Segment 2 Of 2     Previous Hearing Segment(1)

SPEAKERS       CONTENTS       INSERTS    
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THE ENRON COLLAPSE: IMPLICATIONS TO
INVESTORS AND THE CAPITAL MARKETS

TUESDAY, FEBRUARY 5, 2002
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance,
and Government Sponsored Enterprises,
Committee on Financial Services,
Washington, DC.

    The subcommittee met, pursuant to call, at 10:15 a.m., in room 2167, Rayburn House Office Building, Hon. Richard H. Baker, [chairman of the subcommittee], presiding.

    Present: Chairman Baker; Representatives Ney, Shays, Cox, Castle, Royce, Oxley, LaTourette, Shadegg, Weldon, Biggert, Toomey, Ferguson, Rogers, Kanjorski, Ackerman, Bentsen, Sandlin, Jones of Ohio, Capuano, Sherman, Inslee, Moore, Gonzalez, Ford, Lucas of Kentucky, Crowley, Israel, and Ross.

    Also present: Representatives Capito, Tiberi, Jackson-Lee, and Sanders.

    Chairman BAKER. I would like to call this hearing of the Capital Markets Subcommittee to order. This is a continuation of the hearing initiated yesterday as the committee makes its inquiry into the conduct of the audit community in relation to the failure of Enron Corporation.

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    Pursuant to agreement reached yesterday at the outset of that hearing, we were to extend a 30-minute period for opening statements to each side today and to recognize those Members who did not have the opportunity to make opening statements on yesterday to facilitate every Member possible getting an opportunity to make the opening statement.

    In summary of activities to date, the hearing of yesterday created some issues of import to our proceedings this morning. For those who have not participated in the hearing yesterday, we did receive insight from Chairman Harvey Pitt of the Securities and Exchange Commission, as well as comment from Mr. Powers, responsible as a board of directors member of Enron for determining the causal effects of the Enron bankruptcy and the subsequent financial catastrophe.

    Mr. Powers' Report, although not based on the full scope of information necessary to reach final conclusions, has raised some very troubling issues that we hope to address in the proceeding this morning.

    With that in mind, I would now recognize first Mr. Castle as the appropriate Member who was not able to make a statement on yesterday. Mr. Castle, under the rule you will be recognized for 2 minutes.

    Mr. CASTLE. Thank you, Mr. Chairman. As more and more troubling facts are revealed about Enron's collapse, there is one point in particular that many Americans find most disturbing, and that is the ability of a group of inside players at the top of a corporate structure to work the entire system to their advantage while millions of small investors, including the ordinary Enron employees and their life savings, were, in effect, trapped in this moving vehicle as it headed off the cliff long after the drivers themselves had escaped.
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    Investors, be they multi-millionaires or individuals and small investors trying to make the most of their life savings, need to rely on some sort of an objective review of those who have control of their money. They need an independent opinion and review of the practices and the legality of those who are managing their money. We normally expect the independent accountants and auditors to provide this function.

    It is very troubling when it becomes apparent that the supposed independent auditors at Enron apparently completely failed at their assigned task of independently verifying the truthfulness of Enron's financial practices. The auditors are in the games of the players, but they have the authority to call time out and say, these financial practices do not make sense and we are not going to endorse them until they are clarified. At the very least, Arthur Andersen did not perform this role adequately in the case of Enron.

    The worst case scenario is even grimmer. Independent press reports, and now the Powers Report, indicate that there was a complete breakdown in appropriate corporate behavior that extends to Enron's management, to its board, and to its auditor, Arthur Andersen. We are trying to determine if Andersen and its experienced accountants were duped by Enron who were actively involved in constructing their evasive financial practices. Thus far, Enron's explanations have been incomplete and unconvincing.

    If a group of auditors have let investors down and have helped create uncertainty in the entire financial market about corporate accounting standards, we are obligated to try to work out new procedures, new rules, and a new framework that will help prevent this from happening again.
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    We are here to help develop the solution to this tremendously serious problem in our financial system. We hope there are not other Enrons out there, but it is quite possible there are. Arthur Andersen has a long way to go to address questions about its role in Enron's collapse and to provide meaningful proposals to real change in corporate accounting. I hope that process can start today.

    I yield back the balance of my time.

    [The prepared statement of Hon. Michael N. Castle can be found on page XX in the appendix.]

    Chairman BAKER. Thank you Mr. Castle.

    Mr. Lucas is recognized for 2 minutes.

    Mr. LUCAS. Thank you, Mr. Chairman.

    Yesterday, SEC Chairman Pitt outlined the steps the Commission plans on taking to improve and modernize the current disclosure and regulatory systems and I applaud him for those efforts. Also Dean Powers' testimony was very enlightening and very troubling. We need only to look at the performance of the stock market in recent days to see the effects of the lack of confidence in the current situation.

    As we search for solutions to the problems that the Enron collapse has exposed, we should not rush to judgment, hoping only to assign blame. The SEC and Congress must move constructively to restore the integrity of our financial markets, the soundness of our financial systems, and the public's confidence in our markets. I look forward to today's hearings in order that we may better understand the breadth and depth of this problem.
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    I yield back the balance of my time.

    Chairman BAKER. Thank you, Mr. Lucas.

    Chairman Oxley, did you wish to be heard, sir?

    Mr. OXLEY. Thank you, Mr. Chairman.

    We welcome Mr. Berardino back to the subcommittee. As the Chair knows, Mr. Berardino was our witness back in December, and it was the first hearing on the Enron situation and we welcome him back.

    There are some issues that were uncovered in the meantime that Mr. Berardino will be addressing and some questions from the panel, but I do want to say that we have appreciated Mr. Berardino's cooperation in this matter; that, while other witnesses have been unwilling to comply with our request to appear, Mr. Berardino has been very forthright in appearing every time the committee has requested him, and for that we appreciate it. And this gives us an opportunity to explore some of the underlying issues vis-a-vis Enron and the auditor that I think will be in order to our benefit.

    And with that, I yield back.

    Chairman BAKER. Thank you, Mr. Chairman.

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    Mr. Crowley.

    Mr. CROWLEY. Thank you, Mr. Chairman.

    After the stock market crash of 1929, the Federal Government gave the accounting industry the valuable franchise of auditing public companies. In this role, the so-called independent auditors were supposed to be the independent watchdog to make sure that financial book-cooking like we are seeing today at Enron did not occur. These outside auditors are supposed to represent the true oversight role for investors and the American public on the internal controls of a company. They ought to be the investing public's first line of defense.

    We can all acknowledge that there will always be some bad actors in the corporate world, overtaken by power and greed. And while they are the exception and not the rule, from Ivan Bosky to what appears now after reading and listening to the Powers Report, Andrew Fastow, they are out there. But it is the independent auditors that are supposed to catch these criminals before they can wreak the kind of havoc that we are seeing today.

    In a capitalist society this is generally not a role for the Government to play, but I am growing more and more concerned about the actual independence of these auditors. In fact, I am angered by auditors who feign ignorance or claim they too had concerns about the partnerships of Enron, but they continually signed off on the Enron books, books which they questioned privately.

    America's market system is based on both transparency and consumer confidence, and we cannot have one without the other. Therefore, it is imperative to have truly independent outside auditors reviewing the books of publicly traded companies. When these outside auditors fail to perform their duties, they should be punished and punished hard as an example.
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    I look forward to hearing Mr. Berardino explain his company and his industry and hope that, working together with this committee, the SEC and business can work to provide a truly independent auditor for publicly traded companies and ensure that another Enron does not occur again.

    And I'm tired of hearing about, borrowing from a phrase from football, ''all the end runs around Enron.'' That has to end, from the highest levels of Government to the highest levels of corporate government as well. No more end runs around Enron. People have to step up to the plate and take responsibility where it is due. So I do look forward to your testimony today.

    Chairman BAKER. Thank you, Mr. Crowley.

    Mr. Ney.

    Mr. NEY. Thank you, Mr. Chairman.

    For 70 years we have operated on the principle investors making decisions about securities has been based on an honest assessment of the company's financial health. This model has given us the finest and best-regulated markets in the world. Unfortunately, this model is now broken. Investors do not believe that they are receiving honest information about a company's fiscal position. Investors certainly weren't given the truth in the Enron case.

    This has to be fixed. We have got to restore investor confidence, especially during this time in our country's history and all the trauma we have gone through as a Nation and how important it is for our people and for jobs. The image of ourselves being a rubber stamp for companies that are cooking the books has to be done away with. You can't allow a system that breeds such deep cynicism about corporate reporting to remain if we're to have capital markets that invest with people's trust.
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    This subcommittee, of course, is here to explore the best way to put integrity into the accounting profession. And that doesn't mean there is not integrity within the profession. Obviously something has gone wrong. Ideas have been floated to have the Government become an auditor for the auditors or to take over all corporate auditing. Others have floated the idea of a robust industry self-regulator, which we do have examples of that in our country that I think have worked.

    In looking at all these proposals, I think we have to ask the simple question: Will it solve the problem? And if we go upon that course, I think we'll have a better, stronger industry.

    We need to ask our witnesses, of course, to tell us what, in fact, they think we need to do to make disclosure meaningful. I really don't want to see Congress consider legislation just to look like we are doing something, and I know this is not the intent of the subcommittee or committee. I don't want us to make a commotion just so we can say that action is being taken. I do want to be able to go home to the constituents and say that we, in fact, fixed the problem, not that we did something. I want to make sure that the situation, hopefully, never happens again so we can restore the confidence of investors in our markets. I look forward to exploring what's the best way to restore the integrity of our accounting profession and our capital markets in the best way possible.

    Again, I want to thank Chairman Baker and Ranking Member Kanjorski and Chairman Oxley for holding this hearing.

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    Chairman BAKER. Thank you Mr. Ney.

    Mr. Moore, you are recognized for 2 minutes.

    Mr. MOORE. Thank you, Mr. Chairman.

    I, too, would like to welcome Mr. Berardino here today, and I appreciate the fact that he's here, because other witnesses, namely Mr. Lay, have refused to appear. I am going to give my opening statement from yesterday so it is not necessarily directed at the witness here today.

    The healthy function of our capital markets depends upon reliable auditing and accounting information as well as accurate financial statements. Investors have to be able to trust financial statements of the companies in which they decide to place their money. Additionally, investors need to be able to trust the financial analysts who recommended investors buy the stocks of companies like Enron.

    In the case of Enron, as the stock plummeted from its 52-week high, about $90 a share, down to less than $1 a share, financial analysts continued to urge a ''buy'' or ''strong buy'' for Enron stock.

    There are now two separate actions underway relating to the way Enron prevented its employees from making changes to their pensions. The Department of Labor has launched an investigation and a class action suit has been filed on behalf of Enron employees. What I am particularly interested in is the new policy that Enron instituted on October 26, 2001, effectively freezing any employee 401K transactions. Enron ostensibly instituted the freeze due to a change in pension plan administrators. Unfortunately for Enron's employees, the freeze was in place while Enron's stock plummeted, forcing employees to sit by as their retirement savings collapsed.
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    Enron's unfortunate timing of an employee lockdown, while executives maintained flexibility to cash out, is outrageous and potentially illegal and an attempt by Enron to manipulate the rapidly declining value of its stocks by preventing a mass sell-off of the company's stock.

    I am interested to hear today if the witness has any comments to make about $25 million in audit fees paid to his firm, as well, as $27 million paid for consulting fees, and whether there is any conflict there, apparent or otherwise, and I think there needs to be some discussion about that.

    In these difficult times, American workers are having a tough time saving their money for retirement and Congress needs to do whatever it can do to encourage long-term savings. It is now the responsibility of SEC, the accounting industry, and Congress to prevent a corporate collapse and to protect the American people and investors in this country. Thank you.

    Chairman BAKER. Thank you.

    I have identified three additional Members on the Majority side, Mr. Rogers, Mrs. Biggert and Mr. Ross. I am just making that announcement, because it is my intention to proceed with the witness.

    Mr. Rogers you are recognized for 2 minutes.

    Mr. ROGERS. I have no statement.
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    Chairman BAKER. Mrs. Biggert.

    Mrs. BIGGERT. Thank you, Mr. Chairman, I appreciate the way that you have handled the hearing yesterday and I applaud you for the way that you are conducting these hearings.

    I look forward to hearing Mr. Berardino's testimony. As he said in his written statement, there is some explaining to do, and I appreciate his candor. I think his testimony will move us forward in our quest to solve the problems and to restore confidence in the financial system and basically to ensure that another Enron does not happen. So I look forward to hearing from the witness.

    Thank you and I yield back.

    Chairman BAKER. Thank you, Mrs. Biggert.

    Mr. Ross.

    Mr. ROSS. Thank you, Mr. Chairman.

    I appreciate the subcommittee convening this hearing today to discuss the important issues that have surfaced as a result of the collapse of Enron. Like my colleagues, I am disappointed that Mr. Kenneth Lay, the former CEO of Enron, chose not to testify before the subcommittee, and I would encourage him to come to the Congress and respond to the numerous issues surrounding the company's demise and his role as its chief executive in the oversight of its business operations.
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    However, I am pleased that you have decided to join us today, sir, and have come to hopefully begin an honest and open dialogue to discuss your area of expertise and how we can keep something like this from ever happening again. The fallout of Enron has had far-reaching effects.

    There are thousands of people unemployed, and many have suffered enormous financial loss. While most people are aware of the Enron employees' inability to sell their stocks in the company and the subsequent losses in the 401K plans, many are not aware of the numerous companies who also invested in Enron stock. For example, one small company in my congressional district back in south Arkansas lost roughly $276,000, a quarter-of-a-million dollars, last year on Enron stock in their retirement plan for its employees. We are talking about a plan that the total plan is $4.5 million. One-quarter million now gone. This was $50,000 they lost from all other stocks combined during the recent decline in the stock market. This plan serves 35 to 40 people. Many of them I know. Many are first-time investors. They are moms, they are dads, they're trying to raise families and build better lives for themselves, their children, their grandchildren. And this has had severe implications on their future.

    For a district where the average household income for a family of four is $19,000, the need for tools to increase financial security is essential. If this company had been aware of the information surrounding the bleak financial condition of Enron, believe me, they would have had an opportunity to make the necessary changes to protect their employees' interest.

    That is why the financial disclosure requirements for public companies must—and I stress must—be enhanced to ensure the accuracy of the information provided.
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    Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Mr. Ross.

    Mr. Ferguson for 2 minutes.

    Mr. FERGUSON. I appreciate you holding these important hearings. I was extremely disappointed to hear that Mr. Lay was not going to testify before this subcommittee today. And as the committee has indicated, we sought Mr. Lay's testimony in good faith we and were assured it was going to be given.

    I believe that this subcommittee and, more importantly, the American people, deserve to know what happened in the Enron collapse from the people who are most directly involved. Regardless of Mr. Lay's appearance before this subcommittee, we will get to the bottom of this situation. We are going to continue to ask difficult questions and we expect to get some answers.

    The collapse of Enron represents a combination of irresponsible actions on the part of decisionmakers with knowledge of the company's financial well-being, and a meltdown of the financial safeguards used to identify problems at a stage when corrective action might still be taken. I am most disturbed that the collapse has had a substantial impact on thousands of Americans across the country who put their retirement and other investments into mutual funds and pension funds and other vehicles that invested in the company.

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    We have a moral obligation to ensure that safeguards are established to prevent a disaster of this magnitude in the future. While it is near impossible to create a system that prevents all failure, corporate America must be made more accountable to the employees and shareholders, which will require stricter accounting standards and tougher disclosure requirements.

    I thank Chairman Pitt for coming before us yesterday and offering his views on the current financial reporting and disclosure regime, as well as Mr. Powers for discussing his findings of his report, reviewing the facts and circumstances related to the collapse of Enron. Mr. Powers made several statements of particular significance to today's hearing, including the fact that he found failures in the performance of Enron's outside advisers and that the tragedy could have and should have been avoided.

    I also thank Mr. Berardino for returning before the subcommittee to clarify his previous testimony in light of information that he did not have at the time. I look forward to hearing your testimony on current auditor procedures, but I am also particularly interested to hear your thoughts on the impact that consulting fees have on influencing audits as well as to shed some light on the very serious matter of document destruction.

    With that, I yield back, Mr. Chairman.

    Chairman BAKER. Thank you sir.

    The last Member I have for recognition is Mr. Shadegg for 2 minutes.

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    Mr. SHADEGG. Thank you, Mr. Chairman, I will be brief. I want to thank you for holding this, the third in a series of hearings on this important issue. I, too, want to thank the witnesses who testified yesterday. I thought their testimony was very interesting, and Mr. Powers' Report was enlightening and helpful.

    These hearings are extremely important to the future of this country. We must ensure the integrity of our financial markets. If we do not do so, then the economy we currently enjoy and the lifestyle we have will disappear. It is absolutely essential we discover the causes for what happened.

