents and the SPEs for 10 years. Do you find it a little troubling that FASB still is looking and has taken that long to address this?

    Mr. HERDMAN. The policy FASB has had on consolidations includes considerations of the treatment of special purpose entities. We are encouraged at this point that the FASB announced just recently that it is refocusing its project on consolidations to address a number of issues that really are at the heart of the SPE question, and we're very hopeful that they will proceed apace with that and get it done, however, subject to all of the due process procedures.

    Mrs. KELLY. Perhaps, sir, you could at the SEC make sure that it's sooner rather than later. It has been. We need to see a little sooner on this, I think. If I understood your testimony correctly, you said you've issued new cautionary advice with regard to critical accounting policies today. Could you describe that for us?

    Mr. HERDMAN. Certainly. What we're doing is getting something out for this year end to encourage companies to make disclosures of a type that really have not been made before. We're doing this with a view toward accomplishing better disclosure in the 2001 annual reports, as well as facilitating work that we're going to be doing in 2002 to move to very definitive rulemaking in this area. But what these particular disclosures would relate to, critical accounting policies, which we are characterizing as those that really make a difference in a company's financial statements, but also require extremely complex and subjective judgments to be made by management in their application. And often the complexity and subjectivity is due to the fact that there needs to be very sophisticated estimation processes in order to take into account the fact that a lot of accounting has to grapple today with the uncertain effects of the future. So better disclosure about those kinds of things we think will help to mitigate the potential for surprises in the future.
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    Mrs. KELLY. My time is up. Thank you very much.

    Chairman BAKER. Thank you, Mrs. Kelly.

    Mr. Gutierrez.

    Mr. GUTIERREZ. Thank you very much. Thank you for participating this afternoon with us. Some in the accounting industry have argued that the accounting rules have become too complicated for companies to apply rationally and for auditors to apply in connection with their audit. Do you believe this is true?

    Mr. HERDMAN. Congressman, accounting rules have become very, very complicated, but let me also point out that the world is very, very complicated in terms of the types of transactions that are engaged in today which are also very complicated. At the same time, I think that the fact that the FASB is in the process of studying a project that they want to put on their agenda to deal with complexity in the accounting rules is very encouraging. I think that's terrific, because the accounting literature we have today rivals—in fact, exceeds—the size of the Internal Revenue Code and all the various regulations that pertain to that. Ultimately the accounting rules have to be applied by people. Simplification would be a good thing.

    Mr. GUTIERREZ. Is the goal of a meaningful disclosure to provide investors with an accurate and complete picture of a company's financial condition? And has the SEC considered a top down review of accounting disclosure rules? You talked about them a little bit earlier on today.
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    Mr. HERDMAN. One of the critical projects we're going to be working on in the coming months is a real look at the nature of financial information that is conveyed to shareholders. Certainly at this point, we are considering things in addition to the current system of periodic disclosure, and we'll be working with many, many people that are interested in this and are providing and will provide input to us about things like disclosure by companies of trend information on a more current basis than just quarterly disclosure about changes in those types, those kinds of trends that might give earlier warnings about the company's prospects of going up or going down, and all those kinds of things.

    Mr. GUTIERREZ. I think that's excellent. I look forward to working with your team, and obviously, the Members of these subcommittees on doing that, because an accurate picture might have helped a lot of people at Enron, because given what we know today, we didn't get an accurate picture.

    I would just suggest that maybe—and this is a humble suggestion on my part, Mr. Herdman—as you look at the situation, the specific situation with Enron, that you look at the relationship—it's simply a suggestion on my part that you simply look at the relationship between insiders and selling their stock options. The Chairman has been very, very kind to share with us this form, this graph. I mean, January of 2001, you've got the insiders at Enron selling over $160 million worth of stock. Maybe you should look at that, and maybe we could find a way so that, as Mr. Kanjorski said, because it sounds to me that's kind of like the captain jumping off the ship, when the insiders are selling all their stock options, they are obviously not keeping them. And as we look at the sheet, they sold it at the highest point and then they went in May is the next time, and it seems that they sell things at the highest point. They know what's going on, they're inside obviously. That's why we call them insiders. Those are the executives.
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    And if you have a CEO, as in the case of Enron, that's going to sell $100 million worth of his own stock, and it would be good and prudent, in my humble opinion, it would be good and prudent and advisable for the public to know, hey, the CEO is selling all the stock, selling $100 million and we know about it in January so that everybody knows, at least to that extent, what he knows. We can't put him there like his wife wanted a new yacht or his college kid's tuition came up, although I don't know what college you would send someone to for $100 million, but you never know.

    We don't have to know why they did it, but at least know that they did it and when they did it. It's a simple suggestion, because I think that way we would all know.

    Mr. OSE. Would the gentleman yield?

    Mr. GUTIERREZ. Sure, I would.

    Mr. OSE. The insider trading by the Board of Directors of a Fortune 500 who are members of the management team are in fact tracked by the SEC. You can read them in the Wall Street Journal on a regular basis.

    Mr. GUTIERREZ. I would yield, but you know something, if you can read them, then it's interesting that nobody knew about it, and nobody read about it and nobody made a note about it, and maybe our friends here should take a note about it and what kinds of action they can take when somebody's doing specifically that. I know there are Members of these subcommittees that want capitalism to thrive at any extent. I'm certainly a capitalist, but when you have tens of thousands of employees losing their jobs, I think it's a regrettable situation and we should look at ways to correct that situation.
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    Chairman BAKER. Thank you, Mr. Gutierrez. You will note on the form that the document made reference to in the left hand corner, this source is the insider and Form 144 filings, so to support Mr. Ose, there are mechanisms by which this information is publicly available. The real question is as to timing and understanding and I think that perhaps is the bigger concern.

    Mr. HERDMAN. Congressman Ose is correct. It's published in the Wall Street Journal periodically, but certainly I'll follow up on your suggestion, Congressman.

    Chairman BAKER. Chairman Oxley.

    Mr. OXLEY. Thank you, Mr. Chairman.

    Mr. Herdman, the Enron collapse clearly points out the need for Congress to act on netting legislation. Our good friend from Pennsylvania, Mr. Toomey, has that legislation ready to go. Does the SEC have a position on that issue, and if so, what is it?

    Mr. HERDMAN. The Commission is in favor of the netting provisions of the Bankruptcy Bill. Chairman Pitt did sign that letter in November that was also signed by the Chairmen, I believe, of six other regulatory agencies. He signed it on behalf of the SEC and the Commission is very much in favor of that legislation.

    Mr. OXLEY. Mr. Herdman, is it your understanding that if we're able to pass the Toomey legislation before Congress adjourns for the year, that the court would be able to use the netting provisions in the law in the Enron case specifically?
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    Mr. HERDMAN. I can't answer that question, Mr. Chairman. I'm not an expert on that in bankruptcy law.

    Mr. OXLEY. We'll follow up. Thank you very much.

    Mr. Herdman, as you know, there have been a series of accounting shortfalls. Waste Management, ZZ, Sunbeam, and now, of course, Enron—the grandaddy of them all. Does this suggest a systemic problem? If it may, what is the SEC planning to do to alleviate that systemic problem?

    Mr. HERDMAN. I think it's premature, Mr. Chairman, to conclude about whether there are systemic issues here. I also believe that it would be premature to look to only one potential source of whether there might be a systemic issue. Instead, there's work that needs to be done by all concerned in these processes.

    Like Chairman Pitt's op-ed piece in the Journal the other day points out that things need to be done with respect to faster standard setting. Things need to be done with respect to the analyst community, the Big Five accounting firms and the NCPA have already stepped up and said they're going to take a look at self-regulation, the self-regulatory structure that exists today to determine what types of improvements might be needed so there are issues here. The SEC can and will work hard to improve our review process for the review of filings with us, so there are lessons to be learned here for everyone.

    But, I think it's premature to say that that translates into a particular, or a series of particular, systemic issues.
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    Mr. OXLEY. I too read the op-ed piece in the Wall Street Journal by Chairman Pitt. I was most impressed with the breadth and scope of what recommendation that he gave. Obviously we will be pursuing that as a committee, particularly when we take up SEC reauthorization early next year. But indeed, it's fair to say that even before all of the bad news came out of Houston, that the Chairman had already put on the table numerous modernization efforts, and indeed, as you know, many of the regulations date back to the 1934 Act in a modern world of instant communications. In many ways, we still rely on the quarterly report, and I think one of the best ideas he had was more timely disclosure. And obviously the technology and the infrastructure is there today to do that. Maybe even Mr. Gutierrez will be able to pick up some insider trading information electronically instead of having to leaf through the Wall Street Journal.

    My friend from California here is apparently flogging the Wall Street Journal for whatever reason, but I think it does point out that the new Chairman has recognized that we are in a new environment here, and that modernization of our structural regulation is clearly called for. And for that end, we thank you and the Chairman for their aggressive work in that area, and I yield back.

    Chairman BAKER. Mr. Chairman, I would just point out that if it is not a systemic regulatory problem in the matter of Enron, then one would not have a large leap to assume that there's at least significant fraud or criminal conduct. I can't imagine that every person in Enron engaged in that activity. It's got to be one or the other. I would hopefully land on the systemic side for necessary reform and review, and then assume than everybody engaged in activities there was not aboveboard.
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    Mr. LaFalce.

    Mr. LAFALCE. With respect to netting, this is not a new issue. The House of Representatives has passed netting legislation not only in this Congress, but in the Congress before this and in the Congress before that, and so has this Senate. But the leadership of the House and Senate has put this in a bankruptcy bill that is destined to go down to defeat. We need to extricate the netting provisions that have passed three successive Congresses and simply pass it independently if there's such bipartisanship in support of netting. And I was a co-author of all the bills. Let's do it.

    Mr. Herdman, you recently came from the private world of accounting from Ernst & Young, and you are the Chief Accountant now for the SEC. My first question is, very briefly, what are your responsibilities as opposed to the Chief Accountant within the Enforcement Bureau?

    Mr. HERDMAN. The chief accountant in the Enforcement Division works strictly on enforcement matters. As the Chief Accountant of the Commission, I am the principal advisor to the Commission on accounting and auditing matters and——

    Mr. LAFALCE. Would you be more involved with policies, procedures, and general practices, and your counterpart would be more involved with the specifics of individual situations?

    Mr. HERDMAN. That's a fair generalization, Congressman.
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    Mr. LAFALCE. Let's go back to your days at Ernst & Young. There are basically five big accounting firms worldwide I believe. You vie with each other. You want to represent clients because that's the only way you make money, so you have to be competitive. But there's a tension that exists, because you have certain fiduciary responsibilities as members of the accounting profession, and you have other fiduciary responsibilities either to your clients or to the public at large. Tell me a little bit about what you do when a CFO is engaging in practices that are not black and white, but are very grey and make you feel ill at ease. And how could the system be improved to make sure that the grey comes out white rather than black?

    Mr. HERDMAN. First of all, Congressman, auditors have a code of ethics that they follow. As part of doing that——

    Mr. LAFALCE. Accountants do, lawyers do, and doctors do, and virtually every professional organization does. One of the difficulties is sometimes that the code is not too clear or it's not enforced too well.

    Mr. HERDMAN. The code in this case is quite clear, Congressman. Accountants and auditors owe a duty and care and professionalism to their client, and also a duty to make sure that the financial statements that they certify are according to Generally Accepted Accounting Principles and that their audits are performed in accordance——

    Mr. LAFALCE. The CFO is about to do something or is doing something and the audit committee is either unaware of it or goes along with it. And you really don't think they should, although you suppose they could push the envelope that far. What do you do under those circumstances?
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    Mr. HERDMAN. You should keep in mind that recently the accounting profession, as part of its part to implement the recommendations of a blue ribbon panel on audit committees from several years ago, implemented a requirement that auditors meet and discuss with audit committees and management the audit partner's assessment of the quality, not just the acceptability of the accounting principles that companies are following.

    Recently in a speech that I gave last week——

    Mr. LAFALCE. You know, sometimes there's a tendency to say what you think they want to hear, especially if you want to keep them as clients. I'm not saying that it's never once done, but when you're dealing with a firm, and Arthur Andersen I believe is the smallest of the big five, 85,000 employees, how many employees worldwide does Ernst & Young have?

    Mr. HERDMAN. One-hundred-and-fifty-thousand.

    Mr. LAFALCE. I would imagine it's difficult to monitor the activities of 150,000 people, try as hard and best as you can. I'm just wondering how we could improve the system. I know Mr. Pitt wants to improve the system. I'm just wondering if self-regulation is going to be good enough.