    In going through these hearings Mr. Chairman, it occurs to me that one definition of insanity is to do the same thing over and over again and expect a different result. One thing we cannot do in these hearings is decide that we need just one more oversight body or just one more law or one more regulation. We have to find exactly what was the cause here and get to the bottom of it and try to find a solution which will result in the prevention of this kind of a collapse ever occurring again, and ensure that Americans and people throughout the world can have faith in our markets without relying on a regulatory system which will just let us or could just let us down again.

    I notice that in a discussion on one of the morning shows this morning, the comments focused on the fact that the market was down yesterday and that that is as a result of some people looking at the Enron collapse and worrying about whether or not a similar type of accounting nightmare could exist in a company which is still in the market today. And they commented that it is the market itself that can correct these kinds of problems. That is true, but we have an obligation to ensure that the institutions that are supposed to be doing their jobs, that the SEC, FASB and the others are doing their jobs. I commented yesterday in my questioning about how I have a difficult time understanding off-balance-sheet entities as a mechanism for disguising debt.
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    It seems to me—and I quip that my wife and I would like to buy a new home and would like to figure out a way to create in our own personal balance sheet an off-balance-sheet entity where we could put some of our debt and to be able to qualify for a more expensive home.

    It seems to me we have to get to the root cause of this problem. It seems to me that there was clearly fraud that went on. It seems to me that it is impossible to believe these board of director members didn't know and others didn't know what was going on. So we have to try to get to the bottom of these issues. We have to ensure that we have done everything we can.

    We know at the end of the day the market will do what it can to correct, but we also know that it is ultimately the individual integrity of the people involved, the members of the board of directors, the officers, and the accountants that we must rely on for the integrity of the entire system.

    And with that, I yield back.

    Chairman BAKER. Thank you, Mr. Shadegg.

    Ms. Jones.

    Mrs. JONES. Thank you, Mr. Chairman.

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    Yesterday and today, we have the distinct opportunity as Members of this Capital Markets Subcommittee to bring to the attention of the public some of the details of what has occurred with regard to Enron. As we go through this process, it is my hope that we can open some of the doors that have been closed to us so we have a better understanding of a process that's involved when a company like Enron can go 15 years, from nowhere to the seventh largest in our country.

    In Ohio alone, the State's two pension funds for Government employees lost $114 million on Enron stock. Interestingly enough, fund managers were increasing the weight of Enron stock, even when the stock was plummeting, on the belief of Enron's long-term potential. Even pension officials felt that Enron financials were good enough to invest in.

    Ohio's loss is not alone. Other State pension and/or retirement plans were impacted as well. The Florida State Board of Administration lost $335 million. The California Pension Fund lost $49; Alabama, $47; Texas, $24; Missouri, $23 million; and New York City's fund for firefighters, police officers, teachers, and other workers lost $109 million. These losses, coupled by bank exposure estimated around $4.6 billion, will ultimately impact consumers by increased fees and possibly less money to lend.

    Never in my years has one such issue or scandal, depending on how you look at Enron, had so many tangled webs, from extensive political influence that had the White House helping setting energy policy, conflicting interactions with Arthur Andersen, and on and on and on.

    I have more statement. I will put it into the record, Mr. Chairman. I am just hopeful that as the people appear before our committee this morning, we can get to some facts. As a former prosecutor and judge, we can always wade around an issue, but fact is the most important thing we can get for the public so they can have a full understanding of what happened in this instance, so they can begin to educate themselves and never put themselves in a position that these Enron employees have been in, and so that we can put ourselves in a position to pass legislation that would never allow employees such as these Enron employees to not be able to access their funds while the money managers were going on down the road with the rest of the dollars.
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    I appreciate the opportunity to be heard, Mr. Chairman and yield any time I have left.

    Chairman BAKER. Thank you.

    Mr. Ford, you are recognized for 2 minutes.

    Mr. FORD. Thank you. I won't take all that time, Mr. Chairman.

    It is good to see that one of our invited guests made it today. Pleasure to see you. I look forward to hearing your testimony. But one of the things I hope that we are able to get to and one of the things I want to address in my questions as the hearing proceeds, Mr. Chairman—I am from Memphis, it's hard for me to pronounce these big East Coast last names—but Mr. Berardino, is that the correct way? Penn taught me well.

    But I am curious about the destruction of some of the documents. And one of the things I hope to sort of speak to, and I know some of the steps the company has taken, and we applaud the effort to bring on Chairman Volcker, but at the same time, I hope that we can get some commitment from you, perhaps today or in the very near future, from the company regarding mandatory document retention. And perhaps your company can take the lead in providing a template for the industry to follow.

    I see my good friend, Goody Marshall, in the audience as well. Always a pleasure to see you. With that, look forward to your comments and I thank you for being here this morning.
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    Chairman BAKER. Thank you, Mr. Ford.

    That concludes all Member opening statements.

    Mr. Israel, did you wish to be recognized?

    Mr. ISRAEL. I do, Mr. Chairman. Thank you.

    I think it is sadly ironic that Mr. Lay has gone through a revolving door at the White House and suddenly he's grown shy about coming to Washington, but I do appreciate Mr. Berardino visiting with us today.

    I think the real scandal here lies not simply in the potential illegalities of this case, but in the fact that so much of what was done was legal, offshore special purpose entities, fuzzy accounting, lazy and conflicting analysis, lax oversight, conflicts of interest.

    Our financial system depends on a series of checks and balances to ensure market confidence, and every single step in this system, save the short sellers, failed catastrophically. This is nothing short of the worst indictment of our entire system in years.

    Our job is to work together on a bipartisan basis. Marginal solutions are not going to cut it. We need to go back to the drawing board and start over. What do we want our regulatory system to achieve, what are the best structures to get us there, and how do we balance investor protection with clear regulation?
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    I look forward to working with the Chairman and all of my colleagues to restore confidence to our accounting system and to our financial entities. I thank the Chairman and yield back.

    Chairman BAKER. Thank you, Mr. Israel.

    I do believe now that concludes all Members' opening statements. Any Member who wishes to introduce any written statement for the record certainly will have that opportunity.

    Mr. Berardino, it's my pleasure to welcome you back. I want to say for the public record that this is not your first voluntary appearance. It is your second. You were among the first to appear before this committee in mid-December and present your views of where the Enron matter stood as it relates to Andersen. And we appreciate the fact that you have made every effort to provide the committee with your perspectives in regard to this matter.

    I have been directed by the committee in this proceeding with regard to all witnesses before the committee in relation to our work in the resolution of the Enron matter to swear witnesses in. Do you have any objection to testifying under oath?

    Mr. BERARDINO. No, I do not.

    Chairman BAKER. In that light, do you desire to be advised by counsel during your testimony today?
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    Mr. BERARDINO. Yes, sir.

    Chairman BAKER. In that case, would you please instruct your counsel to come to the table and assist you? And I need to ask him or her a question as well.

    Mr. BERARDINO. I am not sure that's necessary, Mr. Chairman. And I have my counsel with me and if I need to refer to him, I will.

    Chairman BAKER. This creates a slight technical thing. We need to consult. I am advised that if your counsel wishes to give testimony, we would be obligated to swear him in as well in conformity with the committee rule. If it is advisory only and he will not be making statements for his own perspectives, it's my understanding that we would be in conformity with the subcommittee direction to only require you to take that oath.

    If that is acceptable to the Members of the subcommittee, I shall proceed then to administer the oath. Would you please rise and raise your right hand?

    [Witness sworn.]

    Chairman BAKER. You are now under oath. Thank you very much, sir. Your statement, of course, has been made part of the official record. You may summarize it or deliver it as you choose.

TESTIMONY OF JOSEPH BERARDINO, CHIEF EXECUTIVE OFFICER, ARTHUR ANDERSEN LLP
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    Mr. BERARDINO. Chairman Oxley, Congressman LaFalce, Chairman Baker, Congressman Kanjorski and Members of the committee. Andersen and this committee share common goals to get to the truth about what happened at Enron and to help develop policies that will improve our capital markets, enhance audit quality and better protect the investing public. That is why I am back before you today for the second time in less than 2 months.

    At the outset, let me make a few important observations. It is abundantly clear that something very tragic and disturbing happened at Enron. All that is involved, in my opinion, has to do with three things. First, we must face up to our responsibilities. That is what my being here is all about.

    Second, we need to get to the bottom of what happened. We know more than we did a couple of months ago and we have learned some unpleasant things which we have been straightforward in bringing to the public's attention. Our investigation is continuing and we will take actions when appropriate.

    Third, and this is the main reason I am here today, we need to think honestly about changes that need to be made. When I last appeared before this committee, I pledged to do just that, and I am also here to report to you that Andersen has already taken the first steps toward fundamental changes in our audit practice here in the United States.

    First, former Federal Reserve Board Chairman Paul Volcker has agreed to chair an Independent Oversight Board to work with us in the U.S. Mr. Volcker and the board will have free access to all information relevant to a full review of the policies and procedures of our firm to assure the quality and credibility of our firm's auditing process. The board will have full authority to mandate changes and such practices. As this committee well knows, Mr. Volcker is a man of unquestionable integrity. He is one of the most independent thinkers in America's finance. Paul Volcker calls it as he sees it and the investing public will be well served by his involvement.
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    Second, we have taken some immediate steps to address concerns about potential conflicts of interest. Andersen will no longer accept assignments from publicly traded U.S. audit clients for the design and implementation of financial information systems. And we will no longer accept engagements to provide internal audit outsourcing to publicly traded U.S. audit clients.

    Third, Andersen will work with each publicly traded U.S. audit client's management and audit committee to establish a formal process for determining the company's acceptable scope and level of fees for those non-audit services that we continue to provide.

    Fourth, Andersen will create a new independent Office of Ethics and Compliance to investigate on a confidential basis any concerns of Arthur Andersen partners, employees, or individuals from outside the firm relating to issues of audit or auditor quality, integrity, independence and compliance.

    And fifth, Andersen will establish a new Office of Audit Quality comprised of senior partners with the sole mission of deriving audit quality.

    These are just the first steps, and I want to stress that, first steps in a process that will fundamentally change our U.S. audit practice. We look forward to working with Mr. Volcker and the Independent Oversight Board as we implement these and other changes. However, the forms we are willing to implement cannot be the end of the matter within our firm and beyond. With the accounting profession in crisis, we all need to do something more fundamental.

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    Let me offer some observations about some of the areas that could benefit from change. Many participants in the financial reporting system, including auditors, rating agencies, analysts, investment bankers, and other financial institutions have a great deal of crucial information about public companies, information that can tell us a lot about their likely future performance. We now have a system which auditors, among others, have what must be considered a very inefficient and ineffective conversation with company boards, management and shareholders. We need to take a fresh look at how auditors communicate the work they perform and the conclusions they reach.

    Today the auditor can issue a standard unqualified opinion or they can disclaim an opinion if so desired. Financial statements prepared by management that satisfy generally accepted accounting principles get a pass. Financial statements prepared by management that comply with GAAP but push the edge of the accounting envelope, and that may pose significant risk to the company and its shareholders, will get the same unqualified opinion as those representing more prudent accounting decisions and disclosures.

    Now, I think we need to keep this in context. Many, many, many companies get it right, but there are some pushing the envelope, and the investing public does not know which one is which. So this system is bad for everyone and for investors most of all, and they don't get all the information they need or would like to make informed decisions. There is a significant danger that they may be led astray by this pass-fail grade in our product called the auditor's report.

    Therefore, I would suggest we consider replacing the current standard auditor's report with a report that grades the quality of the company's accounting practices and business risks. This change will give investors important guidance on how to assess the company's financial statements, the information contained in those statements and related financial risks, but it also gives the company an incentive to have higher disclosure practices and more prudent accounting.
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    But there's much more we need to do. We also need to move to a more dynamic and richer financial reporting model. We need to provide several streams of relevant information, many of which are discussed in some detail in my written testimony. And we need to simplify accounting principles. We need reports, in plain English.

    We need to further strengthen the role of the audit committees by encouraging them to engage manager and auditor to ensure that risk is managed and that crucial information is communicated to shareholders in an intelligible way. We also need to give serious thought to making it a felony to lie or withhold information to mislead investors and auditors.

    Let me also say a word about the Enron Special Investigation Committee Report that was released on February 2. As you well know, that document is more than 200 pages long, took more than 3 months to produce, and was released just this Saturday night. We have experts in my firm that are now analyzing and investigating these findings. The report acknowledges the time and resource restrictions that limited the scope of the review. It notes a lack of access to people and documents that the committee admits may have information relevant to their conclusions.

    The committee did not speak to people at Andersen. When the committee was formed we offered to assist it, but the company's lawyers indicated that they were not ready to discuss anything with us. We did provide the committee with our work papers when requested. The committee asked to speak with some of our people, and we were in the process of working out interviews when Enron fired us. We never heard from the committee again.

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    I would note that the report cites numerous instances of possible additional secret arrangements among the company or related party special purpose entities. The report says there were indications of hidden inside agreements of non-documented transactions between Enron and these SPEs. We need to investigate the accuracy of these alleged matters. If people withheld information from us, they were withholding it from investors, and that can't be tolerated.

    Before concluding, I would like to thank Chairman Oxley for the opportunity to clarify my December testimony, which I did in a letter submitted to the committee on January 21 and in my written statement today. I appreciate the open and forthright manner in which Chairman Oxley handled this matter.

    Mr. Chairman, we have an opportunity to make some good from what happened here. This is a tragedy on many levels. I am here because I want to be part of the solution. At Andersen, we are determined to convert our current challenge into an opportunity, as difficult as that may be; an opportunity to reaffirm the principles that drive our 28,000 people here in the United States and 85,000 people around the world in our desire to serve our clients and the public that relies on our work with candor and integrity. The steps I have outlined today start the process. We will work with you in the days and weeks ahead to continue it.

    Thank you.

    [The prepared statement of Joseph F. Berardino can be found on page XX in the appendix.]

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    Chairman BAKER. Thank you Mr. Berardino.

    I want to ask the committee's indulgence. I have a series of questions I would like to pose to Mr. Berardino that may take me a little over the normal 5-minute customary rule, but if the committee will provide me with this opportunity, I think it extremely important given the fact the committee has under consideration legislation to address the concerns that you have identified and to adopt some of the recommendations perhaps that you have outlined this morning.

    Let me start with the first and most obvious question. Without regard to any specific accountant or any particular event, in general, what would be Andersen's code of ethical conduct requirement for any auditor that finds an activity that diminishes shareholder value that is GAAP compliant?

    Mr. BERARDINO. Mr. Chairman, we have an obligation to speak to the shareholders through the audit committee. There are professional standards that say when we see accounting that is on the edge, major subjective decisions that go in or commonly go into preparing the financial statements, we communicate the risk, the decision is made by management, and our concurrence or disagreement as appropriate, to the audit committee.

    Chairman BAKER. In the scope of Andersen's relationship with Enron, which was over some multiple years, again not with regard to specific meeting, specific transaction, or a specific report, to your knowledge in the last 24 months, has management of Enron met with the audit team prior to its final report being posed to the board or to the audit committee and resultingly changed the findings of the audit or modified the form in which the audit was to be prepared?
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    Mr. BERARDINO. Mr. Chairman, I frankly can't answer that question with authority, because obviously I wasn't there doing the work, and if not——

    Chairman BAKER. Let me ask you differently. Without regard to Enron, as a matter of common practice, does the Andersen team, when conducting a corporate audit, meet first and primarily with the audit committee prior to the release, publication, finalization of the report; and is it customary to meet with management prior to having that report approved by the audit committee?

    Mr. BERARDINO. Absolutely. Yes, sir.

    Chairman BAKER. So you do meet with management.

    Mr. BERARDINO. Yes. And the audit committee.

    Chairman BAKER. Is it customary to meet with management first?

    Mr. BERARDINO. Obviously we are meeting with management all the time as we conduct our work.

    Chairman BAKER. And that is my point. Is it common practice for management to object to a particular method by which a transaction is evaluated or to make recommendations as to the manner in which it is reported? For example, as opposed to having it in the statement, having it in the footnotes; is that a common practice?
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    Mr. BERARDINO. As I am sure you can appreciate, the audit is an interim process. We are looking for the facts. We are looking to understand management's judgment. Management will give us their view. We will challenge their views and we will come to a conclusion.

    Chairman BAKER. So it would be your opinion, from professional conduct of Andersen's general accounting process, that even were you to meet with management, were you to make changes in the reporting of the financial statement, whether it be to put a matter into the footnotes or to reconstruct the manner in which a transaction were to be reported, that you believe that the audit team can reach a professional conclusion in that environment and not have your financial report be distorted in any manner that would not reflect the accurate financial condition to the shareholder?

    Mr. BERARDINO. Mr. Chairman this is a very fundamental and important question. The financial statements are management's and the company's. The only thing we put in that report is our auditor's report.