    Mr. HERDMAN. Congressman, that certainly is a topic that has to be considered at this point. I also would encourage you to think about the fact that big public accounting firms do have numerous controls and procedures to ensure that their people do follow the firm's policies and positions.
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    Mr. LAFALCE. But every now and then, there's a little bit of a slip that amounts to $90 billion, and an awful lot of people get hurt. And I'm not sure how many more $90 billion blips are out there. I do know that your predecessor, Mr. Lynn Turner, referred to the restatements that existed thus far as the tip of the iceberg, and I'm wondering whether Enron is the tip of the iceberg.

    Mr. HERDMAN. I think it's premature to come to that conclusion.

    Mr. LAFALCE. I think it might not be.

    Mr. HERDMAN. I think it's very important at this point that we recognize the seriousness of the Enron matter, but at the same time we should neither under react to it, nor should we overreact to it.

    Mr. LAFALCE. We ought to react to it very aggressively.

    Chairman BAKER. Thank you, Mr. LaFalce.

    Mr. Shays.

    Mr. SHAYS. Thank you, Mr. Chairman.

    Enron's collapse is obviously heartbreaking for the investors and the employees and the retirees who are dependent on it. I don't invest in these individual stocks if I'm not going to do due diligence, but it amazes me that the people who do due diligence—I'm interested in Enron, but I'm also interested in the implications for other investments in other companies. I'm particularly interested in the special purpose entity and I'm new at this and I'm trying to understand it.
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    I gather that if you have more than 3 percent ownership, you have to consolidate and I gather that one of the values of these funds is that it enables you to apply assets.

    What I want to understand first is basically the 3 percent rule was established by the SEC. FASB declared it, but it was SEC generated. And the issue of the controlling test or the risks versus rewards your people in the SEC have been over the last 10 years trying to describe different tests with qualitative factors as well as quantitative factors. I'm looking at one speech that was delivered to the 28th Annual Convention of the current SEC Development by Dominick Ragone, I guess who works for you, a professional accounting fellow. And he went through all of these, which seems to me to almost set up a confusing process for the accounting firms and others.

    And one is I want to know why the SEC doesn't just step in and get this resolved and why it doesn't do it sooner. And I carry with me the basic view that it used to be ''the large ate the small,'' but now it's ''the fast eat the slow.'' And it seems to me you can't have a system that takes so darn long to resolve.

    Mr. HERDMAN. I think, Congressman, actually the first statements that were made by the SEC staff with respect to special purpose entities were directed particularly toward certain leasing transactions.

    Mr. SHAYS. Towards what?

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    Mr. HERDMAN. Towards leasing transactions. Those statements were made in the late 1980s. The Emerging Issues Task Force of the FASB put together a working group which I chaired.

    Mr. SHAYS. So what's your point?

    Mr. HERDMAN. We got rules that were pretty quick with respect to special purpose entities back in 1990. There have been some ongoing comments by the staff with respect to that, but on balance, I think that the special purpose entity accounting is working as well as could be expected right now, but it does cry out for the FASB to finish their project and conclude whether a different set of rules should be enacted.

    Mr. SHAYS. I'm a little confused. What confuses me is my sense is the SEC has been injecting itself in this debate and looking at a standard different than the 3 percent. Isn't that accurate?

    Mr. HERDMAN. Congressman, I'll have to look into that. I've been on board for 2 months. In the time that I've been here we have not been injecting ourselves particularly in that debate.

    Mr. SHAYS. In his speech he said the staff believes that the registrant should not apply any specific factor to determine the sponsor of an SPE and believes that all the facts and circumstances of each transaction should be considered carefully. In this regard, the staff believes registrants should consider the following qualitative and quantitative factors in evaluating who was the sponsor, who the sponsor is of an SPE. And then basically it has a number of qualitative factors and then you have a few quantitative factors.
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    Bottom line, do you think we're going to be able to continue to exist with FASB and the SEC not resolving issues more quickly?

    Mr. HERDMAN. We do need to and it's one of the major points that was made the other day in Chairman Pitt's op-ed article. We need to foster an environment where private sector standard setting moves quickly and decisively to deal with the important issues.

    Mr. SHAYS. Tell me to someone like myself who isn't an investor, tell me what the purpose is of a special purpose entity. I mean, I look at it and I think, why does it exist?

    Mr. HERDMAN. Special purpose entities exist in order to finance—this is a generalization. There are many types of special purpose entities that engage in different types of things. As you may be aware, the banking industry, the credit card aspect of the banking industry relies extensively on securitization, thus providing for the bank a source of liquidity to carry on their ongoing operations.

    This is a huge market. It's done with a great deal of transparency, and there are other types of special purpose entities that are created perhaps to finance particular investments. There are special purpose entities that are created to provide leasing facilities to a company. It's a way to achieve financing, and oftentimes there are some tax advantages associated with the use of these types of entities.

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    Chairman BAKER. Would the gentleman yield?

    Mr. SHAYS. Yes.

    Chairman BAKER. I think there are structural reasons why SPEs have a legitimate purpose, but I think the analysis should be, and I don't know that it has been, does the creation of the SPE create real value for the underlying shareholder of the principal corporation, or in this case, were the SPEs used for self-dealing of the official to profit at the expense of the taxpayer? That's what hasn't been determined.

    Mr. SHAYS. And then the question would be does this happen in other companies and in other areas? I thank the gentleman.

    Thank you, Mr. Chairman.

    Chairman BAKER. I thank the gentleman for yielding.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman, Mr. Herdman. I want to follow up on what Mr. Shays was talking about. But I also want to say, a moment ago—and I can't remember who was asking the question—on the issue of restatements—and I think you're trying to be sincere of just being there for 2 months and looking at this, I think the increasing—it may have been the Chairman's question—I think the increasing volume of restatements is somewhat alarming. And I hope that the SEC is taking a harder look at that.
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    Now I don't know if it's systemic or not, and the more you look at the Enron case, it really does seem to me this is not—it's not certainly not—they didn't fail because of a cyclical reason or a recessionary reason or an economic reason. It certainly appears to me that they failed because of some severe structural reasons in their corporate governance.

    And I think the Chairman is right about the SPEs, and your comments are as well. They can be an attractive, an efficient financing vehicle. But in this case, isn't it a problem or shouldn't it be a problem for the SEC or the auditors, which the auditors did apparently find at one point, when on the one hand you're calling debt an increase in equity and you're really swapping what you're doing. They were double counting notes receivable and double counting equity when it was going the opposite direction. And the restatements were quite severe.

    And isn't it also a problem in having a restatement of a billion dollars plus of equity that's not just going back to the beginning of the quarter that you were filing the 10-Q for, but going back not just 4 quarters, but 4 years? And does it appear—and I know you have to be circumspect on your comments with respect to Enron because it's under investigation. But it seems to me to have every appearance of either using the SPEs as an artifice or self-dealing of some sorts. Even your own chronology in your statement.

    Mr. HERDMAN. I think, Congressman, you referred to the double counting of the notes receivable in the stockholders' equity. What has been disclosed with respect to that indicates that it does not go back 4 years. About $170 million of it arose in 2000 and the other $830 million arose in 2001.
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    Mr. BENTSEN. But they reduced their net income going back 4 years as it related to——

    Mr. HERDMAN. Reduction of that income——

    Mr. BENTSEN. ——as it related to—I think as it related to both Jedi and Chewco. Right. In those they restated it going back to 1997——

    Mr. HERDMAN. That's correct.

    Mr. BENTSEN. ——to the point where they would have, instead of having net income, they would have had a net loss, which is somewhat substantial to the investing public.

    Let me ask you this. When they went through the transition, the CFO was out, the CEO was out. The chairman of the board resumed the role of CEO. In a conference call with analysts, the issue sort of came up, if I understand the chronology correct, that $1.2 billion of equity basically had washed away, no longer existed.

    The chairman and now CEO states in response to a question from analysts, ''Well, that's over my head. I'm not sure I know the details of that and the special purpose entities.'' Isn't it a problem when you have the chairman of the board of a Fortune 500 company, publicly-traded company, and not a penny stock company. It is today. But it certainly wasn't a penny stock company then—who doesn't understand the financing mechanisms of the company as it's operating?
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    Is there a question here of corporate governance and is the SEC looking at that issue? Was the audit committee functioning properly? Are we through the 1933 and 1934 Acts or through the tools you have, are we sure that the boards of public companies are operating efficiently for the benefit of shareholders and the investing public and the pensioners, for that matter?

    Mr. HERDMAN. Congressman, your question carefully weaved in and out of Enron, and to the extent that it pertains to Enron, as you understand, I can't address that.

    Mr. BENTSEN. Well, address it as a hypothetical.

    Mr. HERDMAN. As to a generality, of course chairmen of boards and audit committees should understand the important elements, the material elements of financing for the entities with which they're associated.

    Mr. BENTSEN. Is the SEC doing enough? I mean, obviously, you can't sit and review every company's board minutes and all of that. But, I mean, do you think that the SEC is providing enough oversight in that area? I mean, if everything that has been said turns out—or if half of everything that's been said turns out to be true, the collapse of Enron is going to be one hell of a story and what happened and a huge miss on the part of the board and potentially its auditors.

    I mean, I can see where certain things can be missed and certain, you know, the contract with the copying machine company maybe wasn't the best deal you could get——
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    Chairman BAKER. Could you begin to wrap up, Mr. Bentsen?

    Mr. BENTSEN. But this is a pretty big deal.

    Mr. HERDMAN. The processes that the SEC uses to review filings have been basically based on a selective review process now for 20 years. And we don't talk about the particulars of that process in public, because we don't want companies to know, frankly, when they'll be subject to review and when they won't be subject to review.

    I can assure you, Congressman, that continuous improvement has been the hallmark of working with that review process. And I can certainly assure that going forward, we will continue to do that. We will learn the lessons that are out there to be learned from what we might discern from the Enron matter, and we'll apply those to improving our processes.

    Mr. BENTSEN. Thank you. Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Bentsen.

    Mr. Toomey.

    Mr. TOOMEY. Thank you, Mr. Chairman.

    A question on the SPEs if I could. First of all, maybe you could correct me if I have this wrong. But my understanding is that if you own 2.9 percent of the equity, you as some corporate entity own 2.9 percent of the equity of an SPE and you meet the other criteria regarding the control of the SPE, then your balance sheet is essentially silent on that fact. It doesn't reflect it in any way. Is that incorrect?
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    Mr. HERDMAN. No. Congressman, the 3 percent doesn't have to do with what the company that enters into a transaction with the SPE owns. It has to do with the fact that many SPEs could be formed and providers of capital would be quite comfortable to provide 100 percent of the financing of an SPE in the form of debt securities. Let's say that that SPE was formed to carry out a sophisticated leasing program for a major program. This SPE could be formed. It's a legal entity. It could borrow 100 percent of the money from banks or private.

    What these rules say that in order for there to be enough substance to the SPE, in order for it to be viewed as an entity independent from the sponsor, somebody has to put in some common equity to it.

    Mr. TOOMEY. Right.

    Mr. HERDMAN. And that common equity has to be at least equal to 3 percent of the total capitalization of the SPE.

    Mr. TOOMEY. OK. That's an important clarification. Thank you. If the corporate entity that wants to create the SPE provides a certain amount of that 3 percent equity and other entities provide the rest, then is there a requirement that the be represented on the balance sheet at all?

    Mr. HERDMAN. Yes. That would have to be on the balance sheet.

    Mr. TOOMEY. That would have to be?
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    Mr. HERDMAN. If the 3 percent isn't owned by independent entities, and the other conditions are met, of course, then the SPE would have to be consolidated on the balance sheet.

    Mr. TOOMEY. It would have to be consolidated when the sort of sponsoring corporation has less than 3 percent?

    Mr. HERDMAN. No. It has to be consolidated if the SPE doesn't have at least 3 percent of its total capital owned by outsiders.

    Mr. TOOMEY. I understand.

    Mr. HERDMAN. Independent third parties who have common equity-type capital.

    Mr. TOOMEY. Right. I understand that. I guess what I'm getting at is there is a set of criteria, there are rules that allow for someone to create an SPE. They follow all the rules and they are allowed to change not to consolidate that SPE or in fact they're required not to consolidate it, right? And my question is, if the contribution, if you've made some kind of contribution, say you've contributed your own equity to part of the capitalization, but not so much that you would consolidate, but if you do it in a fashion that has the additional proviso that you'll top up that contribution in the event that the value of your stock declines, then that creates a contingent liability on the part of the sponsoring company, correct? Would you consider that?
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    Mr. HERDMAN. In the rare event when a sponsoring company would be part of the capital structure of an SPE, that's potentially—you could view it as a contingency. I don't think that it would consider it to be a contingent liability.