    Chairman BAKER. Let me interrupt. It is my view, business class 101, that the board establishes an audit committee. The audit committee retains the auditor. They do so so an audit can be made for the shareholder interest to state publicly the value of that shareholder's interest in that publicly traded corporation. Management is to run the company. They are not to run the audit. Do you dispute that point?

    Mr. BERARDINO. Not at all.
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    Chairman BAKER. Then it would be your conclusion, then, given the fact that the audit team in Andersen's work, Enron or not, conducts its activities independent of interference by management to give the true and accurate picture to the shareholder?

    Mr. BERARDINO. That is true, Mr. Chairman. But the point I would like to emphasize is that at the end of the day, these are the company's financial statements. And this is where we get into the issue of companies that report just barely in accordance with the rules and those that are more forthcoming. We cannot make a company report any more than what the rules require.

    Chairman BAKER. I understand.

    Mr. BERARDINO. That's a challenge we need to look at.

    Chairman BAKER. And from that, conclude as to the true financial condition. And I was trying to help you in saying that in all cases, you feel your audit team has taken the managerial information and provided an accurate picture to the shareholder based upon your findings at the time the financial statement was prepared.

    Mr. BERARDINO. Yes, Mr. Chairman.

    Chairman BAKER. In that light—and this is an example of what is a very complicated subject. I will move through it rather quickly, because I believe you to be familiar with it. Enron and CalPers were partners in Jedi. CalPers wanted to extricate itself from Jedi. Its stake was worth approximately $383 million. Fastow and Kopper formed Chewco to buy out the CalPers interest to facilitate their release from that prior arrangement. Enron, I am told, arranged for Jedi to loan $132 million to Chewco, a related party. Fastow and Kopper then arranged for Barclays to loan Chewco $240 million and Enron guaranteed it on the back side. In order to meet the 3 percent minimum investor criteria, the investor had to provide $11.5 million of equity. Barclays then helped provide the credit to facilitate that investor equity position, which later—we are skipping a bunch—is now disputed by Barclays as to whether it was ever an equity position and may have, in fact, been a loan in its entirety.
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    Without regard to the specifics or the facts that I have just made, was there any indication determined by the audit team in the course of their normal audit function that would have led any reasonable accountant to look at the transactions on the corporate books and conclude it was not what management represented to you?

    Mr. BERARDINO. Well, Mr. Chairman, this is part of the fact pattern we need to undertake. I don't know with authority what we knew and when we knew it. What we have testified to is that information had been withheld from us in that transaction, and when it was forthcoming we and the company restated those financial statements.

    Chairman BAKER. It also is important to note that the sale of assets to an SPE, which Enron extended the credit for the purchase to be consummated, was then booked as earned income on the corporate revenue side.

    My point of these facts, only one limited instance and not to take undue subcommittee time, there are many. I am now told that the number of SPEs could well exceed 400, of which 30 or so are questionable in their construct and operation. I am very troubled by the fact that all of these activities require a check, the movement of stock, board approval, physical evidence of a relationship with a party which is not in the shareholder interest, either by failure to make appropriate disclosure or by engaging in activity and having the disclosure so convoluted a reasonable man could not make a determination as to the professional relationship that was being established.

    What can you tell me today, without regard to a specific event or activity, with regard to your perspective and Andersen's role in getting it right, not with regard to one particular quarterly report or one particular financial statement, can you now acknowledge in retrospect that the true financial condition of Enron was not accurately reported in the financial statements prepared by Andersen at the time of their preparation?
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    Mr. BERARDINO. Mr. Chairman, in hindsight we could look at what happened and I really regret to tell you I can't answer your question with authority, because there are several unanswered questions: What did people know, when did they know it? And as I testified last time, everyone's talked about the off-balance-sheet liabilities, but Enron had to move assets off the books with those liabilities. And one of the big questions I have—and I don't have an answer to—is when did those assets go bad and when did people know they went bad?

    Chairman BAKER. Even more simple. From the events as now determined, in 1999, February, you were the auditor at the time of the proposed merger. Published reports which I have read in great detail indicate that VEBA's due diligence, using another audit firm, determined that 75 percent of equity was impaired by off-balance-sheet debts, led to their determination not to proceed with the merger.

    If you were the auditor at the time that merger failed, described in press reports as a merger of equals and giants, an enormously important financial transaction to every shareholder, every partner, every consultant, every auditor and it failed, how is it possible for Andersen not to have known in 1999 as a result of such a public meltdown on a proposed merger, based on the fact that the accounting practices of Enron were being questioned, led to the failure of that merger? What's the explanation? How could you not know?

    Mr. BERARDINO. Mr. Chairman, I wish I could be more helpful. I did not do the audit on this company. There were many people involved who had intimate knowledge at the time. I am not one of them.
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    Chairman BAKER. I don't want to go to the specifics and I don't want to ask who the auditor was or ask what the auditor found. My point is I am reading newspaper articles, now 3 years old, saying that the failure of the merger was questionable accounting practices and off-balance-sheet debt to excess. If I were a member of the board, if I were a shareholder, and certainly if I were the auditor, I would want to have a reasonable explanation on the public record why VEBA's auditors were wrong, or I take the matter up with someone.

    I have greatly exhausted my time on the subcommittee, and I want to come back if you have time and talk about the solution side. But these are very deeply troubling matters.

    Mr. Kanjorski.

    Mr. KANJORSKI. Give me an opportunity, Mr. Chairman, to raise another issue. Mr. LaFalce, unfortunately, has a personal family situation that he has to tend to, and would have liked to have been here. But, I will certainly take his time.

    Yesterday, Dean Powers testified before the committee. His report concluded, in many instances, that the hedges or the derivatives that were established with these special purpose entities had nothing to do with setting off the economic risks, the normal expected purpose of a special purpose entity. In fact, they were a vehicle to take debt off the balance sheet and falsely inflate earnings and profits. You have had a chance now to examine some of these transactions and these sheets. Is his analysis correct or incorrect?

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    Mr. BERARDINO. Congressman, I will answer you specifically, but I just want to remind the subcommittee that this report was issued just Saturday. It's 200 pages long. We were not consulted, had not seen a draft, and there are a lot of questions and conclusions that were conjecture, ''appears,'' ''seems like,'' and so forth.

    But, I want to respond specifically to the issue of SPEs and lack of economic vitality, and I'll suggest what I did last time, which is that the rules for SPEs were not economically driven. Our firm disagreed with those rules because they were not economically driven. They were accounting conventions to move assets and liabilities off the books.

    The reason we disagreed is you have a 3 percent new money coming into these SPEs and the sponsor has 97 percent of the risk and awards. We never thought that made any sense. We lost that debate in our profession, and the rules, in fact, are accounting rules that don't reflect economics.

    Mr. KANJORSKI. You blame it on FASB or someone else. Somebody has got to stand up here, Mr. Berardino, and say ''we allowed this to happen. We participated in misrepresentations to investors, shareholders, pensioners, and 401K investors.'' Somebody has got to stand up. To say, ''well, we just have not examined the report, we just do not quite know yet,'' is not acceptable.

    It is a simple question. You have examined these transactions. Were there any economic risks involved that are the normal intention of hedges, or were these transactions vehicles to deflate debt and falsely inflate earnings and profits? That is a pretty simple question.
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    Mr. BERARDINO. With respect, Congressman, the rules are accounting rules, not economic rules. Number two is we are finding out things that we didn't know. Why did we not know them?

    Mr. KANJORSKI. I do not know why you did not know of these things. Obviously, you are not the man to testify. As a matter of fact, I would make the recommendation to the Chairman we start subpoenaing some of the responsible people that did these things. But, I do know your company helped set up these transactions. You are not some innocent. Coming in here as an auditor and having all these transactions that are out there, you are not just looking at them. You went through the intellectual analysis of how to structure these things.

    When we heard Dean Powers talk about moving $800 million of Enron stock over to one of these transactions in which Enron was hedging itself, it seemed clear to me his interpretation was correct. What strikes me is why it was not clear to a trained auditor or accountant. Those hedges were not worth anything. There was no recovery. There was no setting-off risk. It was strictly a chance to take debt off the balance sheet and inflate earnings and profit. It accomplished nothing. If the Enron stock went down in any respect, it was a sure loss for everybody except the insiders who got their fees up front and got their profits. Is that not a reality?

    Mr. BERARDINO. Congressman, I don't know, because I don't have all the facts.

    Mr. KANJORSKI. Well, did your company see these things and go to the board with them or to the shareholders meetings? Did your company do something?
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    Mr. BERARDINO. Congressman, there were many meetings with management.

    Mr. KANJORSKI. Management, look, we cannot put a lot of faith in what we heard about these managers getting $30 million incomes for setting up these transactions.

    I understand that you are not in a position to prevent greed. But one of our colleagues here, Mr. Shadegg, proposed the idea that the purpose of this subcommittee and what the Congress' responsibility is, is to see that this situation never happens again. We must take positions or pass legislation.

    I am just a small-town lawyer, and I am not sophisticated with hedges and derivatives, but having listened to Dean Powers yesterday I know these instruments are good in the system if they are properly used. It seems to me that everything that Dean Powers testified to yesterday highlighted in capital letters: GREED, absolutely unfettered greed. It is clear to me that the public and the shareholders have a right to assume that professionals, whether they be in the accounting profession or the legal profession or other outside professionals, have a responsibility to use their best judgment. Are their senses as strong as ours?

    What I am worried about is Mr. Shadegg's intention that we cure this problem. I do not know that we can ever develop a drug to cure greed, but we can shine light on greed. But, that is not good enough, because, after the fact, people have already lost. I mean, we are deluding these 401K investors into believing that they are going to get everything back. We are deluding the pensioners, the shareholders, the people that offered credit to this company that they are ever going to get anything back.
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    But what are we going to do? We are not going to cure greed. We are not going to have a drug for it. I have given up on that. It is starting to get to the point of ugliness now, but we can do something with the accounting profession. Something is going to be done with the accounting profession.

    Mr. Berardino, I know you are just a CEO of that huge company, but you have got to help us. You have got to identify who the people were who put these sham transactions together to hide a debt and to expand the appearance of earnings when they were not there. You have got to work with us on this problem. Identify these people, so we can have them up here and put the light on them. We have got to go through their mental processes of why this was done and did they understand, for those lousy $10 or $30 million in rip-offs by inside people in this company, people have paid with their life earnings and shareholders have lost billions of dollars?

    That is an economic tragedy that we can survive from. I think yesterday's market and the news media is really testing the fabric of the strength of the economic system of this country, because of activities, that your accounting firm either failed by negligence or were culpably a part of the inside transactions, that went on to send this company into bankruptcy and to shake the trust of the American people, and maybe the world, in our financial institutions. Something has to be done. I urge you, Mr. Berardino, to cooperate with the Chairman and this committee in giving us the proper people who we can put the light on to find out what was done, when it was done, why it was done and how we can hope to prevent it from being done again in the future.

    Mr. BERARDINO. Congressman, I'm up to that challenge. I'm here for the second time, as you well know. We will work with this committee in any way humanly possible to achieve that end.
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    Chairman BAKER. Thank you, Mr. Berardino. The gentleman's time has expired.

    Mr. Oxley.

    Mr. OXLEY. Thank you, Mr. Chairman and Mr. Berardino.

    First of all, before I ask questions, the comment you made regarding the 3 percent rule and the consolidating of financial statements, it's interesting back in 1996 Andersen was the only company among the accounting firms that actually opposed that rule, and your comments were absolutely correct.

    Mr. Chairman, I would like to make a copy of that available for the record.

    Chairman BAKER. Without objection.

    [The information can be found on page XX in the appendix.]

    Mr. OXLEY. Thank you.

    Mr. Berardino, the Powers Report notes that the disclosures regarding Enron's transaction with LJM and other partnerships were: ''Obtuse, did not communicate the essence of the transactions, failed to convey the substance of what was going on, sought to disguise their import of these transactions and sought to avoid disclosing Fastow's''—who was the CFO—''financial interest.'' The Powers Report states that this misleading disclosure reflects an absence of forceful and effective oversight by, among others, auditors at Andersen.
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    How do you respond to this very disturbing criticism, and what steps is Andersen taking to remedy the situation?

    Specifically, I asked Dean Powers, based on that statement, that indeed it appeared that Andersen was complicit in arranging these special purpose entities and indeed, as I indicated and characterized it, was involved with baking the cake. If that is indeed accurate, what steps immediately can Andersen take to avoid that in the future?

    Mr. BERARDINO. First of all, thank you for that clarification; and I find myself in the awkward position of defending something we disagreed with. But to specifically respond on the disclosures for Enron, let me just suggest that there are no requirements to disclose SPEs unless it is probable that these debts will come back on the books. So there's a judgment call that the manager makes and the auditors make as to the likelihood, probability, or remoteness of these transactions coming back on the books.

    That's why I keep saying, at the important time the assets that went with these liabilities were increasing in value—and then we all know what happened. They decreased, and they decreased very rapidly. When that happened, when it was probable, whether there were side agreements we weren't aware of, these are all questions we still have, and it will be relevant to understand what happened.

    Mr. OXLEY. Is the assumption, then, always that the assets will continue to increase and hold value? Is that the assumption that the accountants use in this process?
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    Mr. BERARDINO. The assumption is that the assets will hold their value and will support the liabilities that are off the books with it.

    Mr. OXLEY. And that is a hard-and-fast rule, that assets never depreciate in value?

    Mr. BERARDINO. No. In order to, in the first instance, set up the transaction, you need to move enough assets off the books to satisfy the liabilities, and you need to monitor on an ongoing basis—the company needs to monitor whether or not these assets can still satisfy the liabilities at such a point that they can't then——

    Mr. OXLEY. What is the auditor's role in that?

    Mr. BERARDINO. To monitor the management's judgment as to whether those assets have maintained their value.

    I would also like to correct the record in one respect, because people keep saying things like we set these things up. Our firm where—the accountants and the accounting advisors' management, in conjunction with their investment bankers, lawyers and others, would present us a transaction and would ask the obvious question, does this pass the rules? And we would give our judgment as to whether it would pass the rules, and at the end of the day those judgments were rendered.

    Mr. OXLEY. Mr. Berardino, that was not the testimony by Dean Powers. Dean Powers made it very clear that Andersen's accountants were very much involved in crafting these special purpose entities, that they were not just checking the box, but were, in fact, trying to find ways to make it work.
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    Mr. BERARDINO. Mr. Chairman, there's room for both of us to be accurate in portraying what happened. This isn't an indurate process. The company is, with their bankers and lawyers, designing transactions that are accounting transactions, and they ask our advice. So we'll say, yes, this works or, no, this doesn't work, that kind of conversation.

    Mr. OXLEY. Isn't it a fact that Andersen received $5.7 million for that advice?

    Mr. BERARDINO. That is true. I would just amplify and say that was over a 5-year period for scores of transactions, and again that was what you would expect the accounting firm to be doing, is looking at these transactions and giving advice as to whether or not they pass the rules or not.

    Mr. OXLEY. Is there some evidence from your perspective or from what the Dean told us yesterday that there was active participation in the crafting of these off-the-books entities, that Andersen did play a role in setting these up? That is true, is it not?

    Mr. BERARDINO. We were aware of the transactions.

    Mr. OXLEY. You were more than aware.

    Mr. BERARDINO. We gave judgments.

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    Mr. OXLEY. Dean Powers was pretty clear in saying that it was pretty clear that Andersen's people were involved in the get-go in creating these off-the-books entities. Is Andersen denying that they were involved in the take-off of these?

    Mr. BERARDINO. Mr. Chairman, I think we may be talking past each other in terms of what involved and what setting up all means. This committee did not talk to us, did not get our perspective on what our involvement was. I wasn't there. I can't tell you how active and what the nature of our people's judgments were. Suffice it to say, we were very much involved as the company setting up these transactions and giving advice on whether they would pass the rules. I'm not sure I'm being inconsistent with the——

    Chairman BAKER. Would you yield, Mr. Chairman?

    Mr. OXLEY. I'll be glad to yield.

    Chairman BAKER. I just wanted to suggest that it's apparent, as Mr. Kanjorski suggested, that there may be others more appropriate to respond to some of these questions; and we need to visit about the time and venue in which we might have some of those individuals available.

    Mr. OXLEY. Precisely. Thank you, Mr. Chairman.

    Chairman BAKER. Thank you, Chairman Oxley.

    Mr. Ackerman.
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    Mr. ACKERMAN. Thank you.

    Mr. Berardino, let me tell you first, before I ask you a question, what's in my heart. You've come back now for the second time to amend some things that you said before that weren't necessarily as accurate as you would have liked them to be, and we have been listening to you for a while, and we've basically gotten nothing, and I'm finding it very difficult to believe that a person who has risen to a position of such prominence and importance in the financial community can present himself as knowing absolutely nothing about what's going on in his own business.

    Maybe it's better to be dumb than culpable, but we want some answers. And I, for one, am extremely troubled by what I'm hearing. Your not knowing what was going on, if that's the case, is basically saying that you have squandered the integrity of your company. You've enabled the enrichment of the greedy at the price of destroying the dreams of so many decent, innocent people, and that is totally unacceptable.

    It seems to me that we had some testimony yesterday from some folks who spent a mere 3 months looking at what's happened and came back absolutely astounded, astounded as are we and as are the American people.

    You were asked the question before about the company that sought a merger with your company and in 2 weeks said this is unbelievable, we can't go through with this deal. Didn't that raise a suspicion in your mind that something that your prestigious firm was auditing and delving into and looking into was off base somewhere if in 2 weeks they could say that this is a house of cards, to say something is wrong with my auditors, I'm the captain of this ship? And to appear before us and say that, well, I was GAAP compliant, and I'm not the auditor, and I didn't—it's not acceptable. You're the captain of the ship.
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    I mean, if they came to you and said we want to rob a bank and here's who's going to drive the car and this is what we are going to pay for the gun and this is the day and time we're going to do it and who are fully disclosing all of this, you don't think you have the responsibility to blow the whistle?

    Now I don't even know what my question is. I mean, this is so mind boggling. I mean, how do you let this happen, Captain? I mean, your ship is going to go down, and you're going to be lashed to the mast unless you start talking to us about what happened. Maybe you can explain it.

    Mr. BERARDINO. Congressman, we are still getting facts. You want me to give you conclusions without all the facts. The special committee——

    Mr. ACKERMAN. How long have you been the auditors of this company and how long have you been their consultants?

    Mr. BERARDINO. This committee had conclusions that——

    Mr. ACKERMAN. Could you just answer that question first? How long have you been the auditors for Enron?

    Mr. BERARDINO. Our firm has been the auditor since I think the mid-1980s.

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    Mr. ACKERMAN. Since the mid-1980s, and now you're just getting the facts. That's very interesting. My kid cousin wouldn't use you to do his tax returns if that's what you're telling me.

    Mr. BERARDINO. Congressman, when I was here last I reported that, in one instance, we had facts and reached an improper professional conclusion and the company restated its earnings. I said, in the second instance, information was withheld from us; and once we had the information, we required and the company restated its financial statements. In this report there are allegations that maybe there was some other information withheld from us. I don't know if that's true or not. I haven't been consulted. We haven't been able to approach the committee.

    Mr. ACKERMAN. I'm just having difficulty here. I'm not making an analogy, but I can't help but think if Hitler was brought to the Nuremberg trials and he said ''I didn't know what was going on, I was just a president of a small country——''

    Chairman BAKER. Your time has expired, Mr. Ackerman.

    Mr. ACKERMAN. Thank you, Mr. Chairman.

    Chairman BAKER. Mr. Ney. And let me, before I recognize Mr. Ney, acknowledge that I'm having distributed the article printed in the New York Times which I made reference to with the proposed merger. I'm the one who's doing that.

    Mr. NEY. Thank you, Mr. Chairman.
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    Mr. Berardino, based on what is now known, did Enron officials, especially Andrew Fastow and Michael Kopper, keep material information about the special purpose entities from Andersen auditors?

    Mr. BERARDINO. I don't know. Apparently in the one transaction that was restated, 80 percent of the restatement information that was relevant was withheld. Who knew it? Who withheld it? We don't have that information.

    Mr. NEY. Are you looking into it to find out internally?

    Mr. BERARDINO. Frankly, we can't look into it. We are no longer the auditors for Enron. We don't have access to their people. We don't have subpoena power. We're sitting here like everybody else reading this report that was issued Saturday.

    Mr. NEY. I understand you're not the auditors, but you still should be able internally to question people that were around Enron, your people, and involved with Enron to find out if, in fact, to the best of their knowledge was information directly kept from them, and maybe they have that information.

    Mr. BERARDINO. Unfortunately, they don't know what they didn't know. OK? There are new facts coming out every day, and we don't have an opportunity to respond to them. I wish we did. I'd like to have facts. I'd like to give you more definitive answers. I just can't.

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    Mr. NEY. There's a new report out that Enron management might have taken large sums, $15 million in 2000 alone, from employee benefits accounts for spending at other departments. That's, of course, outrageous. I think we all know that, and I feel it's a crime. In fact, Ken Lay should have just had a mask and a gun. It would have been much easier than what he did to these people.

    Now, the Enron accountant who found it out reported it to a senior Enron management official, including Ken Lay himself, and Lay supposedly told her to mind her own business. Does Andersen have any knowledge of that conversation?

    Mr. BERARDINO. The first I've heard of it.

    Mr. NEY. Another question I wanted to ask: There has been a lot of news about the $25 million paid by Enron for Andersen's non-auditing services. But the Andersen/Enron relationship, it's been stated, was deeper. A recent news article said that Andersen employees were given permanent office space at Enron headquarters. They were dressed like Enron colleagues—which I wondered what that was—and then they went on to explain they wore Enron golf shirts, shared in Enron office birthday parties and ski trips to Colorado. Enron employees thought, they've stated, that your people were other Enron employees.

    That brings up just, obviously, several issues and questions. Didn't that violate the ethical standards of the CPAs that you're supposed to be independent in spirit as well as, in fact, and are these relationships norm throughout the accounting business?

    Mr. BERARDINO. I don't have any particular insight on that. I will tell you absolutely we are to be independent. It is not unusual, in fact, it is common that we have offices at our clients' headquarters, because we're constantly asking them questions and with a company of Enron's size we were continually doing our audits. So that would not be unusual.
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    These other, you know, social points you raise I just have no particular knowledge, so I can't respond.

    Mr. NEY. Would you please be intent for the future to go back to your company and say, did this happen? Talk to the people who were over there that were your employees to make sure that type of thing, if it happened, doesn't happen again?

    Mr. BERARDINO. Absolutely.

    Mr. NEY. You do have——

    Mr. BERARDINO. Well, we mentioned in my testimony this Office of Ethics, and we are going to make much more considered policies and directives to our people so that they understand what proper behavior might be.

    Mr. NEY. Last question I have, Mr. Chairman, the Powers Report states that the annual reviews of the LJM transactions by the Audit and Compliance Committee involved brief presentations by Enron management. Andersen was present at the audit committee and did not involve any meaningful examination of the nature or terms of the transactions. So the question would be, why didn't Andersen, which was present, seek further information about these transactions which ultimately did contribute to the collapse of the entire company?

    Mr. BERARDINO. I think the record will show in time that there were conversations with this audit committee over a long period of time where these transactions were on the agenda.
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    Mr. NEY. Thank you.

    Mr. Chairman, I hope that we can get down to the bottom of these eventually with other witnesses or whatever, because I think they're important as to the questions that have been raised here to be answered to this issue.

    Chairman BAKER. I can assure the gentleman that, with the committee's assistance, we will have much more informative hearings on the matter to determine as best we can the causes for these problems.

    Mr. Bentsen.

    Mr. BENTSEN. Thank you, Mr. Chairman.

    One thing I wanted to clarify, and I'm sorry Mr. Oxley has left, but he raised an important point. Mr. Berardino, when you testified last December before us, I asked this question, because at the back of your statement you made the comment, and I don't have the transcript in front of me, that at the time you didn't think that disclosing that stock values would affect the repayment of debt was a material item. I think you said something to the effect, and I am paraphrasing here, that the perception was the stock was always going on, and it's similar to what Mr. Oxley was asking, that asset values were always going up. So they weren't necessarily material items. I think now they have become very material in retrospect.

    Let me go back to some other questions, though, that you raised. Knowing what you know today, would Andersen take on Enron as a client? It's a yes or no answer, I mean, I guess.
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    Mr. BERARDINO. Well——

    Mr. BENTSEN. In the way that they appeared to have run their business.

    Mr. BERARDINO. We look very seriously at the integrity of management, the value of their representations, because we do test checks at a company. We don't look at every transaction. And I think the report yesterday was pretty direct in some of its criticisms about lack of supervision and in some cases integrity, and that would prevent us from taking on a client where those were real concerns.

    Mr. BENTSEN. Let me ask you this. Going back a year or so, is there a percentage at Andersen with which clients, long-time clients, are reviewed on a periodic basis, semiannually, annually? Is there a procedure at the partner level, at the management committee level with which you review clients? I mean, presumably you review how much revenues you are raising from clients and whether or not it's worth keeping or not based upon that and your costs associated with that, but did that go on with the case of Enron?

    Mr. BERARDINO. Yes, it did. In fact, there is a February memo that has been well reported in the public where that conversation was taking place within our U.S. management team, and the risks of the company were being evaluated as well as the procedures we would undertake to review.

    Mr. BENTSEN. Was there ever a time at the partner level that questions were raised about how Enron was conducting its business? I mean, was there ever a discussion of whether or not Andersen might want to fire Enron as a client because of concerns about how the business was being run?
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    Mr. BERARDINO. I wasn't part of those discussions. I don't know specifically what was discussed other than the general process we do go through every year about each of our clients as to whether we want to continue and whether or not we have the understanding——

    Mr. BENTSEN. Board meeting minutes or management committee meetings that you've seen.

    Mr. BERARDINO. Not to my knowledge.

    Mr. BENTSEN. Was there ever an occasion at the partner level where perhaps a call came—I mean, presumably somebody looks at the sum of the parts of all of the profit centers within the firm. Somebody has to, I guess, decide how to divvy up the profits at the end of the year. But was there ever a discussion that was made that perhaps there was something, a rather aggressive approach?

    Because you said the books—you're right about the fact that the books are the company's books and the accounting firm is just really adding its interpretation of the books. But it's also for a fee and legitimately, in virtually every case, for a fee is putting its imprint on there. It's giving its qualified opinion which the marketplace takes as an interpretation that things are on the up and up.

    But was there ever a case where you received a call or someone at the partner level or management level of the firm received a call from the division that was responsible for Enron that said, there's a problem with how they want to lay out the books, with either SPEs or SPVs or whatever, dilution of stock, you name it, some of the stuff that's in the Powers Report? Was there ever a call made and the discussion was, look, the client always comes first? Was there ever a situation in the case of Enron like that?
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    Mr. BERARDINO. I'll make two comments. One is that was not brought to my attention, that kind of conversation, until the third quarter of 2001 when we had many conversations with the company on that report. But I'm Chief Executive officer of our firm worldwide. We have a management structure in the U.S. that would have those conversations to the extent they existed, but I wasn't part of those.

    Mr. BENTSEN. For the record, could your firm provide us with an answer to that question, whether or not there were discussions? Because the perception is out there that while the auditing firm looks at the books—and, sure, you've given the information, although, as Mr. Ney was saying, you had offices there so you can pepper them with questions on a regular basis. But when you're sitting down to close a deal—I mean, the Chewco deal wasn't fully baked, but they had to get the deal done, and so they did it improperly. And Andersen was apparently involved to some extent, and they assumed that they would fix it between November and December or whenever they closed their books, and they would find the other 1 1/2 percent equity ownership to make the deal work, make it legal under the terms of FASB.

    The question I have is, somewhere in the management structure was there a discussion that said, look, this isn't quite how it ought to be but, look, they are a good client, you know, they're an upstanding company, whatever, let's work with them to get this done. Because that's a breakdown in the system, and it undermines sort of the old adage of FDR going back to the Securities and Exchange Act, that the whole idea was to have a level playing field. Part of the level playing field is the imprimatur of the auditing firm that the books at least have been looked at even with a qualified opinion; and if the question is that the client is starting to push around the auditor, then we have an unlevel playing field.
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    Mr. BERARDINO. I think that's a fair question. Unfortunately, you have the wrong person in front of you to give you more specific answers.

    Mr. BENTSEN. You are the Chief Executive Officer and presumably you have access to the minutes of the meetings of the partner committees and whoever has responsibility over the U.S. functions, North American functions and could provide those for the committee.

    Mr. BERARDINO. We'd be happy to be helpful if we can be.

    Mr. BENTSEN. We would appreciate seeing that.

    Thank you, Mr. Chairman.

    Mr. BERARDINO. Thank you.

    Chairman BAKER. The gentleman's time has expired.

    Mr. Shays.

    Mr. SHAYS. Mr. Chairman, I would like to just pass for two or three rounds and then reclaim any time.

    Chairman BAKER. Mr. Castle.
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    Mr. CASTLE. Thank you, Mr. Chairman.

    Mr. Berardino, I have had sort of mixed feelings about this this entire morning. It's been interesting. I believe your testimony, which I have tried to read in full, well beyond what you've said here today, is very comprehensive in terms of what should be done. But I consider it sort of a mea culpa testimony, if you will, as opposed to something I'd like to have heard a year ago or whenever it may be.

    I couldn't find my notes on this, but I recall reading that Andersen had done auditing work for, I think, Sunbeam—is that correct—in the past?

    Mr. BERARDINO. Yes.

    Mr. CASTLE. And Rite Aid, was that not correct? Waste Management, all of them had some sort of fundamental non-disclosure issues, particularly Sunbeam. That created tremendous stockholder havoc out there.

    I mean, my whole bottom line on this is that there's a whole series of insiders, of which auditors are one to a degree, but there are insiders who are doing these kinds of things, most of whom hopefully in this country are operating in a perfectly acceptable level. They are the ones who are running the companies, and they are the lawyers and the others who are giving advice, all the investment counselors. There are securities analysts who are giving advice on these various things that have some knowledge about what is going on.

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    Then there is sort of a filter system, and to me the filter system is the auditors, and it's the auditors that have to filter to those of us, and in this case there are millions of people who suffered huge losses out there. And when I say millions, I'm not talking about people who directly own Enron stock, but all the pensions plans—not just Enron's either—but all the pension plans in this country, and all the major stock holdings of a lot of operations and they all lost on it, because that filter, in my judgment, among other things, did not work. The water was plenty dirty by what happened to all the others, but I question, has the filter worked or not?

    I wish the ideas you had in here had been in place in order to have prevented this. I know that you want to be a part of the solution, and I appreciate that, and I have also listened to you, say, three or four times, in various ways, that you did not do the audit, meaning you personally did not do the audit in this particular case, but isn't there a corporate responsibility to know? I mean, is Andersen just too big? Do we have a problem with the big five accounting firms or whatever? Do we need to do this in a way so that everyone knows what's going on at this point?

    It just seems to me unacceptable—and I consider you to be a person of integrity, but it's unacceptable that these kinds of things are happening in a huge, multi-million dollar, fee-based structure for a major corporation in the United States of America, and yet you can sit there and legitimately be able to say I simply did not know. And not that you would have known at the time, because you didn't do the work, but that it would not have somehow have gotten to you.

    Just in a broad sense, what are we doing with auditing in this country?
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    Mr. BERARDINO. Well, I think that's a fair question, and what I came here to do today is to help you with your thoughtful deliberations in terms of what we're going to do going forward. And I've put some very serious proposals on the table that we are just going to do as a firm. We are not going to wait for people to tell us what to do, but also that I think could be part of the fix.

    The fact is, as auditors, we know a lot more than we can tell the public. We tell the public through the audit committee, and the question is whether we ought to be telling more directly to the shareholders in some way. That mechanism does not presently exist. I think there are ways we can get better. We are looking at this crisis. It is a crisis. It is a tragedy we have. We understand that. Real people were involved. But I also understand——

    Mr. CASTLE. I appreciate what you've said, and I agree that your testimony is basically positive and good for us, but still I'd like to know a little more about the question of the size of auditing firms. In other words, it has just gotten too out of hand in terms of the magnitude with a limited number—I think I read someplace that basically all the audits for all the corporations of the country are done not just by the Big Five, but by like about 20 or 25 firms throughout the country. I have to assume they're all big. Even the smaller more regional ones are pretty large.

    Mr. BERARDINO. Right.

    Mr. CASTLE. And we're at the point where we are not getting good independent reporting with good oversight of what's happening there and you're removed from some of these answers.
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    Chairman BAKER. That will be the gentleman's last question. His time has expired, but please respond.

    Mr. BERARDINO. Congressman, that's a question I have given some thought to. Really, you've got a balance here, and I'm not going to say I've got the ultra wisdom here, but one of the benefits of bigger firms is you can develop deeper expertise, invest more in training, and have people on the cutting edge to understand the technology risks, the tax risks, all the risks a company has. And, you know, as a public policy statement I don't know where that white line is.

    No, I don't think we're too big, but when you've got 28,000 people just in the U.S. that make judgments every day—you know, I can't change human nature. People will make bad judgments. We need to limit it. I'm not apologizing for it.

    We are considering every possible avenue to make sure those judgments are better and the backbone and the skepticism is there to ask the hard questions, and every one of my proposals is designed to make sure we're better.

    Mr. CASTLE. Well, my time is up, as the Chairman has so warned me, but I would just comment that the whole structure issue of the way the very firms are set up at least concerns me. I also don't know if it's right or wrong, but it at least concerns me. I hope we add it to the list of things we look at.