    Mr. TOOMEY. Do you think it should be?

    Mr. HERDMAN. It would have to be recognized on the financials.

    Mr. TOOMEY. Right. Well, it seems to me it certainly is a contingent liability. It's equivalent to having sold a put option on your own stock, and therefore it would be required to be reported. Is that correct?

    Mr. HERDMAN. They're really very complicated rules on the accounting for put options and call options on your own stock. And I'd be glad to get back to you on these issues if you'd like to explore this further.

    Mr. TOOMEY. Yes, I think I would, because it seems to me——

    Mr. HERDMAN. There's a lot of detail here.

    Mr. TOOMEY. And it seems to me that this was part of what was going on with at least one of the SPEs that Enron had created. And I'm just wondering whether that had contributed to a larger exposure than perhaps was evident.
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    Mr. HERDMAN. I can't comment on the Enron aspect of it.

    Mr. TOOMEY. I'll yield the balance of my time to my colleague, Mr. Ose.

    Mr. OSE. Thank the gentleman from Pennsylvania. Mr. Chairman, I do want—it's ironic. I was reading through the Wall Street Journal as I listened to some of the comments about the insider trading spotlight, and in fact today, Wednesday, December 12th, there's the most recent report on insider trading listing the top eight or ten individuals, both on the buy and the sell side and the top six or eight companies, both on the buy and sell side. And there's a little footnote down here. It's a Wall Street Journal link. ''See a list of companies with the highest number of insiders filing Form 144 with the SEC disclosing their intention to sell restricted stock.''

    So it would seem to me that the information is being collected at the present. It's in the public domain. There may be some people who perhaps aren't aware of that fact. But as it relates to any directorships or managerial positions liquidating stock, it's a matter of public record by rule, if I understand, that has to be disclosed.

    Mr. HERDMAN. That's correct, Congressman.

    Mr. OSE. Now there's also a secondary cut, if you will, and that is that—correct me if I'm wrong, Mr. Herdman—that members of the board of directors or members of a management team only have specific windows during which they can sell stock that they receive. Is that correct?
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    Mr. HERDMAN. I understand that to be true. But I couldn't give you the particulars on that, because that is a matter of law.

    Mr. OSE. The reason I asked that is somebody put together a very red document here that highlights the sales seemingly on a—for some purpose, but I wonder whether the windows correspond with the dates showing the large amounts of sales. I think that's worthy of being checked out.

    Chairman BAKER. I can help you, Mr. Ose, because if you look down at the left-hand corner it says ''Source: Insider and Form 144 filings.'' That's all the corporate records. And what happened is there were two different types of actors here, a Mr. Lay who sold—I don't have the correct pronunciation—who sold in large blocks. Mr. Lay, however, sold in $10- to $100,000 blocks virtually every week, some every day. So if there were windows that were closing, they took a long time to close in the case of this particular matter.

    Mr. OSE. But there are windows during which they——

    Chairman BAKER. Apparently so. There were a goodly number of them in this case.

    Mr. OSE. Are there different types of stock? This is where I get beyond my level of knowledge. And that is, with respect to senior management, do they hold restricted stock and unrestricted stock? Is that what you're saying?

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    Chairman BAKER. They were exercising stock options. Normally they would be in an acquisition on the morning of the day and the disposition of that same stock that afternoon, and there were various classes of stock being exercised, I'm assuming in accordance with their contractual relationship with Enron, whatever their employment agreement guaranteed them, they were entitled to receive and therefore make disposition of.

    Mr. OSE. And they were eligible to do that because they met certain minimum financial requirements on a personal basis?

    Chairman BAKER. I'm certain that was——

    Mr. OSE. Which are not necessarily available to someone working lower down in the company?

    Chairman BAKER. It was clearly a benefit of their contractual relationship as an employee of Enron, as an officer.

    Mr. OSE. OK. I understand I'm on Mr. Toomey's time. I want to come back to that question. Because the issue of why certain people are eligible to hedge their exposures and others aren't has been the substance of significant debate in these subcommittees and over in the Agriculture Committee on which I sit, relative to the minimum financial standards a participant must meet.

    And coincidentally and quite interestingly, there's been a lot of argument that people who are going to participate in hedging of exposures must meet certain minimum financial requirements. And in fact, that has been a demand from one side of the aisle in particular. And I think that merits investigation, because it's at the heart of people participating in the 401Ks getting stuck, if you will, when stock collapses. And I'm hopeful you'll come back to me, because I know I'm on Mr. Toomey's time. So thank you, Mr. Chairman.
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    Chairman BAKER. And Mr. Toomey's exhausted time. Thank you, Mr. Ose.

    Mr. Sandlin.

    Mr. SANDLIN. Thank you, Mr. Chairman. Just briefly. And thank you, Mr. Herdman, for being here today. The goal of meaningful disclosure is to provide the investors and the market with an accurate and complete picture of the financial condition of the company. Is that correct?

    Mr. HERDMAN. That's correct.

    Mr. SANDLIN. And the public is protected at least in part by an independent audit and by SEC oversight. Is that correct?

    Mr. HERDMAN. That's correct.

    Mr. SANDLIN. It's already been brought out today the issue about the partnerships with SPEs. But it's not been brought out—it's my understanding in this particular case, the partnerships were run by the officers of the company. Is that correct? Of Enron.

    Mr. HERDMAN. That's what's been reported, yes.

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    Mr. SANDLIN. And it's my understanding that these partnerships also were unnamed partnerships. Is that correct?

    Mr. HERDMAN. What kind of partnerships?

    Mr. SANDLIN. Unnamed. That they were not identified by name.

    Mr. HERDMAN. I believe that's correct from the disclosure I've seen, yes.

    Mr. SANDLIN. Would this not cause—that's not in accordance with normal business practice or generally accepted accounting principles, is it?

    Mr. HERDMAN. Congressman, I don't believe that there's a generally accepted accounting principle requirement with respect to related party transactions that specifically calls to name the names of the partnerships.

    Mr. SANDLIN. So, you think it's fine, then, just to list partnerships, but not by name and not to indicate that the partnership is run by an officer of the company?

    Mr. HERDMAN. No, that's not what I said.

    Mr. SANDLIN. That's what I'm asking.
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    Mr. HERDMAN. If that is the related party, is the officer, and generally accepted accounting principles does require disclosure of certain things with respect to——

    Mr. SANDLIN. That's what I thought. Disclosure of——

    Mr. HERDMAN. ——the transactions.

    Mr. SANDLIN. Now these partnerships were treated in this particular case as a separate entity, correct, from Enron?

    Mr. HERDMAN. We're now starting to get far too specific.

    Mr. SANDLIN. OK. In the event that a SPE is set up or a partnership is set up in this sort of situation, then that partnership is considered as a separate entity from the original company. Is that correct?

    Mr. HERDMAN. An SPE or a partnership that meetings the applicable accounting rules to be considered is separate.

    Mr. SANDLIN. And that allows debt to be moved away from the original company. Is that correct?

    Mr. HERDMAN. What that does, Congressman, is it says that the debt that's incurred by the SPE doesn't have to be consolidated in the financial statements of the company that does business with the SPE.
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    Mr. SANDLIN. But in the event that the company or SPEs are set up properly or do not meet accounting principles, then you're allowing the liabilities and equities of the company and ultimately the stockholder be distorted. Is that correct?

    Mr. HERDMAN. Could you repeat that question?

    Mr. SANDLIN. My point is, you're allowing debt of an original company to be spun off into an SPE that's run by an officer of the original company in order to move debt away from the original company so that the stockholder equity appears much higher than it is. Is that correct?

    Mr. HERDMAN. My experience, Congressman, with respect to SPEs is that they normally do their own borrowing.

    Mr. SANDLIN. Should auditors be involved in auditing partnerships or SPEs that they have a part in setting up?

    Mr. HERDMAN. I don't know what auditors would be doing in terms of setting up partnerships. They're not lawyers.

    Mr. SANDLIN. If an auditor that's a part of an accounting firm or a law firm is a member of that same firm and helps set up an SPE or a partnership, should that same firm then regardless of your artificial restrictions within the firm, should that same firm be involved in auditing that setup?
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    Mr. HERDMAN. I don't think there would be any prohibition against doing that.

    Mr. SANDLIN. You don't see a problem in the fact that an accounting firm or a law firm would set up a partnership and then turn around and audit its own work? You think that's fine?

    Mr. HERDMAN. Accounting firms don't practice law, so they don't set up partnerships.

    Mr. SANDLIN. I'm very aware of that. Well, let me ask you this. Should it raise a red flag for an auditor, if a firm is setting up a special purpose entity transactions in the firm's own stock? Is that a red flag?

    Mr. HERDMAN. If the transactions are material to the company's financial statements and if the auditor is aware of them, I would expect that that would be something that the auditors would pursue diligently.

    Mr. SANDLIN. Now the press reported that the enforcement division of the SEC sent a letter in October to Enron about having questions about their disclosure. Could you tell us what disclosures raised the red flags for you?

    Mr. HERDMAN. The disclosures that prompted the letter were those that were made in an October 16th press release in which Enron released the results of its operations for its third quarter of 2001.
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    Mr. SANDLIN. What factors does the SEC consider to determine what filings it's going to review?

    Mr. HERDMAN. Congressman, as I said earlier, the selective review process that's used by the staff of the Commission to determine filings for review is not a topic that we discuss publicly, because it would take what element of surprise is in it out of it, and companies might know better when they might expect to be reviewed.

    Mr. SANDLIN. I'm being tapped, and I think that means I'm done. Thank you for your response.

    Chairman BAKER. Thank you, Mr. Sandlin.

    Just make a brief announcement for the subcommittees. I have to step out for a moment. Mr. Bachus will assume the chair. We'll proceed with questions of Mr. Herdman until—I understand there's a likely vote on the floor about 1:30. It's my hope that all Members could get their questions in before that vote.

    And I'm making this announcement for our second panelists. Pending that vote, we would take a few minutes for a lunch break and probably try to come back around 2:15 if the vote occurs around 1:30, which is a guess at this point. But to let our panelists know they will have a few minutes from whenever that vote occurs, and Members, a little time to grab a sandwich and come back. Let's just make it 45 minutes from whenever the bells first sound so we can get a vote in, get some lunch, and then come back for the second panel.
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    Mr. BACHUS. [Presiding.]

    Mr. Royce.

    Mr. ROYCE. Thank you, Mr. Chairman.

    Mr. Herdman, are you troubled by Enron's use of partnerships to keep significant liabilities off of the balance sheet?

    Mr. HERDMAN. Congressman, I can't comment about any of the particulars of the Enron matter because of the pendency of our investigation.

    Mr. ROYCE. OK. Well, let me ask you then in a broader scope here. Do you see ways in which the SEC can encourage or maybe compel companies to provide financial information that's useful to investors on more of a real time basis? Let's say for large corporations monthly rather than quarterly financial statements. Would that be helpful in your view?

    Mr. HERDMAN. I don't necessarily think that a requirement for monthly financial statements would be helpful. But the things that we're going to be considering with respect to improving the totality of financial reporting could very well lead to disclosures of financial and other types of performance indicator information on a more frequent basis than quarterly.

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    Mr. ROYCE. Well, we've had accounting problems now that are almost systemic. Waste Management. We've had Sunbeam. We've now had Enron. It would seem to me that there would be need to move quickly on developing such changes.

    Let me ask you a question about the ongoing investigation. Let us say that fraud is discovered in this investigation with respect to Enron in terms of insider trading. What is the likelihood that the profits made through fraud through insider trading would then be compelled to be paid back to Enron so that the assets held by the employees of Enron and shareholders of Enron who did not have access to this insider information could then be at least partially benefited?

    Mr. HERDMAN. That's beyond my personal expertise, Congressman. I just don't know all of the particulars about the specific remedies the SEC has available, including the potential for disgorgement.

    Mr. ROYCE. Well, let me just close by saying it seems to me that investors need current information that is, in fact, true on a real time basis, and we have not developed to date apparently an effective system to make sure that it's delivered on a timely basis to them, and I would suggest that the SEC look at changing its procedures in a way that effectively does that, because the Congress is certainly going to look at finding ways to prod just such changes.