    Mr. BERARDINO. I think it is a fair question.
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    Chairman BAKER. The gentleman yields back his time.

    Mr. Sandlin is recognized.

    Mr. SANDLIN. Thank you, Mr. Chairman; and, Mr. Berardino, we do appreciate your coming here today.

    We are disappointed that Mr. Lay has taken the Fifth Amendment by absentia, and we do appreciate your willingness to testify.

    You remember recently when Arthur Levitt and SEC a couple of years ago recommended that accounting firms should separate their auditing business from their consulting business? Do you remember that?

    Mr. BERARDINO. Well, if I could just correct you just the slightest bit.

    Mr. SANDLIN. Well, that's my question. Do you remember that happening?

    Mr. BERARDINO. Yeah, well, no, I don't, because I——

    Mr. SANDLIN. And at that time Arthur Andersen opposed any required division of auditing and consulting; is that correct?
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    Mr. BERARDINO. That's not correct.

    Mr. SANDLIN. And you took the position at the time that the industry could police itself?

    Mr. BERARDINO. If I could just correct you on one small matter, Congressman, the question Mr. Levitt put on the table was whether auditors could do consulting work for their clients, not whether or not they could also be in the consulting business and offer those services to non-audit clients. So that's the only small exception. I did disagree.

    Mr. SANDLIN. And your position at the time was that Andersen should audit what Andersen did?

    Mr. BERARDINO. No, I——

    Mr. SANDLIN. Andersen was doing consulting; is that correct?

    Mr. BERARDINO. My testimony——

    Mr. SANDLIN. Andersen was doing consulting; was that correct?

    Mr. BERARDINO. Yes.

    Mr. SANDLIN. Andersen was doing auditing; is that correct?
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    Mr. BERARDINO. Yes.

    Mr. SANDLIN. In fact, on this self-policing on January 2nd, about 30 days ago, Andersen was touting this peer review that did not identify the systemic failures in Andersen; is that correct?

    Mr. BERARDINO. Yes.

    Mr. SANDLIN. And that report was reported after the Enron problem, after Chewco, after Jedi, after Fastow took off with $30 million, after Kopper made off with $10 million, after Lavorato took a $5 million retention bonus, after Louise Kitchen took $2 million, after the employees were locked down in their pensions. In fact, it was a month after Enron filed for bankruptcy and your peer review said there were no systemic failures; isn't that correct?

    Mr. BERARDINO. Yes, that's correct.

    Mr. SANDLIN. And the report that came from the independent group said, quote; ''Andersen did not fulfill its professional responsibilities in its auditing work.''; Is that correct?

    Mr. BERARDINO. I don't——

    Mr. SANDLIN. You don't remember that being in the report from the Enron investigative board?
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    Mr. BERARDINO. I don't remember the exact wording, but it was something to that effect.

    Mr. SANDLIN. I believe it said ''did not fulfill its professional responsibilities in its auditing work.''

    And talking about failures, when it appeared that Enron was in trouble, the response of Arthur Andersen was to immediately destroy evidence and to shred documents; is that correct?

    Mr. BERARDINO. No, it's not.

    Mr. SANDLIN. Did Enron—excuse me——

    Mr. BERARDINO. Congressman, if I could expand on my answer?

    Mr. SANDLIN. Let me ask you this, and you can ask your counsel if you need to ask questions. Did Arthur Andersen engage in destroying and shredding documents?

    Mr. BERARDINO. Congressman——

    Mr. SANDLIN. Did Arthur Andersen shred documents?

    Mr. BERARDINO. Arthur Andersen is an institution. There were individuals——
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    Mr. SANDLIN. I think Mr. Andersen is deceased. I'm asking if your company and your employees shredded documents after knowing about an SEC investigation. Did they do that or did they not?

    Mr. BERARDINO. We, top management in this firm found out that people had destroyed documents.

    Mr. SANDLIN. Thank you.

    Mr. BERARDINO. We self-reported to the Justice Department, self-reported to the SEC——

    Mr. SANDLIN. So the answer is that they did.

    Let me ask you this. Arthur Andersen received $25 million in auditing fees, $27 million in consulting fees. Taking into account the reports and all the problems that we've had and the money that you got paid, would you now support a complete division and requirement of a division of auditing and consulting services in the accounting business?

    Mr. BERARDINO. Congressman, we put on the table today some very significant suggestions that we think Congress should consider that we think——

    Mr. SANDLIN. Let me ask—and that's a good point. That's a good point. I listened to your five proposals you made, and every one of them was to make it better for accounting and for Arthur Andersen. I didn't hear one thing about the Enron employees. I didn't hear one thing about health care. I didn't hear one thing about the pensions. I didn't hear one thing about Arthur Andersen contributing money to help the people that you helped destroy, the lives that you destroyed. All I heard was what can we do to make it better for Arthur Andersen so we can go on about our business and make more money in the accounting business.
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    Now that was the five goals in the five areas that you listed. I wrote them down. Now are you willing to do something and add a sixth to help the Enron employees, to help the people whose lives that you helped destroy? Can you do that?

    Mr. BERARDINO. Congressman, I'm interested in doing things that pass two tests. Test number one——

    Mr. SANDLIN. Can you help the Enron employees?

    Mr. BERARDINO. Test number one is that this has to be public's interest to build confidence in our profession in the public mind.

    Mr. SANDLIN. OK.

    Mr. BERARDINO. And number two is has to improve the quality of auditing.

    The steps I put forward are first steps.

    Mr. SANDLIN. Thank you. Let me say this——

    Mr. BERARDINO. The first steps that I think will help both those tests, and there will be more as we have a further conversation.

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    Mr. SANDLIN. That's a very charming story and——

    Chairman BAKER. Can you——

    Mr. SANDLIN. Yes, sir. That helps the accounting industry, but I'm interested in Arthur Andersen doing something and taking assets, taking some of those fees and putting them in the funds to help the people whose lives you destroyed, not just the accounting industry.

    Thank you for coming.

    Chairman BAKER. The gentleman's time has expired.

    Mr. Royce.

    Mr. ROYCE. Yes, sir.

    The Powers Report states that your firm declined to speak with the investigatory board chaired by Dean Powers about the Jedi-Chewco transaction which was structured, in their words, in apparent disregard of the accounting requirements for non-consolidation. Now, today you told us that you did not refuse to cooperate with the board, and my question would be: would you be willing, then, to communicate with the Powers investigatory board regarding those questions?

    Because we have two assertions that we have heard, one yesterday and the other today, by you. I guess the comment you made is, well, we're off the case, we're no longer employed by Enron. But that doesn't answer the question as to why you shouldn't respond to their inquiries, and my first question is, are you——
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    Mr. BERARDINO. Because they didn't make an inquiry. We offered to help. We were very available. We begged them to talk to us. We never saw a draft of the report. The board fired us in the middle of the investigation, and you're asking me to respond to things I saw on Saturday night for the first time.

    Mr. ROYCE. I see.

    Mr. BERARDINO. To answer your question specifically, we have been the most forthcoming firm, the most forthcoming profession. We're back here for the second time voluntarily, because we want to get it right. We will be happy to talk to anybody who's interested in getting to the bottom of this so I can answer these questions more specifically.

    Mr. ROYCE. So if Dean Powers approaches you next week and asks to talk to the auditors who were on—site so we might be able to glean some information, you would be willing to allow them to do that?

    Mr. BERARDINO. Absolutely.

    Mr. ROYCE. The second question goes to the issue Chairman Oxley raised and just to repeat that assertion, as the New York Times put it, Enron's accounting treatments for the partnerships LJM and Chewco were determined with extensive participation and structuring advice from your company which billed Enron $5.7 million above and beyond its regular audit fees for this service. Chairman Oxley raised some questions. If we put those questions in writing so that you could then go back to the auditors who conducted this audit, could we then get some answers about that structuring agreement, about your participation, your firm's participation arguably in setting up those partnership agreements?
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    Mr. BERARDINO. We are here to be helpful any way we can be helpful.

    Mr. ROYCE. All right. Well, I appreciate that.

    The next question that I would have would go to the question of the document shredding that's been raised here today. What exactly was shredded? Could you enlighten us about what we know about those files? What did they pertain to? Was it the partnership agreements?

    Mr. BERARDINO. Well, unfortunately, it's hard to recreate shredded documents. You can recreate deleted e-mails. And, from the moment we knew about this at the top of this organization, we have been trying to recreate whatever is possible to recreate, and we're able to recreate a lot of it. We are still studying what happened, why it happened, and as soon as that investigation is complete, we will make those results publicly available.

    Mr. ROYCE. Could you give us some insight, since you've got some of the puzzle pieces together, as to the subject matter of what was shredded?

    Mr. BERARDINO. No, I cannot. I just don't know.

    Mr. ROYCE. All right. And it's been reported that Arthur Andersen cut a deal to handle some of the internal auditing work for Enron along with vetting its public reports for the trading firm's audit committee. The fact that your company audited Enron's internal and public financial data seems to pose a serious conflict of interest with Andersen developing Enron's internal accounting controls on one hand and then publicly attesting to the veracity of the data produced on the other. As CEO, did this strike you as a serious conflict of interest up until——
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    Mr. BERARDINO. No, it hasn't. And I would say back to the debate we had 2 years ago with the SEC, this issue was specifically debated and it is permissible for auditors to do internal audit work. Now, as you've read in my testimony and my spoken testimony as well, we understand that though we may win on debating points technically, there is a concern in the public interest, and that's why I have those two tests, is the public interest being served, does it undermine our credibility in the public? In this case, it obviously does, and that's why we voluntarily stepped forward and will no longer provide those services.

    Mr. ROYCE. Do you think the entire accounting industry should pick up this same remedy in terms of conflict of interest and establish it as a reform industrywide?

    Chairman BAKER. That's the gentleman's last question. His time has expired, but please respond.

    Mr. BERARDINO. Frankly, given what happened here, the whole system needs to be looked at, and we are putting forward our ideas on our part in the system, and I think this is part of the conversation.

    You've got the benefit of my wisdom. To the extent you agree with it or disagree with it, I think we can have a healthy conversation and debate and end up in a place where the public has more confidence in the profession and where we can do even better audits.

    Mr. ROYCE. I thank you, Mr. Chairman; and I will be getting back with the questions that Chairman Oxley asked and that I asked so that we could have those in writing so that there could be some time for the witness to respond to us, because we'd like the specifics. Thank you, Mr. Chairman.
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    Chairman BAKER. Thank you, Mr. Royce. I'm sure the subcommittee will work on a follow-up series of questions on the subject you have brought to the attention as well as Chairman Oxley and a number of other issues which I think would be very helpful for the committee's proceedings.

    Mrs. Jones.

    Mrs. JONES. Thank you, Mr. Chairman.

    Mr. Berardino, I, too, would like to have the benefit of your wisdom. Could you tell me how long have you been the CEO of Andersen, sir?

    Mr. BERARDINO. Just over a year.

    Mrs. JONES. What were you doing previously, sir?

    Mr. BERARDINO. I was in charge of our auditing practice.

    Mrs. JONES. And what's the purpose of an audit, sir?

    Mr. BERARDINO. The purpose of the audit is to give investors an opinion on the fairness of the financial statements in accordance with the rules that are established.

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    Mrs. JONES. So, based on your audit, it was your opinion that Enron was an organization that investors should invest in; is that correct?

    Mr. BERARDINO. We don't make judgments on who should be investing or not. It was a public company.

    Mrs. JONES. Excuse me. Let me rephrase my question, then. Maybe I should say that, based on your audit, people in reliance on the name Arthur Andersen invested in Enron.

    Mr. BERARDINO. Among other things that they rely on. They rely on their investment advisors, and so forth.

    Mrs. JONES. Except that the reason we are seated here and you no longer represent Enron and the public is outraged, that there was something about this audit that did not represent the true financial status of the Enron Corporation. Is that a fair statement, sir?

    Mr. BERARDINO. We're here because a big company collapsed very quickly.

    Mrs. JONES. Let me restate my question. The reason we are here is because you audited Enron Corporation and the representations you made were not, in fact, a true financial picture of the corporation such that a lot of people lost money, and we're in a public hearing trying to decide whether the auditing principles that have governed our Nation for the past few years are truly in the best interest of the public. Is that a fair statement, sir?
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    Mr. BERARDINO. And I'm here to give you some thoughts on how we might go forward with a much better——

    Mrs. JONES. Well, then why don't you give me some thoughts? How is it that the public would not have been able—strike that. How is it that the public could not see what was wrong with Enron based on your auditing practice?

    Mr. BERARDINO. I don't know how to answer that question. The public——

    Mrs. JONES. You're an auditor, though, sir, aren't you?

    Mr. BERARDINO. Yes.

    Mrs. JONES. So based on the audit that your firm did, shouldn't the public have been able to see the problems with Enron?

    Mr. BERARDINO. The public—really, what I can tell you is that in the 9 months before any of these accounting issues became public, this stock went down 70 percent.

    Mrs. JONES. Let me ask you this.

    Mr. BERARDINO. A number of——
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    Mrs. JONES. Hold up a minute. As the auditor, shouldn't you have been able to see the problem with Enron such that you could have told the public the problem that was going on?

    Mr. BERARDINO. I think that's a fair question, Congresswoman, as to what our role should be. We audit in accordance with certain rules. If the rules are passed, we have no ability to say anything beyond what's in the management's financial statements.

    I think a fairer question is——

    Mrs. JONES. I'm not asking you to ask the questions. I'm asking the questions, sir. Hold on a second.

    Let me say this, then. You, as Arthur Andersen and this group of auditors who give consultation to the SEC, and so forth, have the ability to lobby as to what are the appropriate rules and regulations, do you not, sir?

    Mr. BERARDINO. Yes, we do.

    Mrs. JONES. In fact, you lobbied very recently just in 1995 to have some change in the Private Security Litigation Reform Act that, as a result of that Act, there have been a high number of restatements by many corporations restating what their financial picture is, because before they were able to camouflage it; is that correct, sir?

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    Mr. BERARDINO. There have been a lot of restatements. There have been—we did participate in that bill being prepared. We also lobbied against these SPE rules and were unsuccessful.

    Mrs. JONES. Let's stay with what I'm talking about. You can talk about SPE rules in your testimony, OK?

    So there have been a ton—not a ton—a high number of restatements, and the restatements that were made by these public officials speak to what—excuse me—by these corporate officials speak to what?

    Mr. BERARDINO. Restatements happen for one of two reasons. One is, there's an honest misapplication of generally accepted accounting principles or there is just a difference of opinion between the SEC staff and the auditor as to what the result should be.

    Mrs. JONES. An honest misapplication of auditing principles or a disagreement between the SEC and the representatives of Arthur Andersen can cause Enron employees and people across the country to be in a financial disaster right now; is that correct, sir?

    Mr. BERARDINO. I don't know.

    Mrs. JONES. Let me ask you this, sir. What is the purpose of a consultant? I might be out of time, but answer that question for me.

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    Mr. BERARDINO. A consultant is to offer advice to a company on areas within whatever area of expertise they might practice.

    Mrs. JONES. So on the one hand you audit and you give them—you go through the books based upon representations and you represent to the public the financial status of a company on the other side and you sit and consult and give them advice on how they should answer those questions.

    Mr. BERARDINO. Well, auditors——

    Mrs. JONES. Yes or no?

    Mr. BERARDINO. Auditors have tremendous insight into a company and how they can be approved.

    Mrs. JONES. But my question was a yes or no answer. Is that true what I stated about consulting and auditing?

    Mr. BERARDINO. Yes.

    Mrs. JONES. Thank you. I yield my time.

    Chairman BAKER. The gentlelady's time has expired.

    Judy Biggert.
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    Mrs. BIGGERT. Thank you, Mr. Chairman.

    Mr. Berardino, as you know, Chairman Pitt testified before our subcommittee yesterday, and one of the questions that I asked him was regarding the SEC guidance that was released on January 22, and it involved the special purpose entities and the market-to-market accounting and the related-party transactions. Have you seen that release of the guidance?

    Mr. BERARDINO. No, but I'm generally aware of it. In fact, we had a conversation with the SEC encouraging just that release because of the confusion that was out there in those issues.

    Mrs. BIGGERT. On a couple of the issues, for example, the market-to-market accounting, and they were talking about the 3 percent rule, and I recall in someplace that your firm has not been in accordance with the SEC on the use of the 3 percent rule?

    Mr. BERARDINO. Well, when that rule was put in place, we disagreed with it, and we're on record as disagreeing with it, but other people felt differently.

    Mrs. BIGGERT. Do you think that—I just wondered if there was a change in that rule under these guidance terms.

    Mr. BERARDINO. Not to my knowledge. I think there is suggested additional disclosures which were very unclear in the original pronouncement.
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    Mrs. BIGGERT. Does your firm intend to respond to those?

    Mr. BERARDINO. Yes. Absolutely. I should say our clients are, and we are insisting that they do.