    Mr. HERDMAN. Congressman, Chairman Pitt, since the time he's assumed office, has been talking about modernization of the financial reporting system, including more current information. Congressman, if you'd like, I could ask our general counsel, David Becker, to respond to your question about remedies and recoveries.
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    Mr. ROYCE. Certainly I'd be happy to hear from the general counsel. Thank you, Mr. Herdman.

    Mr. BECKER. Congressman, on remedies, we do have a variety of remedies in cases in which we can go to court and get disgorgement of ill-gotten gains. If the folks who misbehave still have the proceeds of the fraud, we'll get them and we'll——

    Mr. BACHUS. If you could lean a little closer to the microphone.

    Mr. BECKER. Sure. If the folks who violated our anti-fraud rules still have the proceeds of the fraud, we'll get them, and we'll make them give it up.

    Mr. ROYCE. Well, I would suggest that besides changing the ground rules so that we can get this information to investors on a more timely basis, that the other part of the equation is to aggressively pursue just such actions so that there will be a deterrent effect in the future. And I thank the gentleman for his answer.

    Mr. HERDMAN. I agree with you very much, Congressman.

    Mr. BACHUS. I thank the gentleman.

    The lady from Ohio.

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    Mrs. JONES. Thank you, Mr. Chairman. Lots of questions, not enough time. You stated earlier that we should not overreact to a situation such as Enron. What would be an overreaction, sir?

    Mr. HERDMAN. An overreaction might be to say that financial reporting is not trustworthy in this country. I think that would be an overreaction.

    Mrs. JONES. What should we say, then, if based on Enron, financial reporting in this country is?

    Mr. HERDMAN. I think we should say that financial reporting in this country is challenged and appropriate steps need to be taken to learn what needs to be done to improve it, and that should be done quickly.

    Mrs. JONES. OK. The filings that we're talking about on the chart over there on insider trading, these insider and Form 144 filings. How often are they filed, sir?

    Mr. HERDMAN. I'm not an expert. I believe that they're filed on a transaction basis. In other words, if an insider sells——

    Mrs. JONES. Can your general counsel answer that question for me?

    Mr. BECKER. I hope so. On the Section 144(a) transactions, they have to be filed fundamentally contemporaneously on general sales of stock they have to be filed, I believe, monthly or within 10 days.
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    Mrs. JONES. Say that again, please. I didn't hear you.

    Mr. BECKER. Fundamentally, they all have to be filed within 30 days.

    Mrs. JONES. Is there a level of insider trading that would cause the SEC to say hello?

    Mr. BECKER. Well, the short answer is depending on what else is going on, yes. If there's an extraordinary transaction and folks have traded and we want to know why.

    Mrs. JONES. OK. I'm Company Outwalk, so you don't have to talk about Enron. And in January I had $180 billion million worth of insider trading. Would that make you go ''Wooo''?

    Mr. BECKER. I suspect that that's something that we would look at. I will tell you, though, that the fundamental philosophy of the Federal securities laws is get the information out and have investors evaluate the wisdom of their investment decisions. We do look at a variety of sources, including visual patterns of trading, to see if there is any fraudulent conduct going on.

    Mrs. JONES. But, the goal and purpose, Mr. Herdman, the Chief Accountant, U.S. Securities and Exchange Commission, is you have an oversight obligation over all these different accounting firms and auditing firms and the OAB, which was the office of—the POB, excuse me, the Public Oversight Board, to sit with them and give advice and counsel on the standards of what becomes appropriate accounting procedures. Wouldn't something like that be part and parcel of something that you would say to the world? Well?
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    Mr. BECKER. This information—our fundamental mission is to see to it that information relevant to investors is out in the public and that financial statements and disclosures are fully transparent to the public. And this type of information is information——

    Mrs. JONES. You know what? You could sit down if you'd like.

    Mr. BECKER. Oh, thank you. Mr. Herdman's got his briefcase here, so I wouldn't. So, in fact, this type of information is information that's pushed out to the public quickly. One of the paradoxes—not talking about Enron in particular—one of the paradoxes, and this is where the role of analyst comes in, is that often that there is information out in the public, but people don't necessarily focus on it and take it as seriously as in hindsight they should.

    Mrs. JONES. Let me ask this, then. We've got a company—I called myself Outwalk. And Outwalk, my company, not only is showing $180 million worth of insider trading, but is—let me back up. Is there an obligation to also show how many subsidiaries or partners that you have as they become partnerships under your or become what do you all call them? The SPEs or something?

    Mr. BECKER. I think this is one for Mr. Herdman.

    Mrs. JONES. OK. I'll take him.

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    Mr. BECKER. But, the basic answer is, sometimes yes, sometimes no.

    Mr. HERDMAN. SPEs sometimes are accounted for as subsidiaries, in which case there would be information about them, and sometimes if they meet the appropriate standards, they're not accounted for as subsidiaries, in which case there wouldn't be information about them.

    Mrs. JONES. Based on what we know about my company—Outwalk—and perhaps it would not be an overreaction for us to look how do we let the public know that there are a number of FPEs or SBEs operating within a company that could, in fact, camouflage the economic condition of a company such that poor little me, who doesn't know anything about this area that I'm investing in, might think twice before I would invest my money in Outwalk Company?

    Mr. BACHUS. The lady's time has expired.

    Mrs. JONES. Thank you, Mr. Chairman. Can I get a quick yes or no on that question? Can I get quick yes or no on that question?

    Mr. HERDMAN. I'm sure that's something that the FASB, when they finalize their rules on SBEs, will take into consideration.

    Mr. BACHUS. Thank you.

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    Mr. Herdman, there's been some disturbing allegations with respect to the failure of the board of Enron to monitor the activities of management, in particular related to the special purpose entities, the SPEs, as you've referred to them, and the related party transactions. What would you recommend to increase board oversight for these kinds of transactions and entities?

    Mr. HERDMAN. Congressman, there have been significant developments in the various structures about audit committees, about boards in recent years, particularly about audit committees. And the Commission really has no plans to do anything further with respect to rulemaking in that regard. And once again, this is an area where I believe that if we learn something as a result of our investigation that should be applied more broadly, we'll move ahead aggressively with that.

    But at this point, there have been significant changes in what audit committees do, in the amount of their interaction with auditors, and so forth. And those are all fairly recent within the last year or two. And right now there's no indication that that's an area that needs something to be done with it.

    Mr. BACHUS. OK. How should a board react when they think that generally accepted accounting principles or GAAP-compliant disclosures are inadequate?

    Mr. HERDMAN. Well, under the conditions today to be a member of an audit committee—and these are encompassed in rules—as I say, they were not that long ago enacted by both the New York Stock Exchange and Nasdaq, is that members of audit committees have to be quote/unquote: ''financially literate'' and each understand enough about accounting and about financial reporting and financial statements to be able to critically engage management and the auditors in discussions about the accounting principles that are used, the disclosures that are made, and so forth.
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    That being the case, when these discussions occur, if there are instances where the financial statements or where management doesn't intend to follow generally accepted accounting principles for some reason or it doesn't want to make a disclosure that is required by generally accepted accounting principles, the discussion has to be with the members of the audit committee if discussions just between management and the auditors haven't yet resolved the problem. That's not to say that if the right accounting doesn't get used and the right disclosures don't get made that the accountants would give a clean opinion in dialogues that occur, these sometimes are iterative, and the audit committees do have an important role in those types of matters.

    Mr. BACHUS. Thank you.

    Yesterday, Chairman Pitt called for a self-regulatory organization for CPAs. Does the commission intend to issue a rule proposal for public comment on this? Or do you know what the timeline is?

    Mr. HERDMAN. Actually, Congressman, the article today that indicated that Chairman Pitt called for a self-regulatory organization, I think, misspoke. And where the Chairman and where the Commission are at this point is we've begun a dialogue with the accounting profession, with the major firms in the AICPA. They've indicated that they're going to take a look at what changes are needed to the self-regulatory process. We're eager to continue to work with them on that, and we're not predisposed at this point to either a continuation of the current system of self-regulation or to a statutory self-regulatory organization.

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    Mr. BACHUS. OK.

    Mr. HERDMAN. If that were to go in the direction of an SRO, I believe that in order to be enacted it would have to be a matter that was put out for notice and public comment.

    Mr. BACHUS. Now are you also considering something like an enhanced FASB or an enhanced AICPA or something like that? Or are you talking about just an entirely new body?

    Mr. HERDMAN. What we're talking about is the self-regulatory structure that currently is housed within the AICPA in its Division for Firms and is overseen by the Public Oversight Board, which is comprised of individuals of high integrity that are not practitioners of accounting and what have you. That's the structure that exists today. It does certain activities. They're outlined in my testimony. And the questions have to do with are those activities sufficient? Does more need to be done? Does discipline need to be more transparent, and so forth. Those kinds of issues.

    Mr. BACHUS. OK. Thank you.

    Mr. Mascara.

    Mr. MASCARA. Thank you, Mr. Chairman.

    Mr. Herdman, when did the SEC suspect there was a problem at Enron? And what action did the SEC take? And how soon afterwards? I heard you mention in an earlier question the third quarter, October of 2001, was it?
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    Mr. HERDMAN. The first letter Congressman, was a letter that was sent to Enron on October 17th of 2001.

    Mr. MASCARA. And what action did you take?

    Mr. HERDMAN. We sent them a letter requesting that they provide more information about the losses that had been reported in their earnings press release the prior day.

    Mr. MASCARA. What role does the SEC play in SPE filings? I would imagine there is some kind of a filing someplace that someone's required to file. Did you say earlier that these liabilities do not appear if they have 3 percent invested in the total offering? On a consolidated statement, do these numbers appear there?

    Mr. HERDMAN. What I said earlier was they do not appear on the consolidated financial statements if the owner of the special purpose entity has invested in equity capital of that entity in an amount that's equal to 3 percent or more of its total capitalization, and its total capitalization would include the amounts that the entity borrowed from various sources.

    Mr. MASCARA. It's my understanding that Enron had a plethora of SPE filings. So if they invested a minimum of 3 percent, they would not be required to place that liability on their balance sheet? I think that's outrageous if the answer is yes.

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    Mr. HERDMAN. It's not, as I said earlier, Congressman, this is complicated, but it's not how much Enron has invested in the SPE or another sponsor of it. Let's not talk about Enron. When a sponsor of an SPE invests it's—because they can't invest anything. It's how much is invested in by independent third party investors.

    Mr. MASCARA. So if any independent investor invests at least 3 percent, Enron or any other company would not be required to list the liability on their balance sheet on a consolidated balance sheet?

    Mr. HERDMAN. That's correct, Congressman. The sponsor before the 3 percent requirement was put in place was quite willing to lend 100 percent of the capitalization of SPEs in order to effect these transactions.

    Mr. MASCARA. How is your staffing at SEC? Is it sufficient to oversee the financial world of risk that's many times out there? Do you have enough employees to oversee those activities?

    Mr. HERDMAN. I'm certain we have enough employees in the Office of the Chief Accountant. With respect to the other divisions, we're constantly looking to see where and how we can use our resources better and to redeploy resources to particular issues that—you know, radiate attention at a particular point in time.

    Mr. MASCARA. I have an accounting license. I'm asking you this question because I can't answer it. Does any of this have to do with what went on recently in the dot.coms where people were looking at anticipated revenues rather than anticipated earnings? Is there any similarity between the——
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    Mr. HERDMAN. Based on what, Congressman, I don't see any similarity at all to the dot.coms. The dot.coms were speculative entities that generally didn't have much history in their business. They frequently have enough cash to carry out their money-losing activities as a result of the public investing the cash. Notwithstanding the fact that there was clear and transparent disclosure that these companies were vulnerable, that they didn't have any, and so forth. That was all out there on the table, and yet a lot people bought those stocks and I guess today wished that they hadn't.

    Mr. MASCARA. Thank you, Mr. Herdman. I think we've just touched the tip of the iceberg. I'm afraid what's coming. But I thank you and I thank you, Mr. Chairman.

    Mr. BACHUS. Thank you, Mr. Mascara.

    We intend to recognize Mr. Inslee and then Ms. Jackson-Lee. There's probably about 7 minutes left on the floor, so for such time as we have, I'm going to recognize Mr. Inslee first and then Ms. Jackson-Lee.

    Mr. INSLEE. Thank you, Mr. Chair. I represent a district up in the State of Washington. I can tell you that my constituents have a lot of real hard questions here. And the reason is is that they think of Enron as sort of a financial octopus with tentacles not only just into the investor community, but that touches Americans in a lot of different kinds of ways.

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    And one of those kinds of ways is in the energy field, the energy prices and the like. And I heard one of my colleagues say something I guess I'll take a little issue with to say that somehow Congress should not get to the bottom of the question of how this company hijacked America's energy policy. Because it appears from the press reports that I'm reading that there's good reason to believe that Enron's fingerprints are all over the American energy policy that exposed my constituents in the State of Washington to millions of dollars of overcharges last year in the electrical market and have led us into the situation where the country has huge failures in our energy policy.

    And there are questions that I think—and I hope you and others help us answer—like, is the reason that we're giving Enron $254 million in tax relief instead of investing in clean energy is the answer Enron? We'd like an answer to that question. Is the reason that the Administration is doing nothing about global climate change, is the answer Enron? Is the reason the Federal Government is not taking action to improve automobile mileage standards, is the answer Enron? Because there's a lot of evidence that at least we've been hearing about, about the ability of Enron to affect our Government's policy, and we're very concerned about that.

    And there's a relationship between this financial world and the energy world. I was just reading, I think it's in the Los Angeles Times, it's talking about Mr. Lay's role in the replacement of one of the FERC commissioners. And it says, as the New York Times reported, ''Ebert [phonetic] had barely settled into his new job this year when an unsettling telephone conversation with Kenneth Lay prodded him to back a faster pace in opening up access to electricity transmission grid to companies like Enron.'' Lay admits making the call, but in an unctuous defense of his influence peddling said: ''the final decision on Abrams [phonetic] job was going to be the President's, certainly not ours.'' Soon after, Ebert [phonetic] was replaced by Texan Pat Wood, who was favored by Lay.
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    I think that there are a lot of questions here that are going to be related to the abuse of stockholders to also the abuse of energy payers, consumers, and those who care about our whole energy world. And we encourage you and others to engage in trying to answer those questions that Americans have.

    And I want to ask you one specific question about abuse of stockholders and employees. And I know you can't comment on the investigation, so I'll ask you in a hypothetical form. If a company on October 17th, the very same day the SEC announced it was investigating that company, chose to change plan administrators of their 401K, which thereby automatically locked in their employees so they couldn't sell their product. And then the insiders, including some of the executives that were partially, in my view, responsible for the pathetic energy policy we have in this country, to go on this binge of selling their stocks to jump ship and leave their employees in a sinking ship, is that, number one, legal? And number two, is there disclosure required for that activity?

    Mr. HERDMAN. Congressman, I think what happened to the employees with that 401K plan is just one of the most terrible things I can imagine. However, nothing about 401K plans comes under the jurisdiction of the Securities and Exchange Commission. Those are matters that have to do with the Department of Labor. And as to whether there would be a need for disclosure in SEC documents, I don't believe that there would be.

    Mr. INSLEE. Well, should we consider requiring disclosure that if executives are going to treat their employees, of essentially getting into the lifeboat and leaving them on a sinking ship, should we consider requiring disclosure on that in some regard?
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    Mr. HERDMAN. I don't know whether there was disclosure made to the employees in advance about the fact that the change in administrator was going to prevent them from changing their investment elections for a period of time. I just don't know.

    Mr. INSLEE. Let me ask a little broader question.

    Mr. BACHUS. I thank the gentlemen for his questions.

    Mr. INSLEE. Thank you, Mr. Chairman.

    Mr. BACHUS. Thank you.

    Ms. Jackson-Lee. And at the end of her questioning, we're going to recess for 45 minutes.

    Ms. JACKSON-LEE. Thank you very much, Mr. Chairman. I'm a guest in this hearing and I want to thank the Chairman. I want to thank the Chairman of the Full Committee, Mr. Oxley, the Ranking Member, the Chairman and Ranking Members of the subcommittees as well.

    I am here because Enron is in the 8th Congressional District of Texas, my District in Houston. The eyes of the Nation, Mr. Herdman, are on these particular hearings, and more specifically the eyes of Houston are on this particular hearing because, of course, Enron was a very good civic and corporate anguish in Houston, Texas now and I believe as it moves across the Nation, in the Nation. As the SEC's responsibilities, if, for example, in 2000 December a stock price of $84 and then around October of 2001 it had a stock price of $33, why did the SEC do more to that particular company—and particularly if there was a loss of about $600 million?
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    Mr. HERDMAN. As I understand it, the loss that you may be referring to wasn't reported until November when Enron announced that it planned to restate its financial statements back to 1997. Once again, as Mr. Becker pointed out earlier, the purpose of the securities laws is to require disclosure, to provide disclosure to investors so that they can make informed decisions about whether to invest, when to invest, when to sell, and so forth. And the fact that a stock price changes—we'll look into this, but I'm not persuaded that that would be an effective means for the SEC to screen filings and determine whether a particular company's filings should be looked at as contrasted to some other procedures that are applied in our selective review process. But we'll certainly look into that.

    Ms. JACKSON-LEE. I appreciate your assessment on that. I would think with the overwhelming—you just answered my question. Wouldn't you think it's now time to reassess or to look into what might be additional resources, regulations and laws that might assist in that review on behalf of the SEC?

    Mr. HERDMAN. We'll be taking a look at ways to improve our processes as well.

    Ms. JACKSON-LEE. Let me close on this question because my other duty is to cast my vote on the floor of the House, and I will return for the second panel. I thank the Chair. With respect to the law, the difficulty that they provide in camouflaging the acts of a particular company. How do we address that and treat that? I'm not using the correct terminology, but truth in information. That is not truthful.

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    Mr. HERDMAN. Ma'am, I don't think you can conclude that it's always not truthful. This is why we have the Financial Accounting Standards Board to develop the appropriate criteria as to when those assets and liabilities should be part of the consolidated financial statements and when they should not be part of their consolidated financial statements, and we will urge them on to the swift completion of that task.

    Ms. JACKSON-LEE. Let me leave you just with this. Maybe we will heighten the standards on the utilization or the proctoring of those kinds of companies. It may not be a question of truth in information, but maybe there needs to be a higher bar.

    Mr. HERDMAN. Perhaps.

    Ms. JACKSON-LEE. Thank you very much.

    Chairman BAKER. Thank you, Congresswoman Sheila Jackson-Lee. We are now going to dismiss this panel. We want to thank the witness for testifying today, and we also want to give the Members of the Congress 30 days in which to put together any additional questions that they might want to ask you. So I'd like to acknowledge that for the record.

    We are going to reconvene with the second panel at 2:15 after this vote is over. So, thank you again for your testimony here today.

    Mr. HERDMAN. Thank you.

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    Chairman BAKER. By way of advisory, Members will be returning momentarily. I thought it would be helpful to proceed with the receipt of testimony so that by the time we have a full complement and get to our questions there will be sufficient Members here to engage our panel.

    Our first participant this afternoon is Mr. Joseph Berardino, Chief Executive Officer, Arthur Andersen.

    Before I recognize you for your comments, Mr. Berardino, I just want to, by way of personal acknowledgment, express my appreciation to you in the manner in which you have responded to the subcommittees in this difficult manner.

    I wish all officials who had similar participation in the issues before the subcommittees had exercised your judgment and expressed your willingness to cooperate with the subcommittees in seeking a commonly beneficial resolution to this matter. So I do appreciate your openness and your willingness to be here today.

    Thank you, sir.


    Mr. BERARDINO. That is very kind of you, Mr. Chairman.

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    Good afternoon. Thank you for inviting me to appear before you today. I am here because faith in our firm and the integrity of the capital market system has been shaken. What happened at Enron is a tragedy on many levels. We are very aware of the impact this has had on investors and the pain this business failure has caused for Enron's employees and others.

    Many questions need to be answered, some involve accounting and auditing. I will do my best today to address these.

    I ask you to keep in mind that the auditing and accounting issues are very complex and are part of a bigger picture. None of us yet know all the facts. Today's hearing is an important step in enlightening all of us.

    If there is one thing you can take away from my testimony, I hope it is this: Andersen will not hide from its responsibilities. That is why I am here today.

    The public's confidence is of paramount importance. If my firm has made errors in judgment, we will acknowledge them. We will make the changes needed to restore confidence.

    In my written testimony, I have addressed two issues that go to the heart of concerns about our role as Enron's auditor: did we do our job, did we act with integrity?

    To aid the subcommittees in their inquiry, I have provided detailed answers to these questions in my written statement and I would like to touch on a few of the key points.
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    On the accounting issues, Enron has said it will restate its financial statements back to 1997 as a result of issues with two special purpose entities or SPEs. These are sophisticated financing vehicles used by many companies. They are well known to the investment community.

    On the larger of these which was responsible for 80 percent of the SPE-related restatement, it appears important information was not revealed to our team. We have notified the audit committee of possible illegal acts within the company.

    On the smaller of the SPEs responsible for 20 percent, we now believe, based on a second look, that our team has made an error in judgment. An honest error, but an error nonetheless. But I do believe we did a professional job overall and that this error did not cause Enron's collapse.

    There have been questions about the sufficiency of Enron's disclosures. It is true that Enron did not disclose every transaction or every contingency. It was not required to. Accounting rules also do not require a company to disclose losses, such as the sudden rapid decline we witnesses in Enron's stock price and credit ratings.

    Finally, let me spend a minute on fees. We were paid $59 million by Enron, including $25 million for our audit. There is a perception that the remaining $27 million was for traditional management consulting work such as installation of computer systems. In fact, the bulk of that $27 million was for audit-related work, tax work and work that could only be done by auditors; $13 million was for consulting work done by Arthur Andersen.
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    Some may assert that even $13 million in consulting work is too much, that it weakens the backbone of the auditor. There is a fundamental issue here. Whether it is consulting work or audit work, the reality is that auditors are paid by their clients.

    For a system to work, you and the investing public must have confidence that the fees we are paid, regardless of the nature of our work, will not weaken our resolve to do what is right and in the best interests of investors. I do not believe the fees we received compromised our independence. Some will disagree and I have to deal with the reality of that perception.

    I am very aware that our firm must restore the public's trust. I do not have all the answers today, but I can assure you we are carefully assessing this issue and will take the steps necessary to reassure you and the public that our backbone is firm and our judgment clear.

    Andersen will have to change to restore the public's interest and confidence and we are working hard to identify the changes we need to make. The accounting profession will also have to reform itself. Our system of regulation and discipline has to be improved and others will have to do things differently as well: companies, boards, audit committees, analysts, investment bankers, credit analysts among others.

    I believe we can work together to give investors a more meaningful, relevant and timely information. My firm, and I personally as CEO, will do our part.

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    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you very much.

    Our next participant is Mr. Charles Hill, Director of Research, Thomas Edison Financial/First Call.

    Welcome, Mr. Hill.

    Mr. HILL. Thank you.

    Chairman BAKER. And grab that microphone and yank it around toward you there. It needs to be pretty close.


    Mr. HILL. Chairman Oxley, Chairman Baker, Chairwoman Kelly, Ranking Members LaFalce, Kanjorski and Guttierez, and Members of the subcommittees, I welcome the opportunity to again testify in front of the House Financial Services Committee. I believe these subcommittees have been addressing substantive issues that are important not only to the future health of the investment community, but important to the general public's perception of and confidence in the overall capitalist system.

    The excesses associated with Enron that led to its bankruptcy are more far-reaching than just their impact on Enron. There is plenty of blame to go around in the mistakes made in the Enron situation. I am here today to focus on the role of the broker analysts in the debacle.
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    In my previous testimony before these subcommittees, I did not tread lightly on what I thought were some serious problems in analyst behavior that needed to be remedied. I am here this afternoon, however, to say that analysts to some degree were more victims rather than culprits in the Enron situation. Not that they were without blame, particularly in the late stages of the Enron collapse, but they were not the underlying cause of the excessive rise in Enron's stock that later proved to be irrational.

    The performance of the analysts should be judged on two fronts. The first is their analysis of Enron's fundamentals, particularly in regard to earnings. The second is their valuation assessment and recommendations of Enron stock.

    The thing that stands out most visibly about the analysts' analyses of Enron is over the 3 years up to October 2001, their estimates at the beginning of each year for that year had minimal changes. The few changes that did occur were always upward and usually followed the guidance given by the company when they reported quarterly earnings.

    The narrowness of the spread of estimates among analysts was remarkable, especially for an energy company. The coefficient of variance for Enron estimates was consistently below the average for the S&P 500 during the same period.