    Mrs. BIGGERT. I noticed that he said that there have been no negatives to it so far. But, of course, it's only been 2 weeks, so that's not a very long time.

    One of the proposals that has been suggested is rotating auditing firms every 5 years or so or at least a change in the partners in charge every 3 to 5 years. How long was David Duncan the partner in charge at Enron?

    Mr. BERARDINO. I don't know, but I will tell you that there is a 7-year policy in our firm and in the profession, where you cannot be the signing partner on an audit for more than 7 years in a row.

    Mrs. BIGGERT. The number of corporations that have retracted and corrected prior earnings has doubled in the past 3 years, and I think we have talked a little bit about this with Sunbeam and Waste Management, and these were not detected by the accounting firms, including yours. Do you think that the profession should, you know, maybe consider what are the ethic standards to avoid more of these embarrassments?

    Mr. BERARDINO. This is a very fundamental question, and one of the problems we have is these rules are overly complex and subject to very different interpretations firm to firm and individual to individual. And although these restatements are very high, that does not mean companies are doing something illegal or immoral. It means that the rules are complicated, and we've had disagreements within the profession on how to apply them, and that does not do much for the confidence of the investing public when they see these restatements.
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    So I think there's a real serious question, I allude to it in my testimony, as to the complexity of the accounting, the legalistic nature of it, a flight to the lowest common denominator in financial reporting by some companies that really needs to be addressed as part of this conversation we're having.

    Mrs. BIGGERT. Let me just go back to the 3 percent rule again. Because it seems that 97 percent of, you know, a special entity could be, let's say, Enron and only 3 percent an outside company, and that—or investor—and that would be enough—is that to cause a whistle-blowing on it or to say that there's something wrong with this.

    Mr. BERARDINO. Well, to try to to defend the other point of view, not the one we had, the idea was that if you've got certain assets you wanted to move off your books, if those assets were sufficient to pay off the debt, an arbitrary bright line of 3 percent was brought in to say you need to have some outside investor involved.

    We looked at it and said, you know, if you look at the form of it, you get to the answer of moving it off the books. But when you look at risks and rewards, 97 percent stays with the sponsoring company. It just didn't make any sense to us. And this is one of the fundamental questions about accounting as to what are you trying to accomplish. And in this case, unfortunately, the rules were drafted the way they were drafted.

    Mrs. BIGGERT. Thank you.

    Thank you, Mr. Chairman.
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    Chairman BAKER. Thank you, Ms. Biggert.

    Mr. Capuano.

    Mr. CAPUANO. Thank you, Mr. Chairman.

    Mr. Berardino, I guess I'm one of the few people who have no trouble pronouncing your name.

    But I'd just like to start off—I was just reading in the paper today some items on the issue, obviously, and some of the comments relative to Mr. Pitt's testimony yesterday and some of the concerns about his past association with the accounting field, and there was one comment I'd like your opinion on. After some of the recommendations you've made and some of the comments you made today, do you still think it's a good idea for the two open slots in the SEC to be awarded to people who are currently working for two of the major—the Big Five accounting firms, or do you think maybe we should reach a little bit for a little more independence?

    Mr. BERARDINO. Congressman, you're an expert in public policy and oversight, and I'm not. I will tell you this. If you look at the accounting profession today, we are the most regulated profession you'll ever see. We have State Boards of Licensing. We have a Public Oversight Board. We're now putting two more Public Oversight Boards——

    Mr. CAPUANO. Mr. Berardino, excuse me. That is not even close to true. I don't mean to be disrespectful, but I'm an attorney. I've dealt with accounting firms. My wife is a CPA. I know very well how you were overseen, by whom and by what; and most of the oversight for the auditing field is done by other auditors, as is proven on an annual basis or a semiannual basis by a peer review audit.
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    You are not the most heavily regulated profession in the field. You're not even close. That is one of the reasons, in my opinion, why we are here today.

    Earlier, in response to one of the Chairman's questions, you said you cannot make clients report more than is required. I agree with you. However, you can add comments to your audits, which of course in this particular case every written report I have seen indicates, or any of those comments were confusing or misleading.

    You can also qualify your reports. You can also add a disclaimer to your reports and if any of that fails for any reason, any partner within the firm can also add a dissenting opinion to the work papers for those audits.

    Have any of those occurrences happened relative to Enron and Arthur Andersen? Have you had any disclaimers? Have you had any dings? Have you had any dissenting opinions in your work papers which you would know, because they are your work papers?

    Mr. BERARDINO. The SEC will only accept an unqualified opinion. There is no such thing anymore as a qualified opinion. You can disclaim an opinion if you think the company is ready to go out of business.

    Mr. CAPUANO. The problem with a qualified opinion is, you can do it, you just won't do it.

    Let me tell you something else. When I was the mayor of my city, Arthur Andersen was the auditor of my community. They did a good job. As the client, like most taxpayers, part of my job is to push the envelope as best I can. I understand that. I respect that.
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    Do you know how people like me are kept in check? By the auditors saying if you do that we have to put a comment, we've got to put a ding, we've got to put a disclaimer. And that's what stops clients from going over the line. And if you tell me that you didn't do it—which I know you didn't do it, you know you didn't do it—that doesn't require any legislation, that doesn't require any hearings, that doesn't require the SEC.

    That requires Arthur Andersen or any other auditor to look in the mirror and say, is this right or is this wrong? If it's wrong and over the line I need, I am required—not can—I am required to put a disclaimer in there. I am required to walk away from this client.

    Arthur Andersen didn't do that. And honestly I am not that angry. I am angry, of course, about the whole situation. What I am is disappointed. As a professional, I am disappointed that another professional organization that holds the belief and the trust of the American public in your hands blew it so badly.

    Let me ask——

    Mr. BERARDINO. Congressman, can I respond to that?

    Mr. CAPUANO. Sure.

    Mr. BERARDINO. One of the suggestions I put in the testimony I gave you is that we ought to have a formal ability to do that in our auditors' report, that we ought to have a formal ability to risk-adjust our opinion for those companies that barely get over the line of acceptability and contrast that with those that are at the gold standard.
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    Yet we say no. We say no a lot.

    Mr. CAPUANO. Mr. Berardino, you do have that ability by walking away from a client. You say, excuse me, I love being paid, but this company is going to get Arthur Andersen in trouble. This company is going to get me in trouble. This company is going to render my partners liable for millions of dollars of problems in the future, possibly against me.

    You do have that ability. You choose not to use it. I respect it. You do have that ability.

    I was also reading about Global Crossing today. You have a great distinction of being the auditor on the largest bankruptcy in history and now the fourth largest bankruptcy in history. And I actually think that this committee should start looking into things other than just Enron.

    I think we need to start asking questions; many of the same questions relative to this instance may or may not apply to other companies. Global Crossing has a lot of questions coming up. I am sure you are preparing for it internally because it is going to come. That's a problem. You got the first and the fourth.

    Nobody saw it coming? Nobody did a disclaimer? Nobody did a dissent? That is problematic to me.

    Chairman BAKER. You need to wrap up.
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    Mr. BERARDINO. Congressman, with respect, Global Crossing stock has been coming down for months and months and months, because its business was not succeeding. The prices for its product came down precipitously. And I think what we need to do—and you know this well, I'm sure—is we need distinguish between a business failure—and there will be business failures in this country—and an auditing failure.

    And I suggest to you there will be more and more business failures, and if we immediately rush to judgment that said, where were the auditors——

    Mr. CAPUANO. You are telling me that some of the news reports, which is all I know about Global Crossing, that they are all overreacting? There's no problems at Global Crossing? Please don't tell me that. I am not looking to catch you up. And I don't know anything about Global Crossing except what I read in the general media. But please don't say that today because you're under oath.

    I am not looking to trip you up. Please don't say that, because I really don't want to be back here 6 months from now with you in front of us telling us, well, it really wasn't a business failure, there were accounting issues as well.

    Chairman BAKER. That's the gentleman's time, but please respond to his comment.

    Mr. BERARDINO. Congressman, all I'm trying to do is make sure we debate what we need to debate so we can improve the system. And I do think there is a misunderstanding in the American public between a business failure and an audit failure.
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    All I am suggesting is we are going to have the debate, and I am here because I want to be part of that debate. Let's debate the right issues, and I think your comments are very understandable and very fair in terms of what the right issues should be.

    Chairman BAKER. The gentleman's time has expired.

    Mr. Rogers.

    Oh, Mr. Shays.

    Mr. SHAYS. Thank you, Mr. Berardino, for being here. I think it's very clear that the Powers Report basically had an indictment practically of every profession. It went after attorneys, accountants, regulators, management, the board, bankers, analysts and the rating agencies, and it basically said, all of them, these independently failed to act properly. And you're obviously a major player in this process.

    I give you high marks for coming before the committee in both December and now. But I am concerned, frankly, as I have been listening that you are deflecting questions by saying not enough time and you weren't there.

    Mr. Oxley asked you a softball question. Even though you may not like to give it, he said, with hindsight, isn't it clear that Arthur Andersen failed to do its job properly? And I am going to ask you the same question, because maybe you have had more time to think about it.
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    Mr. BERARDINO. Congressman, you put me in a difficult position asking that question. It's a fair question, but I do think there are a lot of facts we don't know like, were we misled, was there information withheld from us, and I just don't know the answer to that question. I have admitted early on that we made a bad judgment and that caused part of the restatement.

    We have also admitted that information was withheld in another transaction, and that was restated.

    Mr. SHAYS. I would have to say to you that the easy answer and a simple one would be simply to say, we failed to do our job properly. I mean, that is the bottom line. It's what Powers has said. It's just basic reading of the documents to see what ultimately happened.

    This company went under because it made very risky investments, but it was able to conceal these investments. When I look at what's available to you—I mean, the memo that was sent to Mr. Duncan by Michael Jones is a devastating memo. Did you read that memo?

    Mr. BERARDINO. Is that the one in February?

    Mr. SHAYS.T4 YES.

    Mr. BERARDINO. That was a memo, Congressman, where our team was discussing the risks at Enron.
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    Mr. SHAYS. Did you read the memo?

    Mr. BERARDINO. Yes.

    Mr. SHAYS. Let me read the paragraph.

    ''Ultimately the conclusion was reached to retain Enron as a client citing that it appeared that we had the appropriate people and process in place to serve Enron and management in our engagement risks. We discussed whether there would be a perceived independence issue solely considering our level of fees. We discussed that the concerns should not be on the magnitude of fees, but on the nature of fees. We arbitrarily discussed that it would not be unforeseeable that fees could reach $100 million per year.''

    That is an extraordinary—when I look at it, because then after February, then you get Raptor and you get exactly what happened, the failure to disclose and basically hide $800 million of liability and losses. So I would think as CEO, as president, as chairman, you would look and say, we know we failed to do our job; and now, as CEO, I am going to take care of this, as chairman, I am going to take care of this and correct it.

    Mr. BERARDINO. Congressman, I put together six bold ideas as a first step. I am not sitting here telling you we did everything right. I am telling you we can do better. And I put some suggestions on the table to provide a good-faith deposit with this committee and the American public.

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    Mr. SHAYS. These ideas are very helpful, they truly are, both in terms of what you can do for your company and what you can do for the accounting industry and the profession at large.

    Let me take your statement and say—this is on page 5: ''As every accountant also knows, some companies do the bare minimum to meet generally accepted accounting principle requirements, while others are much more prudent in their accounting decisions and disclosures.''

    And then you go down and say: ''What can an auditor do when financial statements prepared by management barely pass the current test, when they comply with the GAAP, but push the edge of the accounting envelope, when they disclose required information, but not other information that would be meaningful for investors?''

    What else can the auditor do when a client squeaks by? Our only other option is to resign the engagement. Isn't there something in between? You know, we have a qualified question.

    Mr. BERARDINO. That is exactly what I am recommending in my proposals here.

    Mr. SHAYS. But you can qualify it. You have the ability now.

    Mr. BERARDINO. Under our professional guidelines, we can issue a standard form report.
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    Mr. SHAYS. But part of that can be qualified. You can highlight a question that is of concern; isn't that true?

    Mr. BERARDINO. I don't think so. And what I'm suggesting is——

    Mr. SHAYS. I need to understand this part. You're telling me you either give them an A-plus or nothing or resign? Can't you express concerns about transactions? Can't you put footnotes in that say——

    Mr. BERARDINO. We can recommend that and we have those conversations with audit committees who stand in the shoes of the shareholders because they are elected by the shareholders, and that's part of my comment about this quote-unquote conversation.

    We report this to the audit committee, we make recommendations, but at the end of the day, we only can give the standard form report. And what I am suggesting is, you've got companies that are gold standard, others something like less than that.

    Wouldn't it be helpful for us to have, if you will, a risk-adjusted opinion?

    Mr. SHAYS. It would be helpful, but I would dispute and take strong issue that you don't have the ability to highlight a concern in a report with a footnote, with a qualified report. I, for the life of me, can't believe that you don't have the ability to do that.
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    Chairman BAKER. I think that is what certainly can be addressed with legislation the committee is formulating. If there is any doubt, I think we can make clear that that is a minimum requirement of audit responsibility.

    Thank you, Mr. Shays.

    Mr. Sherman.

    Mr. SHERMAN. Thank you, Mr. Chairman.

    As the only CPA Member of the committee, I am perhaps the most disappointed. I would agree with the witness that, right now, your only tool is a nuclear bomb, that is to say that you can insist that reclassifications be made and the financial statements change. You can insist upon a footnote. If they say no, you can nuke them or you can acquiesce.

    By nuking them, that is failing to give them an unqualified opinion. If you give them a qualified opinion, the SEC throws out the statement and the stock is selling for 25 cents the next day. If you give a disclaimer, the stock is selling for 15 cents the next day. And I do look forward to working with my colleagues to give you some conventional weapons.

    I would like to put into the record with unanimous consent the New York Times article, January 27, 2002, that deals with this failed 1999 merger, because it's been characterized that VEBA, the German company, wouldn't go through with the merger because the accounting problems of Enron were so obvious.
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    I would point out that, at least according to the article, it was a clash of management styles plus a belief that they were being told it was going to be a merger of equals, but it would be like the Daimler/Chrysler merger, in which the merger of equals led to the Germans taking over and probably would have led to Enron taking over; and only as the third reason for the merger not going forward were concerns about aggressive accounting principles. And as I understand it, some of the people involved on the VEBA side were free to short the stock of Enron and none of them did.

    [The article referred to can be found on page XX in the appendix.]

    Chairman BAKER. Would the gentleman yield on that point? Since the discovery of that article, I have pursued some of the principles in the German-based corporation. We have talked to intermediaries and, for the record, although the article did not characterize it in that fashion, I am told by officials of the affected merger that that was one of the principal contributing factors for their concerns—for the record.

    Mr. SHERMAN. I'm sure that it was an important consideration.

    But I want to go on to Mr. Sandlin's comment, what are you doing for those who are hurt, particularly the employees, and ask you whether you would be willing to contribute to the relief fund, the amount equal to all of the fees you have collected from Enron in the last 10 years so long as a mechanism was designed so that if you had any liability through the legal process that you would get credit for your advance contribution?

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    Mr. BERARDINO. Congressman, I am not sure what the legal implications of what you suggest are. But I will tell you we feel deeply for the people who have been impacted.

    Mr. SHERMAN. They expect the sympathy. They'd like the cash.

    Mr. BERARDINO. I understand, and we'll take it on board if you don't mind.

    Mr. SHERMAN. I hope that you'll get back to me in writing, because many predict that you are going to have billions of dollars of liability, whether you do or not. So long as you get credit for it when the books are closed, you ought to be providing that money now because a lot of people have lost their jobs already.

    I've got a couple of questions where I am going to ask you to respond in writing because my time is going to expire.

    I'm from the tax world where the IRS auditor and the private advisor are two very separate—and nobody goes to the IRS and says, can you structure my business deal for me, auditor, at the IRS. Now you are going to stop engaging, for your audit clients, in certain business consulting activities.

    Can I count on you, or have you decided not to be engaged in structuring transactions and providing advice for, then, how your auditors will approve those transactions that are going to be reported?
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    Mr. BERARDINO. Congressman, I put a few—I said a ''good-faith deposit'' on the table in terms of these ideas. We need to have a broader conversation.

    Mr. SHERMAN. Because that is where I see the greatest harm. A number of my colleagues have talked about the idea. If you get paid for advising on how to set up a SPE and then you come in and audit to see whether it's been done right, that may be of greater concern, being involved in internal auditing, which I wish perhaps you would continue to consider, or we as a committee ought to consider, whether that should be an area that you're involved in. Because there, at least, you're learning something about the company.

    I would like to turn to the Enron transactions, because here you had phony transactions with phony entities, and all the discussion has been about the phony entities. Let me ask you if all the transactions that have been engaged with Jedi and Chewco and whatever, if all those transactions had been engaged in with legitimate, well-capitalized, genuinely independent entities, would Enron statements have to be restated in major part?