    This pattern is highly suggestive that the analysts were being spoon fed as to what Enron expected earnings to be. The analysts might have been willing to accept company guidance, be it overt or inferred, as long as the company kept meeting expectations each quarter. Since at least the beginning of 1998, Enron has met or exceeded analysts' estimates every quarter.
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    One reason that analysts may have been more willing than normal to accept company guidance for Enron was that it was becoming increasingly difficult to understand how Enron was achieving its revenue growth and profitability. Extensive use of derivatives, particularly when the company is using mark-to-market accounting, is extremely difficult in the best of situations.

    We now know that a big additional reason for the difficulties in analyzing Enron's financials was that there were significant parts of Enron's business that were hidden from the balance sheet.

    Often, the way out for analysts when faced with difficult-to-analyze situations like Enron is to drop coverage. Why take the risk when there are plenty of companies that are transparent enough to do meaningful analysis with confidence?

    The problem with dropping Enron was that it had become the giant in the industry. If you were an analyst covering that industry, you essentially had to cover Enron. That was further reinforced if your firm was one of Enron's investment bankers or investment banker wannabees.

    The real problem, though, was having sufficient information about the off balance sheet items. Whether the accounting for each of these items was within FASB rules or not is not yet clear, although the announced restatement of prior periods earnings is a strong signal that at least not all was kosher.

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    But what is clear is that Enron was not providing what could even be considered minimum transparency in its financials and that the analysts did not have all the tools necessary to make a reasonable analysis.

    In evaluating the analysts' performance on recommending Enron stock, one first has to understand how the brokerage community's recommendation system really works.

    As I have testified before to these subcommittees, the investor needs a two-level decoder. The first level of the decoder gets all the brokers on a common recommendation scale. The most common scale is a five-tiered one, where the top category is a ''strong buy''; the second is a ''buy''; the third is ''hold''; fourth, ''sell''; fifth, ''strong sell.'' Most brokers have a five-tiered scale, some have a four-tierd one, and a few have a three-tierd scale.

    In addition, many have very different terminology. The term ''buy'' may be the term used for the top category at some brokers, or for the second-best category at many brokers, or, in at least one case, for the middle category. There are more than a dozen different terms used for each of the top three categories and almost as many for the bottom two.

    Unfortunately, getting all the firms on a common scale is not the end of the decoding. Analysts are overly biased on the positive side in their recommendations. The typical distribution is about 33 percent of all recommendations are in the top or ''strong buy'' category, about 33 percent in the second or ''buy'' category, about 33 percent in the middle or ''hold'' category, and only about 1 percent in the remaining ''sell'' and ''strong sell'' categories combined.

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    If the recommendations are put in numeric terms where 1 is a ''strong buy''—or whatever the broker's term is for that top category—2 a ''buy,'' and so forth, using this numerical scale consensus recommendations can be calculated for each company.

    Most of the time, the average consensus recommendation for either the companies in the S&P 500, or for the roughly 5,000 companies that analysts cover, is a 2.1. Occasionally, the average may be a 2.0 or 2.2.

    Therefore, the second level of the decoder would move the recommendations into three more meaningful categories—those in the 1 or ''strong buy'' category would really be saying ''buy,'' at least in relative terms. Those in the 2 or ''buy'' category would really be saying they were neutral on the stock, and those in the 3 or ''hold,'' the 4 or ''sell,'' and the 5 or ''strong sell'' categories all would be saying sell the stock.

    For Enron, the consensus recommendation, as shown on a graph that is in the handout, was about a 1.5 from May 2000 until the end of September 2001. Even if we had our decoder to compensate for analyst optimism, it is clear that the analysts covering Enron were very positive with their recommendations.

    But, during that same period, the analysts had similar or higher consensus recommendations on competitors like Calpine and Dynegy. While a consensus recommendation for Enron was much better than the average for S&P 500 companies, their enthusiasm was not limited to Enron.

    In early October 2001, the consensus recommendation spiked up from a 1.5 to a 1.3 as several analysts raised their recommendations ahead of Enron's reporting its third quarter earnings on 16 October.
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    On the day of the earnings announcement, one analyst raised their recommendation, pushing the consensus to a remarkable 1.2. But as the Enron story began to unravel over the next few days, the recommendation downgrades exploded, plus six of the 17 analysts dropped coverage.

    In these kinds of situations, it is easy to point a finger at the analysts for mistakes made. In my prior testimony, and in other forums, I have taken the analysts to task for not performing to an acceptable standard in certain situations. While the analysts are certainly not without blame on Enron, they are not the real culprits in this situation.

    I am not an expert in doing the actual accounting at a company, or in auditing a company's accounting, but having been an analyst for 22 years, as well as closely observing analysts' behavior at First Call for the last 10, I can say without reservation that this was a situation where either the company or its auditors or both were at fault in not providing investors, especially including the analysts, with the tools necessary to understand Enron's business.

    Whether the letter of the accounting rules were met or not, it is patently obvious that the spirit of the rules were violated in that Enron's financial statements did not fairly convey enough information for investors to reasonably analyze the company's operations.

    In that climate, it is hard to be too critical of the analysts' optimism. Enron had a long history of showing consistent and substantive earnings growth. If it had been up to me, if I was in that situation, I would have dropped coverage long before October 2001. The financial reports and details of operations had become more and more inscrutable well before then. But, as I mentioned earlier, most, if not all, analysts did not have that option. All things considered, they probably did as well as could be expected until October 2001, although in hindsight it is easy to say that they could have at least tempered their bullish recommendations to some degree.
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    However, once the issues of the off balance sheet items became an unexplained issue on the 16 October 2001 conference call on third quarter results, it does seem that the analysts could have moved quicker to either suspend their recommendation or dramatically drop the level of their recommendation. The unexplained $1.2 billion balance sheet writedown was not a caution flag, it was a red flag.

    But Enron is not the situation on which to challenge analysts' performance. There are far more significant situations where analysts' conflicts and performance are at issue.

    The lessons to be learned here is how to ensure that companies and their auditors can be relied on to openly provide the necessary tools for investors to meaningfully analyze the company's business.

    Thank you.

    Chairman BAKER. Thank you very much, Mr. Hill.

    Our final participant is Mr. Richard Trumka, Secretary-Treasurer, AFL-CIO.

    Welcome, sir.

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    Mr. TRUMKA. Thank you, Mr. Chairman.

    Good afternoon, Chairman Baker and Chairwoman Kelly and Ranking Members of the committee and subcommittees. My name is Richard Trumka and I am Secretary-Treasurer of the AFL-CIO.

    On behalf of the AFL-CIO and our 13 million members, I would like to commend these subcommittees, and Chairman Baker in particular, for his leadership in calling this hearing and his foresight in looking at the issue of analyst independence last summer.

    I am here today first and foremost to make clear who the victims were in the Enron catastrophe. Let us start with those hurt worst by the conduct of the board and officers at Enron. More than 12,000 Enron employees participated in Enron's 401K plan. On October 17th, the same day that the SEC announced it was investigating Enron, the company implemented a plan to switch 401K administrators, knowing that their decision would freeze employees' accounts and that freezing took three times longer than is normal in these situations.

    Meanwhile, Enron executives continued to sell their stock, continuing a pattern of inside sales that netted a handful of executives over a billion dollars.

    Now, 5,000 of these same employees have been laid off and Enron has tried to extract waivers of liability from these laid off workers in exchange for their severance. Many of the 1,000 members of the International Brotherhood of Electrical Workers at Enron's subsidiary, Portland Gas and Electric, suffered catastrophic losses. Members like Roy Rinard, who watched helplessly, his accounts frozen, as 22 years of retirement savings dwindled from $472,000 to less then $3,500. Or Tim Ramsey, a 33-year veteran, who lost $995,000 from his retirement account.
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    Most pension funds and institutional investors held some Enron stocks or bonds. The AFL-CIO's pension fund held Enron bonds and watched them lose 75 percent of their value.

    Much of this money was going to fund pension benefits for working families, for the public employees we are counting on to protect us during this period of national crisis, for the pensions of the ironworkers, for instance, now clearing the rubble at Ground Zero.

    All of us who have S&P 500 index funds in our 401Ks or mutual fund portfolios lost money in Enron, probably about one-half a percent of the total assets in those type of funds.

    Much of what happened at Enron, as has been stated earlier, remains murky, but from what we know, this is a story first and foremost about conflicts of interest, about a long list of people and institutions that were supposed to look out for workers' retirement savings and instead looked out for themselves.

    Now, what do I mean by a conflict of interest?

    Let us begin with the first line of defense, when management goes sour. That is the board of directors. At Enron, most of the board was independent of the company, according to the SEC filings. But look another layer deeper and you find some of these ''independent'' directors were actually investing in Enron-sponsored limited partnerships.

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    Then there were the auditors. Arthur Andersen, who testified earlier, was the company's long-time auditor, but management was funneling lucrative consulting contracts to Andersen, as was stated, $59 million in fees.

    Then we come to the Wall Street analysts. Practically every Wall Street firm and post-Glass-Steagall commercial bank had an interest in courting Enron. Out of the 13 Wall Street analysts that covered Enron in October, according to Forbes Magazine, 11 were bullish, while the majority of independent investment newsletters were bearish.

    Finally, there were money managers. Alliance Capital, a major money manager for pension funds, shared a director with Enron. Alliance kept buying Enron shares this summer and this fall, so many shares that Alliance ended up as Enron's largest holder. Enron was a company that talked about a future of transparent markets, but whose CFO openly bragged that, and I quote: ''We don't want anyone to know what's on those books. We don't want to tell anyone where we're making money.''

    Enron's mantra was deregulation and privatization and now Enron itself is a demonstration of why workers need both defined benefit pension plans and a Social Security system safe from the conflicts of interest that appear rampant in the capital markets.

    In response to these causes of the Enron fiasco, the AFL-CIO is today submitting two rulemaking petitions to the SEC. These proposals have the support of the Council of Institutional Investors whose members have nearly $2 trillion in assets. We ask in these petitions that the Commission act to ensure independent directors are really independent.

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    In the accounting area, our proposals are aimed to keep auditors independent and include a prohibition on accountants reviewing transaction they themselves structured, direct audit committee approval of any audit consulting arrangement, as well as the audit engagement itself.

    These proposals follow efforts in early November by the AFL-CIO and the Amalgamated Bank, a large index manager of union pension fund assets, to reach out to Enron's outside directors.

    Mr. Chairman, we did that immediately upon the announcement of their losses. We wrote to those independent directors and cc'd all the boards of directors.

    We asked for more independent directors and more extensive disclosure immediately, but we never received a substantive reply. In fact, the independent directors never wrote back. The company itself wrote back saying thanks for your letter.

    In the wake of the Enron bankruptcy, the Amalgamated Bank took the last step remaining open to investors, bringing suit last week in Federal court on behalf of Enron shareholders.

    Our funds will fight as hard as we can to get our money back, but the truth is, only strong Government action, led by the SEC and the Department of Labor, and the support of these subcommittees, and Congress can ensure that investors are not victimized again in this way.

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    Mr. Chairman, I and the AFL-CIO look forward to working with you and these subcommittees in the coming days on these very, very important tasks.

    Thank you very much.

    Chairman BAKER. Thank you, sir, for your good testimony.

    I just want to make a brief comment before asking my first question and that is I can assure all of you that every Member of the subcommittees, regardless of the philosophic perspective, finds no comfort in the fact that thousands of people are unemployed, their retirement benefits gone, their 401Ks vanished. Regardless of the circumstance and how it came to be, this is a most unfortunate event over which there is no happiness anywhere.

    From here forward is the issue. How do we preclude it from reoccurring? In order to do that, we must understand how this came to be.

    I happen to believe that within the capital markets most people, as in politics, get up every morning and try to do the best they can to do the job they are assigned to do. It appears to me without knowing all the facts yet today that there were a few individuals engaged at very high levels within the corporate structure that did not provide the disclosures that are required perhaps by law, but certainly by good moral judgment, either to the accountants, to the analyst community, to the journalists or to anybody else and that it appears from the disposition of assets over the time preceding the bankruptcy filing that their profiteering coincided with the lockout of the employees' access to their own funds. If these facts turn out to be the case, this is a travesty.
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    Now, could a change in our structural law have precluded it?

    I do not know, but that is what we are about.

    To that end, Mr. Hill, you were making the comment that some analysts, because of enthusiasm and the pressure of prominence, take an LTCM, they were making hand over fist great sums of money, very bright people, never had a back-to-back trading loss, banks were throwing money at them, investors were throwing money at them. It was almost as if you had a question about their methodology, there must be something wrong with you, because you did not understand the business model.