    Mr. BERARDINO. I don't know. I am not an expert.

    Mr. SHERMAN. I hope you address that for the record within a month or two. Finally, if the Chair would indulge me, your written statement from your last testimony, where you said that you passed on $51 million of adjustments on the theory that they were immaterial when they were over 8 percent of normalized income and over 50 percent, or about 50 percent, of actual reported income, can I have your assurance that Arthur Andersen will require the restatement of all of its clients if there's a matter involving 5 percent of normalized income?
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    Mr. BERARDINO. We have worked closely, 2 years ago, with the SEC on the SAB 99 that came after the events in question, that have substantially clarified that issue. And we are giving our people very clear guidance on having no past adjustments.

    Mr. SHERMAN. But you did not, when that announcement came out, require the immediate change in Enron's 1997, I believe, financial statements?

    Mr. BERARDINO. No, we did not.

    Chairman BAKER. The gentleman's time has expired.

    Mr. Shadegg.

    Mr. SHADEGG. Thank you, Mr. Chairman.

    Mr. Berardino, I appreciate you being here, and I appreciate the tough position you're in. I think on the one hand, as Mr. Shays said, you get high marks for coming forward. I think your testimony is well done. I think the suggestions you have come forward with are appropriate and they are an attempt to try to improve the future.

    Clearly, we have to do some things to improve in the future. The tough time you are getting here though has to do with the past. The analogy that occurs to me, it's like you own a bakery shop and it is a big bakery shop, and you discover that some baker down in the shop, unbeknownst to you, did some things that were inappropriate and now you are being called to answer the customer standing in front of you, yelling at you about the bad baked goods they got and the consequences that came from those, which could be pretty severe.
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    In this instance, the consequences are very severe, and I don't know how anyone in your position at the top of that bakery with thousands of bakers working for him can answer every question or solve every problem. I think you can, as you have done, come forward with some proposals for the future, but that doesn't resolve the past.

    Now, I acknowledge that you can't admit certain things here. I'm a recovering lawyer. There are plenty of practitioners that are going to be taking a look at your testimony, and I don't expect you to make statements that are going to hurt your company in the long run.

    I am troubled by a couple of different things. It seems to me that on the one hand, if we try to improve the system in the way you've outlined, without creating bright lines, hard rules—you cannot do this, you can do that—that we are going to put people back in this impossible position.

    You talked about the nuclear weapon. You guys are put in a position where you have a very profitable account. You lose that account. If you give a certain answer, you keep that account; if you give the other answer, we are putting people in an impossible position.

    It seems to me, we have to come up with hard and fast rules that say, for example, you cannot have an off-balance-sheet entity under these circumstances; and I think a lot of the trouble goes to FASB. A great deal of the fix has to go to whether FASB can be fixed or whether this Congress has to step beyond FASB and set some hard and fast rules.

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    Going, however, to some of the questions that go backward to what happened, I am looking at the memo actually of a meeting that happened exactly a year ago today, and that's the meeting that is documented in this memo where it says we need to do certain follow-up. And it appears to me that while you have done a good job of saying, here's what we should do in the future, I don't know what you have done about Andersen internally with regard to these people.

    For example, on the to-dos, ''Inquire as to whether Andy Fastow or LJM would be viewed as an affiliate from an SEC perspective, which would require looking through the transactions and treating them as within the consolidated group,'' was that, in fact, done?

    This is clear back to last February and nothing came out until October.

    Mr. BERARDINO. I don't know. I would be happy to get back to you.

    Mr. SHADEGG. Are you looking at your personnel to see if that was done?

    Mr. BERARDINO. We are looking at everything—not just our personnel—our processes, the way we run our firm. That is why we brought Chairman Volcker in, because frankly I wanted to get some outside perspective, not just have us be thinking in our usual paradigm. So I gave you some initial ideas. We will be coming forward with more ideas.

    Mr. SHADEGG. This memo goes on to say that a special committee of the board of directors should be created to look at these ethics issues. Have you determined whether that special committee was established?
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    Mr. BERARDINO. I don't know. Eventually, as you well know, Vinson & Elkins did work more toward late summer.

    Mr. SHADEGG. It seems to me that as forthcoming as you are being in looking forward and the suggestions you are making to go forward, Arthur Andersen has to look at these individuals and has to decide whether they acted properly and whether they didn't and do something about that.

    That takes me to another troubling instant. This memo is written to David Duncan, and he's now been fired; and I have to tell you, for the all the world, he looks to me like a fall guy. He has now been fired over the issue of shredding of documents. And yet there are memos that appear in the popular press that I have read that suggest an attorney in your Chicago office by the name of Nancy Temple, in fact, pretty much instructed him to shred, albeit in a cagey way by saying that we have this policy on shredding, and then pretty much telling him not to or to stop the shredding. And it seems to me it is not doing Arthur Andersen any good or anyone in this investigation any good for you to try to create a fall guy.

    Did you do a thorough investigation of both Mr. Duncan and Ms. Temple before he was fired? And are you looking yourself now in terms of rehabilitating Arthur Andersen and whether or not it was appropriate to fire Duncan or whether or not he is, in fact, being made just a fall guy?

    Mr. BERARDINO. Congressman, I personally do not look for fall guys. I understand the optics of what we have done. Within days of finding out about this destruction, we self-reported, publicly reported; and on the preliminary—underline ''preliminary''—investigation, realizing there was some egregious conduct, we also brought in Senator Danforth to say that we are open for inspection and we are completing that investigation.
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    So from the beginning of January, about a month ago, we first found out about this. And we are not looking for fall guys; we are looking for the truth, and we will deal with the truth when we have all the facts. And many people will second-guess what we will do, and they're welcome to, because we are not an organization that looks for fall guys. We are looking for the truth.

    Mr. SHADEGG. Let me ask you two quick follow-up questions.

    Do you agree with me that we need some hard and fast rules here, and do you agree with me that FASB has to be a part of this overall review in terms of having generalized rules that people can bend putting them in an impossible position?

    Mr. BERARDINO. Congressman, I agree with just about everything you said. I think everything is up for grabs and we need to look at all these issues, including the ones you mentioned.

    And I want to specifically thank you for recognizing the hard position I'm in with all the investigations in terms of looking backward and admitting or denying or anything else. The facts will come out. This firm will be forthcoming. We have given every possible signal to our availability for these inquiries, through our actions when things went wrong that we prefer didn't go wrong, to let people know what the real values of this organization are.

    And now we are putting forward some ideas for all those who want to come forward as part of the solution to be involved in.
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    I fully respect your points of view and I wish I could be even more forthcoming.

    Mr. SHADEGG. I appreciate your testimony and particularly the suggestions you have made.

    I yield back the balance of my time.

    Chairman BAKER. The gentleman's time has expired.

    Mr. Inslee.

    Mr. INSLEE. Thank you, Mr. Chairman.

    You know, the thing that's most stunning to me in this is that as far as I can tell, no one stood up at your firm until the very last second of the game and said, ''Houston, we have a problem.'' And because no one did that personally—I am not talking about institutionally—but, no one took it personally upon their shoulders to take that stand.

    You're having a very well-deserved flogging today. But I want to tell you that it's not just your firm that was affected by Enron—I think you should be aware of this—it's the whole Federal Government.

    You know, first Enron captured the Administration's energy policy of this country and exposed the western United States to enormous increases in their electrical bills. Second, then they captured the House that passed a tax cut bill that would have given Enron over $250 million worth of retroactive tax relief. Back in the 1990s, they captured the Commodities Futures Trading Commission, which obtained total deregulation of their futures contract that formed the whole basis of this disaster.
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    They have captured the Federal Government, not just your accounting firm. Now we are trying to do something about that by passing campaign finance reforms.

    Mr. Shays has been one of the great leaders on that subject in Congress. And we are going to have that up for a vote shortly, and I would like to know if you think that it would be helpful to regain investor confidence, the public's confidence not only in you, but in the Federal Government's ability to regulate these industries to pass a campaign finance reform bill. Does your company back that?

    Mr. BERARDINO. Congressman, I am not a politician. I'm a citizen. I'm a professional. That is not really my area of expertise, and I just really can't offer you a professional opinion on that.

    Mr. INSLEE. We would appreciate you developing a position on that, because you ought to recognize, if anybody does, what happens when the Federal Government drops the ball regulating private industry. And you need to develop a position on that, and Corporate America needs to develop a position on that so we can get honest campaign finance reform through here.

    I want to ask you about this FASB situation. This 3 percent rule—and I'm sorry to say I was not aware of it until these hearings started—is one of the most ridiculous things I ever heard of in terms of trying to capture real economic activity. You have taken the same position, in essence.

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    Looking at the track record of FASB and the lack of a track record, do you think at this moment we are going to have to assume some decisionmaking by elected officials who are answerable to the public to really get some meaningful reform to get these rules to really be more reflective of honest economic activity?

    Mr. BERARDINO. Congressman, I think that's a fair question. I don't have a strong point of view except to this extent.

    The American public—and I recognize I am speaking with the people today—have got to decide what they want from the accounting profession, from management, from the whole structure that we have. And one of the fundamental problems we've got is, nobody knows what these financial statements are supposed to do. And as a result, we have evolved to this bright-line rule-making.

    There's one opinion on derivatives that's 500 pages long. You need to be a rocket scientist to understand it and interpret it.

    So are there fundamental problems and questions? Absolutely. I would suggest that it starts with an honest conversation as to what we're trying to accomplish, and honest people can be in different places there. And that, I think, is a fair dialogue; and I think FASB and the SEC, accountants' offices and others need to be part of that conversation.

    Mr. INSLEE. Let me ask you, in your opinion, how much have these failures—I will call them failures—been repeated, and are they being repeated right now. Let me tell you why I'm real concerned.
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    You passed, I'm told, with flying colors what was styled as a peer review fairly recently. I have to tell you, that is very concerning to me to think that given what happened in this instance, you were given in a peer review a passing grade.

    How prevalent are the auditing activities that you were engaged in, where you essentially allowed a corporation to hedge with its own stock over and over and over again? How prevalent is that in auditing in our economy?

    Mr. BERARDINO. Congressman, great question. Two points:

    Number one is, the vast majority of companies wake up every day trying to get it right. Some cases, the rules are really hard; some cases, the subjective decisions are very difficult.

    Number two is, our 28,000 people in the United States wake up every day trying to get it right. I have been going all over this country speaking with my clients, and they say, who's the real Andersen, the one we read about in the paper or the one we see every day that's tough as nails, that's calling it hard, that's making us make the changes that are required or the one we read about in the newspaper? So I would suggest to you that this is big, this is tragic, this is something alarming here. But many companies, and our firm, get it right a lot.

    Chairman BAKER. This is your last, Mr. Inslee.

    Mr. INSLEE. I want to read you something from Mr. Powers' Report. He says, ''Let me say that while there are questions about who understood what concerning many of these very complex transactions, there's no question that virtually everyone from the board of directors on down understood that the company was seeking to offset its investment losses with its own stock. That is not the way it's supposed to work. Real earnings are supposed to be compared to real losses.''
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    My question is, how many other corporations besides Enron would that statement apply to today as far as you know? Is this——

    Mr. BERARDINO. Very, very few. Many companies enter into SPEs. That's very common. But I would suggest to you that many, many companies, a vast majority, 99 percent, are trying to get it right.

    Chairman BAKER. The gentleman's time has expired.

    Mr. Ferguson.

    Mr. FERGUSON. Thank you, Mr. Chairman.

    Just an introductory comment on some of my colleagues' comments before. We have to be very, very careful not to turn this into a partisan battle. This is not a partisan situation. You know—we are in a fact-finding mode right now; and you know, one thing that we do know is that Enron made billions of dollars when the Clinton Administration was in power, and when the Bush Administration came to power, they went bankrupt. That is not a suggestion of anything other than there are certain things we need to know and there are certain things we need to find out. But one thing that we are realizing very quickly is that—as we try to score political points in this situation, we realize that the facts simply don't support that.

    Now, in our continuing fact-finding mode, I have some questions and I had some questions during my introductory comments. I am interested in the use of SPEs; and specifically, Mr. Berardino—and I realize that you are in a difficult position here. I do appreciate the fact that you're here. I realize there have been a number of questions that you have been unable to answer, and frankly, I think there are some you should be able to answer and I hope you will get back to us with some of those answers.
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    And what I said in my introductory comments, that we are going to ask tough questions and we are going to expect some answers, we are going to ask that you get us those answers in as quick a manner as possible. We will expect that from other witnesses who did not show the courtesy of responding and appearing here today, and I appreciate your willingness to be here today.

    How many of Andersen's other clients currently use SPEs to keep material amounts of debt off the books? Do you have any estimation of that?

    Mr. BERARDINO. No.

    Mr. FERGUSON. Can you find out?

    Mr. BERARDINO. We can try. Yes. Sure.

    Mr. FERGUSON. Is that of interest to you? There is a catastrophic result in not finding out that type of information. In this particular situation, I would think that that might be something that you would be interested in finding out from some of your other clients.

    Mr. BERARDINO. As one of your colleagues mentioned, the SEC recently put out some clearer rules and guidance on SPEs.

    We have clearly given our people guidance to say that SPEs exist, the kinds of disclosures, the kinds of audit procedures, the kinds of discussions with boards. I don't know that we've accumulated which clients are in that category, but I will give this committee every confidence that we're all over this issue with all of our clients.
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    Mr. FERGUSON. Let's talk about credit rating agencies. Do you believe these agencies have fulfilled their responsibilities to the public?

    I'm not asking you as an expert. I'm asking your opinion. You're a CEO of a major company in the financial field.

    Mr. BERARDINO. Credit agencies—I refer to them in my statement; they have unfettered access to all the information relevant to the financial health of an organization. They made judgments, we made judgments; you can draw your own conclusions.

    Mr. FERGUSON. Do we need to be considering additional regulatory reforms in this regard?

    Mr. BERARDINO. I think everybody in the system should be evaluated, and I would put them on my list, absolutely.

    Mr. FERGUSON. They are on my list. I can't speak for the Chairman or anyone else in this committee, but we have regulatory oversight and legislative responsibility. And this is a tragic situation, as others have noted. And in addition to the frustration that I feel for those who have lost out, in my estimation, to others who have made millions of dollars, including Mr. Lay, that is an unbelievable development, in my estimation.

    The last question I have is that of the report that Ken Lay was given a fully-funded pension of a half-a-million dollars. Are you familiar with this? Was it audited? And can it be rescinded?
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    How can a bankrupt company give a half-a-million-dollar pension to an embattled, if not problematic, CEO?

    Mr. BERARDINO. It's a good question, and I don't have an answer. I was not aware of it until you mentioned it.

    Mr. FERGUSON. Thank you, Mr. Chairman. I have no further questions.

    Chairman BAKER. Thank you, Mr. Ferguson.

    Mr. Moore.

    Mr. MOORE. Thank you, Mr. Chairman.

    And thank you, Mr. Berardino, for being here. Are you aware generally of the timeframe in August of the year 2000 that Enron stock peaked at about $90 a share?

    Mr. BERARDINO. Yes.

    Mr. MOORE. Are you aware that in August, 1 year later in 2001, that Jeff Skilling resigned as CEO and Ken Lay became the new CEO?

    Mr. BERARDINO. Yes.
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    Mr. MOORE. At that time the stock price was about $43 a share; does that sound about right?

    Mr. BERARDINO. Sounds about right.

    Mr. MOORE. That was August 14 of 2001. And 1 week later, are you aware that Ken Lay sent an e-mail to employees, touting the stock of Enron; and basically said that he, quote: ''never felt better about the prospects of the company; our growth has never been more certain.''

    Are you aware of that memorandum?

    Mr. BERARDINO. Yes.

    Mr. MOORE. Do you believe that to be a truthful statement, accurate statement at that time in August of 2001?

    Mr. BERARDINO. Congressman, I have no inside information of what might have been in Mr. Lay's head.

    Mr. MOORE. I'm not asking you about what was in Mr. Lay's head. I'm asking you, as the auditors for Enron in August of 2001, and specifically about August 21, do you believe that to be a correct statement that the prospects for Enron were never better?

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    Mr. BERARDINO. We audit and don't predict the future. I have no point of view.

    Mr. MOORE. I am not asking you to predict the future. As of August of 2001, I'm asking; at that time in August of 2001, specifically the 21st, sometime in August of 2001, was Enron in good shape?

    Mr. BERARDINO. I don't know.

    Mr. MOORE. You were the auditor and you don't know if Enron was in good shape in August of 2001?

    Mr. BERARDINO. Our firm was the auditor, and you need to talk to people who were closer to the account to get a better answer. I just can't answer that responsibly right now.

    Mr. MOORE. Would you try to get me an answer for that from your firm?

    Mr. BERARDINO. We will be happy to make whatever information we have available.