    It would seem from what I know now that to a great extent the Enron story is not too dissimilar. The principal difference, however, is that in the closing days of LTCM the principals believed in their own philosophy, they were putting money in. In this case, the principals were taking money out. That is a tremendous difference of great public policy consequence which troubles me greatly.

    But to your point about the independence of the analysts, as of 2:40 today, December 12th, checking by Yahoo! finance page, we have 13 analysts listed covering Enron, we have two ''strong buys,'' we have one ''buy,'' we have eight ''holds,'' one ''sell'' and one ''strong sell.''

    How do you respond to that today? Is there something of value that these subcommittees are missing? How could anybody look at these events and come to the conclusion that this is a ''strong buy'' opportunity?
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    Mr. HILL. I have a problem with the ''strong buys.'' Again, if you have your decoder, you know that the holds are really meaning sell, so the majority of them are saying sell now to those that—as we said last time——

    Chairman BAKER. But given these circumstances and the public discussion and the pending investigations and all the other matters that are out there, why not for the first time break the code and say, for goodness sakes, to the American public, ''sell this stuff''?

    Mr. HILL. I agree.

    Chairman BAKER. If you can.

    Mr. HILL. I agree. But this is not new, you know, this whole thing. I mean, you brought up Long-Term Capital Management, and I have in my notes here that when we got into the questions to mention it, so you beat me to it on that one.

    Not long after I got in the business, there was a company that I was covering called Memorex. It was selling back then at over 100 times earnings. I do not remember the exact date, but it was some time in the early 1970s. Larry Spitters, the Chairman of Memorex, came to Boston to explain to the financial community their lease accounting and we have talked this morning about the similarities between off-balance lease accounting and off-balance derivatives, but same idea, there was no transparency. Part way through the presentation—he was using flip charts in those days—he got to the point where he threw up his hands and said, ''I can't explain it, I can't answer your questions.''
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    I think a lot of us either dropped coverage or went to ''sell'' on Memorex.

    Chairman BAKER. And let me ask on that point, what is the significance in the market if someone drops coverage? What is the decoding of that activity?

    Mr. HILL. Well, assuming it is not because an analyst is leaving or whatever, it is interpreted as there is a problem here.

    Chairman BAKER. So what we also need——

    Mr. HILL. And to me, that was the easy out, would be at that point certainly once that restatement——

    Chairman BAKER. Well, are all these actions, the drop coverage, the hold comment, is this the prominence problem? Is that we do not want to downgrade someone because of the consequences of that to the firm?

    Mr. HILL. Absolutely. And the conflicts are threefold. First is the obvious one that most everyone is aware of, is the investment banking problem. And until we change the compensation situation for the analyst, which means we have got to find some way to go back, for the firms to get paid for research.

    When I was an analyst, my bonus was incentivized to do good fundamental research, but that was when the commissions were high enough that the firm was getting paid for research.
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    Chairman BAKER. Well, let me interrupt you, if I may. I want to get one question in to Mr. Berardino. My time is expiring. If we have a chance for a second round, I really want to come back.

    Mr. Berardino, I think what troubles me, I am standing on the presumption that the in-the-field auditor has no direct benefit from a lucrative contract with the larger firm and that in my view of the operative auditor function, he has a contractual relationship with the company, certainly he wants the company to be profitable. But, in the case of Arthur Andersen, whose gross income per year is in the millions and millions and millions of dollars, the relationship with Enron I do not view as being a significant factor in the judgment of an in-the-field auditor looking at the books.

    What troubles me, I believe, is in this case it appears that individuals who were responsible for disclosing the books or the activities to the in-the-field personnel in most cases may have not been providing you with the appropriate information or insight.

    If that is the case, what do we do about changing the system to correct for that problem? How do you know the data that the auditor is looking at is the real set of books?

    Mr. BERARDINO. That is a very complicated question and a very fundamental question, Mr. Chairman.

    As you probably know, Enron was an extremely complex company. They had over 20,000 employees. In fact, I recently found out they had 600 CPAs. So they spent a lot of time trying to keep their books. They had 3,000 subsidiaries all over the world.
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    And as auditors, you know, we do not live there. We do test checks, we do statistical samples to inspect the transactions as the company presents us the information. And the company does have a legal obligation to present us information that we require.

    Chairman BAKER. Let me do this, because I do not want to run inordinately time since I am trying to keep other folks on the clock.

    To put a simple point to it, must we make the consequences of failing to properly disclose, to provide transparency so severe that it ain't worth the risk?

    Mr. BERARDINO. I think that would be very helpful. It will add, though, and I made this comment in my testimony, it is an illegal act to withhold information from an auditor.

    Chairman BAKER. Well, I understand that and, believe me, in my experience in Louisiana political life, having something be illegal is not necessarily a prohibition. I think we need to have something a little more strenuous than just the fact that you get written up in the books. And I do not know what that is in this case, but it ought to be pretty significant.

    Mr. BERARDINO. Well, that is worth investigating, sir.

    Chairman BAKER. Mr. Kanjorski.

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    Mr. KANJORSKI. Yes. I was just thinking to myself as we heard the dialogue between yourself and the Chairman, if this were 1942, Nazi Germany, and people were talking about the death camps, it seems like a tremendous establishment of plausible deniability. If you do not know, you do not have to answer and you are all home free, other than Mr. Trumka.

    I do not quite sense——

    I will give you a chance, Mr. Hill, are you not outraged? Are you not outraged? Do you two gentlemen just not think this is horrendous, what happened to the shareholders, what happened to the investors, what happened to the employees?

    I mean, do we not have to say something to the system?

    If this system is so broken that the seventh largest corporation in the United States can play these silly games and everybody comes and just says, ''Well, I did not know,'' or ''we did not understand,'' or ''we have these complications,'' are we any different than any other nations in the world that are having problems with transparency?

    Mr. HILL. I think when you get into this derivatives issue, we are in a whole new world and I do not know what the answer is. I do not know whether we need another class of security or whatever for people whose business is essentially driven by derivatives. I do not know what the answer is, but I agree with you, that we have to have some kind of different system because the normal fundamental analysis really does not apply to these kind of companies. I just do not know how you could really do it.

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    Mr. KANJORSKI. Let me ask something. You know, I thought corporate statements were required to give an understanding of what is going on and these special purpose entities, I have to confess, I know very little about them as to how they operate or derivatives. We have had hearings on it, everybody has come in here and said they are so important, they balance and hedge the market and do not worry about it and they get into the trillions and trillions, it is all OK. But why not just disclose it?

    If there is a special purpose entity, why should it not be disclosed? Unless it is constructed, and I think you gave an indication to me yesterday when we talked about this, it is particularly constructed so that it does not hurt the disclosure in the company?

    So here you are.

    Mr. BERARDINO. Well, Congressman, you are obviously getting right to the heart of the matter, which I appreciate. There is no great answer to your question right now. These special purpose entities have been in business for years.

    Mr. KANJORSKI. And I understand that. But, by God, did not the accounting profession say, hey, by having these things, we are not really giving transparency here and disclosure?

    Mr. BERARDINO. Well, you know, there have been great debates and there is a great irony, unfortunately, in all of this. There is been a great debate within the accounting profession as to what goes on off balance sheet and there are two schools of thought, if I could just do a little accounting 101, maybe.
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    One school of thought is if you lose control, if you are an Enron and somebody else has control over these SPEs, simplistically defined as more than a 51 percent vote, these transactions go off your balance sheet, assuming these other tests, 3 percent, and so forth, are passed.

    Mr. KANJORSKI. In spite of the fact that by doing that you lose transparency of what is really occurring in the company?

    Mr. BERARDINO. If you will just bear with me for a second, Congressman.

    The second school of thought, which is the school of thought Andersen has always been in, is that one ought to look at risks and rewards. So even though these transactions went off balance sheet, Enron could maintain 97 percent of the risks and rewards.

    Mr. KANJORSKI. And we are arguing that in the accounting.

    Mr. BERARDINO. We lost that debate within the accounting profession.

    Mr. KANJORSKI. And it has been going on for years?

    Mr. BERARDINO. Things go off balance sheet, it has been going on for years, people know about it.
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    Mr. KANJORSKI. Ten years, I think you told me yesterday. And as a result of that not coming to some conclusion, we are now faced with somebody lost $80 billion, I think a hell of a lot of somebodies who Mr. Trumka was talking about that are important, and innocent investors and a lot of bad guys who were inside traders made billions while this thing was going to hell in a basket.

    And now you are putting Congress as representatives of the people in the position that if we have had enough and we are fed up, you are telling us the Government better come in and regulate your profession, the corporations, disclosure, the business interests of this country seem to me to make the most compelling case in the world of we need heavy regulation.

    And that sort of offends me, because I felt that we could rely on the decency, the honesty and the professionalism that the professions aiding these corporations and the corporate executives would be using the highest moral and ethical standards and I just—somebody was in the hen-house. And I think it is up to you guys to tell us who that was. And then let us find out—are we going to slap them on the wrist with a $1,000 fine and put them in jail for a year so they can take their billion dollars in jail and speculate and make two or three billion? Or maybe set up some more special purpose entities out there?

    Mr. BERARDINO. Congressman, I am here voluntarily because I want to be part of the solution. The points you raise are valid. I understand them. I do not feel good about where we all are. But I think the Chairman set the right tone here by saying we have to learn from this. We are prepared to shed whatever facts we can on the accounting and auditing side of this because I think we can get it better.
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    Mr. KANJORSKI. And I appreciate that and I want to tell you I appreciate you having the—I am trying to use the right word here—nerve to be here today. I think my patience at this point is fully tested. I applaud the petitions for regulations filed by the AFL-CIO. I think America is going to go back to a lot of instances of re-regulation where it will be counterproductive to the market if we do that, but it is going to happen because people are not going to take it, $80 billion, what that means to America, where we could go with it, and to allow——

    I do not know whether this is a Ponzi scheme or what the hell it is, but when the best analysts from the best investment banking in the country are, at a time when everything is gone, still recommending heavily that people buy and put their pensions, their savings—I think we have to do something and I think that is very unfortunate, that the business community here is forcing the Congress on behalf of representing the people to get involved with the accounting profession on conflicts of interest, with the analysts and the way they get paid. That should not even be an issue, as you indicated.

    We have so many compromises out there it is amazing that anything is working in this system.

    I know I have had my time. Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Kanjorski.

    Mrs. Kelly.
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    Mrs. KELLY. Thanks, Mr. Chairman.

    First of all, I want to say thank you, Mr. Trumka, because you represent a lot of people, not only in AFL-CIO, but by your words today you represent a lot of other people out there in the United States who also got involved, not because they were in the union, but because they trusted. And I think it is important that your testimony was heard.

    I want to turn to you, Mr. Berardino. I want to follow up on the mark-to-market situation.

    Do you think that the mark-to-market accounting system has yielded a situation where we have misleading information being provided to investors?

    I was not real happy with what I heard this morning. I would like to hear it from your standpoint.

    Mr. BERARDINO. I think it is an extremely important issue and I will hide behind theory to start and then I will get real life for you, if you do not mind.

    Theoretically, it is a very appropriate way to account for transactions. You get a more current valuation. I think what you heard this morning is some of the difficulties in the methodologies that go into evaluating something. It is easy to evaluate something that might be due tomorrow than something due 30 years from now.

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    We share your concern, and by ''we'' I mean the accounting profession. We issued a statement, the five CEOs of the major firms, just 1 week ago, where we called to the SEC and said we need more disclosure so people know what is going on this mark-to-market stuff. It is hard, it is complex and there are different interpretations as to how to get there.

    We think it is a real issue, we think it is an important issue. It is on the agenda. We have put it on the SEC's agenda and we are fully prepared as a profession to try to get some guidance out before this year end as companies are ending their years December 31 so that there will be more clarity this year than there might have been last year.

    Mrs. KELLY. Well, bear with me for a minute. How would you really do that?

    What are we talking about? How can you get a type of transparency in that type of transaction so that people understand why decisions were made to do the projections that they have done and that they can evaluate the sensibility of those projections?

    Mr. BERARDINO. This is very difficult, very difficult, because these are highly sophisticated transactions that require a number of estimates and in some cases where there are not active markets day to day that one can refer to. So it is not going to be easy. But I do think it is an area worth exploring and we are fully prepared to help in real time to come up with some more clarity.

    Mrs. KELLY. Did you ever ask the SEC for guidance on the Enron audits?
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    Mr. BERARDINO. I do not remember.

    Mrs. KELLY. Would there be somebody here who could advise you about that?

    Mr. BERARDINO. I was not directly involved. Perhaps. If you do not mind, let me just check with my friends here.

    Mrs. KELLY. Feel free.

    Mr. BERARDINO. Thank you.


    Mr. BERARDINO. The answer is yes. On mark-to-market, we were heavily involved with Enron back in the early 1990s and working through with the SEC how they might do mark-to-market on their portfolio. Very open conversations to try to get to the best answer. And there have been consultations on many different items, not just mark-to-market, since then.

    Mrs. KELLY. Did you find them forthcoming? Maybe you want to consult on that one, too.

    Mr. BERARDINO. Did I find who forthcoming?
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    Mrs. KELLY. The SEC. Were they helpful? Did they have guidelines? Were they able to give you what you needed in order to do something that is complicated and bringing the mark-to-market——

    Mr. BERARDINO. Oh, again, these are hard issues that you need a lot of smart people in a room to try to figure out what is right, and in the early 1990s this was new, and the SEC was very helpful in that conversation.

    Mrs. KELLY. Do you think the kind of environment exists at the SEC to encourage public companies to seek their advice?

    Mr. BERARDINO. Well, I think that that has varied over the years, quite frankly, and in the past, there has been unfortunately more of an adversarial relationship and less of a let us work this all out together relationship, which I think the current chairman is trying to change and which, frankly, we welcome because it is—you know, many people think accounting is a science, where one number, namely earnings per share, is the number and it is such a precise number that it could not be two pennies higher or two pennies lower.

    And I come from the school that says it really is much of an art, that a company like Enron, $500 million transactions going through Enron online, highly complex organizations where there is no one number, and one of the challenges we have and one of the reasons I think we have the opportunity for reform here is the accounting model has traditionally been historic. You know, we told you what happened 90 days ago or a year ago. Most analysts, most investors are really interested in predicting the future. And we do not have an ability in our present financial reporting model, mark-to-market is an attempt to get there, to give investors more current information on a more timely, real time basis.
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    I think this is a time for change and I think some of the stresses in the system we have seen at Enron, not to understate them, will provoke all of us to be thinking outside the box. So I think your questions are incredible. And I will tell you we are prepared to be part of the solution.

    Mrs. KELLY. Thank you very much. I appreciate your being here.

    Chairman BAKER. Thank you, Mrs. Kelly.

    Mr. LaFalce.

    Mr. LAFALCE. Thank you very much, Mr. Chairman. And I thank all the panelists for coming here, especially you, Mr. Berardino, for stepping up to the plate. It is not an easy task to be the number one person at the accounting firm that is being looked at right now, but I commend you for the integrity of your comments and the approach you are taking.

    Let me just ask a few questions. First of all, any of you, what percentage of the CEOs, CFOs, and members of audit committees have their compensation in large part based upon the market valuation of their stock?

    Mr. BERARDINO. Quite a few.

    Mr. LAFALCE. A very high percentage?
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    Mr. BERARDINO. Yes, sir.

    Mr. LAFALCE. I would think that that creates a tremendous incentive on their part, both the officers and the directors, especially the audit committee, to have a good market valuation and therefore to report good earnings. Is that correct?

    Mr. BERARDINO. Well, Congressman, this is a paradox, is it not? The shareholders——

    Mr. LAFALCE. Well, it is a fact, I think.

    Mr. BERARDINO. Well, but——

    Mr. LAFALCE. There may be a subsequent paradox that is coming, but——

    Mr. BERARDINO. Well, it is a fact to some, but to others as shareholders, do you not want your CEO to help the stock price go up? I hope you do not want him to have it go down.

    Mr. LAFALCE. So long as it is real rather than imaginary.

    Mr. BERARDINO. Of course.

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    Mr. LAFALCE. And that is the difficulty. So my point is simply that there really is a need, it seems to me, for improvement in the system and you have called for improvements. The question is where do we start?

    And it seems to me we have to start first with the issue of corporate governance. And what do we—independence?

    I do not think you could bring it into the management itself, but what do we do to bring independence into the audit committee of the board? Or can there be some audit committee outside of the board? But some committee that does not have a vested interest in doctoring earnings because of the market valuation that will determine what their compensation is.

    I mean, it is an outrageous conflict. And then my first question is how do we deal with it?

    Let me ask you to come back to that, but I do think that is a very threshold question.

    The second question or point is you made the statement, Mr. Berardino, that it is a violation of the law to withhold information from the accountant auditor, correct?

    Mr. BERARDINO. Yes.

    Mr. LAFALCE. Is that a criminal or a civil violation?

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    Mr. BERARDINO. I am not sure. Probably criminal.

    Mr. LAFALCE. Well, in your prepared testimony, you said with respect to the one SPE, the one that accounted for approximately 80 percent, the one with the far larger impact, our audit team was not provided critical information.

    Now, applying the logic and syllogisms that I learned in my Jesuit days, it would seem to me that you are therefore saying and that therefore Enron violated the law in their relationship with you.

    Mr. BERARDINO. Congressman, I also have a Jesuit education.

    Mr. LAFALCE. That is why I am referring to it.

    Mr. BERARDINO. I am also taught to believe that we need to have all the facts. And if I could shed some——

    Mr. LAFALCE. But you did say it would appear.

    Mr. BERARDINO. Yes. I mean, to shed some color commentary, what had happened was that the requirement for 3 percent equity from an outsider was met in one end of the Enron house and in a completely distinct other part of the house a compensating balance was offered to that same investor and when you look at the two together it flunks the test.

    Now, we do not know if that was willful or not, but once we had all the facts and the company had all the facts, we had to restate the financial statements.
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    Mr. LAFALCE. OK. Mr. Hill, because my time is about to expire, most companies who are doing an analysis of stocks, the strong buy, buy, hold, accumulate, sell or what have you, it is my understanding that in the year 2000, only 1 percent of all the recommendations made by all the research firms were sell recommendations and that if you go back a half-a-dozen years or so, it was more like 6 percent. That is a considerable decline.

    I have recommended to the SEC and others that every recommendation be accompanied with at least one thing and that is the number of recommendations a firm makes, if they make 200, and a statement, ''we are recommending a strong buy'' and 150 of our recommendations are ''strong buys,'' 25 are ''buys,'' 20 are ''hold,'' and 5 are ''sells,'' or whatever it might be.

    I think that would be a good idea. I would like to know your thoughts on that.

    Second, it took Mr. Baker two seconds to go to Yahoo! finance and tell you that there are approximately 20 firms analyzing the stock right now, of which two are ''strong buys,'' and one is a ''buy'' or what-have-you.

    What about if we required that any written recommendation of an analyst's firm give you the number of firms covering it, at least as of close of business yesterday, according to some criteria, whether it is an SEC or First Call or what have you, and if they are issuing a strong buy, it would be interesting to know that there are 12 others that are recommending sells and we would like to know who they are.
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    What are your thoughts on that?

    Chairman BAKER. Mr. LaFalce, let me suggest this, if I may. I am trying to help Members get on the record on this issue, particularly Mr. Bentsen and Ms. Jackson-Lee, before the recess.

    We have six votes and I am afraid we are going to be on the floor for about an hour and I feel very badly about having kept our witnesses here all morning and then keeping them here another hour into the evening. And I understand perhaps one has another appearance which cannot be missed anyway at 4:00.

    With the subcommittees' understanding, Mr. Shays has waived his time.

    Mr. SHAYS. Well, just one quick question.

    Chairman BAKER. Yes, Mr. Shays.

    Mr. SHAYS. I want to thank our witnesses. I understand that we are going to have more hearings, so it makes sense to close this hearing, but I just want to say to you, Mr. Trumka, that I believe that you are going to take your retirement funds and not invest them all in Treasury bills, thank God, and I just have to say I hope with Social Security funds that we also do the same.

    Chairman BAKER. Thank you, Mr. Shays.
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    I would like to suggest to the subcommittees 2 minutes to Mr. Bentsen, 2 minutes to Ms. Jackson-Lee, call the meeting to a conclusion and let our witnesses go, but with this caveat, we have to have participation in future hearings. This matter is too complex to have covered it even in a day. This has been just a very light introduction to the subject.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman. I appreciate the panel being here and I have comments with Mr. Hill and Mr. Trumka, but I am going to have to do those another time.

    Mr. Berardino, in your testimony, there are two things that stick out. One, when you talk about the SPEs and particularly the Jedi and Chewco SPE, you talk about no prohibition against company employees being involved as investors.

    That seems to me to be pretty closely related parties and if the law does not address that now, it sure as hell ought to address that in the future.

    And, second of all, it would appear to me on the issue of the international financial institution that—and you may not want to answer this—that looks a lot like a pretty contrived deal to create an off balance sheet financing vehicle that really was not one. And if they did not disclose that you as their auditor, then I think they have some real problems on their hands and I think that may be a crux. And you may not want to address that.
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    The other thing which I think is a serious issue is on page 6, where you talk about some people say we should have required the company to make more disclosures about contingencies such as accelerated debt payments, which did in part bring the company down, associated with the possible decline in the value of Enron's stock or changes in the company's credit rating. They ran some very high octane structured deals that were—and the credit consideration, the credit covenants were critical to that company going because they were extremely highly leveraged.

    How that could not be a material item for disclosure, I do not know and, again, you may not want to answer it. I assume this issue will come up in other forums, but——

    Mr. BERARDINO. Well, I will partially answer it and then there is some disclosure. I will not say it is in neon lights, but there is some disclosure in the derivatives area about the fact that this company relied on the confidence of its trading parties and, frankly, one of the issues was what happens when your trading parties do not want to trade with you? Do you have a business?

    And there is no requirement to anticipate every possible contingency in terms of where a company's stock price might go and we obviously understand your point. I think it is one worth further exploration.

    Mr. BENTSEN. Well, my time is up, but let me say this. Stock is a pretty volatile instrument and to not treat it as such in disclosure, disclosure is only as good as in the eye of the beholder and so I would hope that the industry would look at that.
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    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Bentsen.

    Ms. Jackson-Lee.

    Ms. JACKSON-LEE. Mr. Chairman, I cannot thank you and the Ranking Members and the Full Committee chairs and Ranking Member enough for your extreme courtesies to me and to the colleagues on this committee for their extreme courtesy. Very briefly, because we all are learning and I mentioned earlier that the eyes of the Nation are on us, and Houston, and particularly the pain and anguish that is experienced by those in Houston.

    Mr. Berardino, thank you for your presence. Very quickly, I just want to know as it relates to the information that you thought you got incorrectly or made a mistake on the SPEs, what could have been done differently? Why did you probe further when you thought you had the information or are you just finding out you had incorrect information in your testimony?

    Mr. BERARDINO. Well, thank you for your question. These are not easy issues. On the 80 percent where we did not have all the facts, this is a very complex company. They do lots of these deals. It is not like there is one a year that everyone looks at. There are, you know, scores and scores of them. And unfortunately, we just did not have the information. And once we and the company, the accounting department, had all the information, we all knew what the right answer was and unfortunately it resulted in a restatement.

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    On the other issue, where we made a mistake in judgment, at the time, our team made a very good faith, reasonable decision in terms of looking at these transactions and in hindsight they made an error in judgment. And let me be clear, you know, in no way do we think that this caused the collapse, but it is unfortunate that with the thousands and thousands of hours of work——

    Chairman BAKER. Twenty seconds, Ms. Lee, because we are running out of time to make the floor vote.

    Ms. JACKSON-LEE. Thank you very much.

    Let me just say, Mr. Trumka, I thank you very much for being here. One quick word. How catastrophic is this to working people?

    Mr. TRUMKA. We do not know the entire answer, but we can tell you that as far as Taft-Hartleys are concerned, the Taft-Hartley pension funds have probably lost a minimum of $250 million in stock and another $250 million in bonds. When you put all of the pension funds together, we are talking about tens of billions of dollars. When you look at individuals, many individuals have had their entire 401K retirement benefit wiped out. They are penniless.

    Ms. JACKSON-LEE. Thank you, Mr. Chairman. We just have a lot of work to do.

    Thank you so very much.
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    Chairman BAKER. Thank you. We will return after the Christmas recess to this topic, the analyst topic, transparency questions, a long litany of issues.

    I wish to keep the hearing record open an unusually long period, 30 days, for all Members not only to formulate further questions, but for interested parties to make comment. I do appreciate your courtesies in being here and your longstanding patience throughout the day. We have to run. We have less than 2 minutes to make this vote.

    Thank you.

    [Whereupon, at 3:20 p.m., the hearing was adjourned.]