    Mr. MOORE. Would you make that information available to me by talking to the people who conducted the audits, and tell me if they believed in August of 2001 that Enron was in good shape, ''never been in better shape''?
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    Mr. BERARDINO. Congressman, with respect, we do not pass judgments on whether companies are in great shape, terrible shape, and so forth.

    Mr. MOORE. You give a pass and fail, right?

    Mr. BERARDINO. We give an opinion on financial statements, based on their applying the rules.

    Mr. MOORE. How many SPEs were associated with Enron?

    Mr. BERARDINO. I don't know.

    Mr. MOORE. You don't have any information as a result of being the auditors how many SPEs there were?

    Mr. BERARDINO. We can try to get you that information.

    Mr. MOORE. I would appreciate that, as well. Is there an obligation to disclose all SPEs associated with a company such as Enron?

    Mr. BERARDINO. No.

    Mr. MOORE. And that's the 3 percent rule; is that correct.

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    Mr. BERARDINO. No.

    Mr. MOORE. Correct me then.

    Mr. BERARDINO. Many companies have special-purpose entities where they move assets and liabilities off the books. The judgment that has to be made is, how probable is it that those liabilities will come back on the books, because the assets that had been moved off the books—you know, will it be a self-sustaining entity or not.

    The rules are designed for those assets to pay off the liabilities. If at any point——

    Mr. MOORE. Why would those be moved off the books?

    Mr. BERARDINO. Because the company wants to show a better financial position, perhaps attract a lower cost of capital.

    Mr. MOORE. They want to show a better financial position to the people who might purchase their stock, correct?

    Mr. BERARDINO. Yes.

    Mr. MOORE. And would the people who might purchase their stock be in a position to know about these SPEs when a company such as Enron moved these SPEs off their books to show themselves in a better financial position?
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    Mr. BERARDINO. The rules at the time—if the assets can sufficiently satisfy the liabilities, there was no requirement——

    Mr. MOORE. I understand what the rules are. I am asking you—let's strike that and move on here.

    Would you support a provision for full disclosure of all SPEs without regard to 3 percent?

    Mr. BERARDINO. I support a relook of all the SPE rules, because they are mistaken in the first place.

    Mr. MOORE. How are they mistaken?

    Mr. BERARDINO. We ought to use the judgment—the authoritative literature should look at the risk and rewards of the SPEs which—in this case, we're using the 3 percent—would be 97 percent, and therefore many of them should not be moved off the books.

    Mr. MOORE. Is there any reason that you know of that there shouldn't be full disclosure?

    Mr. BERARDINO. Well, I think it really depends on the risks inherent in the SPEs. Many of these are fairly benign where the assets will liquidate the liabilities. And you get to the point where you give so much information to an investor, it's data, it's just information that is hard to sort.
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    There needs to be a judgment at the end of the day, and that's why I resist some of these bright-line rules, and others seem to agree with that, because you need judgment as to what would be relevant to an investor.

    Mr. MOORE. You told Congressman Inslee there needed to be a debate, and the American people need to decide what information they need. Do you remember that comment?

    Mr. BERARDINO. Sure do.

    Mr. MOORE. Would you agree that the American people are entitled to full information, accurate information, so they can make an informed decision before they decide to purchase stock in a particular publicly traded corporation?

    Chairman BAKER. And that is the gentleman's last question.

    Mr. BERARDINO. Yes.

    Chairman BAKER. Mr. Cox.

    Mr. COX. Thank you, Mr. Chairman.

    Mr. Berardino, have you read this, apparently, e-mail that my colleague Mr. Shays referred to earlier, from David Duncan in February of 2001—to David Duncan from Michael Jones in Houston saying about the 14-person meeting, some by telephone and some in person, and the purpose of that meeting was to determine whether to keep Enron as a client? Are you familiar with that memo?
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    Mr. BERARDINO. Yes.

    Mr. COX. Am I characterizing it fairly, that the purpose of that meeting, which is recounted in this e-mail, printed in this memo, was to determine whether to keep Enron as a client?

    Mr. BERARDINO. I'd just make a slight modification.

    We have meetings like this regarding every one of our clients, to assess the risks of the client in terms of their financial viability, the accounting they're using, the people we have assigned and, yes, the decision as to whether we would retain them or not.

    So I'd suggest, this is part of a process and not a unique meeting relative to Enron.

    Mr. COX. Presumably, in most of those meetings you don't have discussions with so many people about the fact that your client's month-to-month earnings are, quote: ''intelligent gambling,'' which is stated——

    Mr. BERARDINO. That's a fair characterization.

    Mr. COX. This is a pretty serious meeting, and it was a year ago.

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    Mr. BERARDINO. Absolutely.

    Mr. COX. Did you write a letter to the audit committee of the board on the basis of that meeting?

    Mr. BERARDINO. Not to my knowledge.

    Mr. COX. Are you aware that Federal law requires you to do so if there's any concern about violation, for example, a 10(b)(5) violation of the requirement to present fairly the financial results?

    Mr. BERARDINO. We are very aware of those rules, but that was not the context of the meeting nor the conclusion of the meeting.

    Mr. COX. I'm referring to in Federal law, Section 10(a) of the 1934 Act, as amended by the Securities Litigation Reform Act of 1995, Section 10(a) which was added, imposes—and I am sure you are familiar with this, because you used to head up auditing—imposes a requirement on the auditors that if in the course of the audit engagement, they come across any information that might be illegal—and ''illegal'' is defined as even violating a rule—then they are required formally to bring it to the attention of the audit committee. And if the audit committee doesn't do what they like, then they are required to formally bring it to the board.

    The board gets one business day to notify the Commission, and the Commission is supposed to copy you on that letter to make sure that you know the Commission got it.
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    Did any of those things, at any time in your representation of Enron, take place?

    Mr. BERARDINO. Congressman, I read that memo, and I didn't see anything in that memo and——

    Mr. COX. You resigned the engagement. When did you resign the engagement?

    Mr. BERARDINO. We were dismissed by the client at the end of December.

    Mr. COX. When did that occur?

    Mr. BERARDINO. I don't remember. December, sometime.

    Mr. COX. December. At any time during your representation of Enron did Arthur Andersen ever follow the procedures outlined in Section 10(a) of the 1934 act?

    Mr. BERARDINO. The only situation that I'm aware of was the Watkins memo in late August.

    Mr. COX. In response to the Watkins memo, did you trigger the process described in Section 10(a)?
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    Mr. BERARDINO. The company took it immediately to its legal counsel, outside legal counsel, for investigation.

    Mr. COX. Vinson & Elkins interviewed two Andersen partners that were quite sure that Andersen was on notice of everything that was going on with that Watkins letter and the Watkins meeting with Lay.

    In response to that, did you then start the procedure that's described in Section 10(a)?

    Mr. BERARDINO. I don't know, Congressman. We will have to get back to you with that.

    Mr. COX. Section 10(a) of the 1934 Act also requires that you take into account the potential materiality, although it doesn't require materiality. The Act explicitly states even if it's not material, then you've got to start this procedure; but one of the things you are supposed to do in your investigation is to determine the litigation effect, the potential damages and so on.

    Did Arthur Andersen ever do that? Did you ever figure out how much money people might be liable for in a lawsuit as a result of—let me make a request; and I have discussed this with the Chairman, and with his permission, let me make a request that Andersen provide to this committee your work papers and any documentation of the tests that you performed and the analysis and estimates that you performed under Section 10(a) of the 1934 Act.
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    Mr. BERARDINO. Well, you know, I don't see any reason we couldn't provide that, but we will confer and we will be as helpful as we can be.

    Mr. COX. Let me say in conclusion that your statement, what can an auditor do, what is an auditor to do, strikes me as amazingly cramped. It's a cramped view of the tools at your disposal.

    You don't lose your First Amendment rights to write a letter to your client. There's nothing preventing you at any time from writing a letter to your client saying ''Today, we have issued you a clean opinion. We have done so because technically you are in compliance with GAAP. We want you to know however, Mr. Client, that we think you are skating on thin ice. We disagree with the judgments you have made, and we think there is a serious risk that you are misrepresenting to investors and to the public and to everybody who depends upon these financial statements the results of operations. Therefore we strongly recommend that you make different accounting choices. Consider this to be an integral part of our opinion that we have issued today. Sincerely, Mr. Berardino.''

    There is no reason in the world you can't do it. The 10(a) procedure that we added in the 1934 Act to the law that we passed in 1995 has a formal way to do that, and it also provides whistle-blower protection so that nothing you say in such a letter could be used to hold you or any accountant that works for you liable in any civil proceeding.

    You are completely free to say whatever you like so far as the rules hemming you in: What's an auditor to do? My gosh, we would have to resign the engagement or nuke them there or else keep our mouth shut.
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    There are a lot of ways in between that you could address it.

    Chairman BAKER. That is a did-you-know, and that is your last question.

    Mr. BERARDINO. Congressman, we would be happy to show you whatever documentation we have on the conversations that we had with the audit committee. And I will tell you, there were meaningful conversations. So I understand your point; I think it's a fair point. I just want to let you know that there were specific conversations with the audit committee.

    Mr. COX. I would yield to Mr. Shays.

    Mr. SHAYS. I think that would be helpful if you could submit that to the committee.

    Chairman BAKER. I can assure the Members on both sides that all issues raised in the course of questions today will be summarized in a document by staff and forwarded to Andersen for their appropriate response on all matters raised for which there was no direct resolution today.

    So this matter certainly will be one of the topics on which we will——

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    Mr. BERARDINO. We'd be happy to be as helpful as we know how to be.

    Chairman BAKER. Mr. Gonzalez.

    Mr. GONZALEZ. Thank you, Mr. Chairman. This is a postmortem on Enron. And what we're trying to do is identify an individual's misdeeds, shortcomings, as opposed to those that may be systemic; and it is not the easiest thing to do. And not to overreact, overregulate or overlegislate, but we've reached a point where something's going to get done. And it's going to get done real quick. And when something gets done real quick in the legislative body it's not always the best result. So I am hoping that we will cautiously proceed.

    I used to be a district court judge, and the plaintiff's expert accountant would get up there and evaluate an estate or company at $10 million. Then the defendant's expert accountant would say it was a minus-$250,000. And I thank God for the independent accountant that I would appoint to come in and testify.

    Now all three qualified—their credentials, their licensing—and they all came down and they would say they all applied the generally accepted accounting principles. So what I would ask the court's expert, then how can we have such a range? And he would say, garbage in, garbage out. And that was the quality of the data that was looked at by the experts.

    My question to you really has to do with the quality of the data that your people look at that's provided by the client and to the extent that you control the quality of that information. In your written testimony you say, what can an auditor do when financial statements prepared by management barely pass a current test?
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    When they comply with GAAP that push the edge of the accounting envelope, when they disclose required information, but not other information that would be meaningful for investors, the auditor can go to the company's board through its audit committee. You said you conducted meaningful conversations—your people had meaningful conversations. You did take that step; is that correct?

    Mr. BERARDINO. Yes.

    Mr. GONZALEZ. And you still felt that at that point the only thing you could do was give them a passing grade; whether they pass or not, you just move them on?

    Mr. BERARDINO. I am talking about that in the abstract, not in the context of Enron.

    Mr. GONZALEZ. Well, in the context of Enron, because this is an Enron postmortem.

    Mr. BERARDINO. I can't answer that question specifically on Enron, because you are absolutely right about garbage in, garbage out.

    But the only thing I would add is, why is it OK to mislead an auditor or hold information away from an auditor; and we don't know to what extent that happened in this case.

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    Mr. GONZALEZ. Now the German outfit some time ago had enough information, less than what was available to you as the auditor of Enron, and came to a conclusion that those books did not really tell the true story.

    Mr. BERARDINO. I don't know what they had, what they didn't have, nor the basis of their conclusion.

    Mr. GONZALEZ. The New York Times story, January 22, notes that as early as November, 2000, Andersen had concluded that Enron's internet servicing unit, which the company considered crucial to its growth, had such poor controls that there was a high risk that its financial results would be misrepresented. So you knew there were some problems going on.

    Mr. BERARDINO. I haven't denied that, and I just responded that we had meaningful conversations with the audit committee about some of these problems.

    Mr. GONZALEZ. What do you do to guarantee the quality of the information that you are receiving?

    I agree with you that they have no right to mislead you, but you're in a position to know when they're pulling your leg.

    Mr. BERARDINO. And we have got human beings making judgment calls, and I don't know how good or bad those calls were, because I don't have all the facts.

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    Mr. GONZALEZ. Let me conclude with this. This is from your written testimony.

    ''In recent days''—it is not; it was a report—''Andersen has announced that it will no longer accept new assignments related to internal audit outsourcing and the design and implementation of financial information systems for its publicly traded audit clients.''

    Does that translate to consulting services, and if it does, did it allow you to basically design a reporting model that determined the quality of the information that was being presented out there for public consumption by Enron?

    Mr. BERARDINO. We did not design any accounting models for Enron. What we put on the table here is in response to public observations that we will take some of these consulting services off the table as it relates to our audit clients, because it passes those two tests I mentioned earlier.

    Mr. GONZALEZ. Design and implementation of financial information systems. What does that mean then?

    Mr. BERARDINO. We will no longer do that for audit clients. And 2 years ago when we had debate with the SEC, we agreed that that would be OK to do that.

    Mr. GONZALEZ. How did this manifest itself in your relationship with Enron?
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    Mr. BERARDINO. We did not, to my knowledge, design systems for Enron.

    Chairman BAKER. The gentleman's time has expired.

    Mr. Ford.

    Mr. FORD. To follow up where I think my friend was going with regard to Andersen's suggestion that you would no longer design or implement these financial information systems for your future audit clients, aren't these types of consulting engagements, Mr. Berardino, a fraction of the consulting work that Andersen performs for its audit clients?

    To what extent rather does this represent——

    Mr. BERARDINO. That information is public knowledge.

    Mr. FORD. That may be true, but just to what extent. I am not that bright.

    Mr. BERARDINO. It's meaningful. It's not 100 percent.

    Mr. FORD. How much of the $52 million in fees you received from Enron last year are attributable to this type of consulting work that you now propose to discontinue?
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    Mr. BERARDINO. Very little.

    Mr. FORD. Say the system was in place beforehand. To what extent—and I know, again——

    Mr. BERARDINO. The number would not have changed significantly, because the nature of the work we were doing for Enron was accounting and auditing related.

    Mr. FORD. I would imagine that this controversy in the wake of this controversy is what motivated this proposal on the part of Arthur Andersen.

    Mr. BERARDINO. Actually, Congressman, with permission, this is not the test case. Enron is not the test case in terms of the nature of the work we were doing, being auditing our own work. There are many other companies where we do quite a bit more either in absolute dollars or percentage-wise.

    The reason we have taken this step is because I think in the current context it is important that my firm, my profession, builds more confidence in the public in terms of potential conflicts of interest and the quality of our auditing. And I thought from a public positioning standpoint, this would be an appropriate step.

    Mr. FORD. The only reason the public is even interested in what you guys do is because of what happened. This case is such a high profile. And forgive me for presupposing, but maybe this was motivated by the failure of this company.
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    So can I take it, perhaps the motivation for this, also, that one can glean from this proposal is that this is perhaps an admission on the part of Arthur Andersen that maybe you were wrong to oppose Mr. Levitt's recommendations?

    Mr. BERARDINO. Well, you know, frankly, I challenged Mr. Levitt on those proposals.

    Life goes on, and I do think it's important that we respond to public perceptions, and that's what we're doing.

    Mr. FORD. Is this——

    Mr. BERARDINO. Let me be honest with you. I don't think the fact that we will not do this work will make us better auditors tomorrow. I think some of the other proposals they put on the table will move us in that direction more clearly.

    Mr. FORD. Of the $5.7 million you received for your services, how much of that was for the design and implementation of these financial information systems?

    Mr. BERARDINO. None.

    Mr. FORD. You have suggested withholding of material information from an auditor should be made a felony. Are you willing to go on record saying that the destruction of audit-related documents should also be classified as a felony?
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    Mr. BERARDINO. Congressman, as you know, we put the limelight on that issue. I am embarrassed at what happened in my firm. And I have been forthcoming in reporting it and forthcoming in inspecting it, bringing in Senator Danforth, a man by who all reports enjoys many peoples' respect, to help us come up with the best possible policy and, hopefully, a model.

    Mr. FORD. But you've taken the bold step of suggesting that if your clients withhold this information, that that should be classified as a felony. Shouldn't destruction of documents, audit-related documents, also in the same vein, be classified as a felony?

    Mr. BERARDINO. I think it already is, Congressman. If you purposely destroy documents that you think are relevant to an investigation, but, you know, it's inappropriate, it should be unlawful. I agree.

    Mr. FORD. We have heard, as I stated in my opening, we've heard of other instances of document destruction by auditors in the wake of a problem audit. Grant Thornton being an example, another big accounting firm, destroyed documents during litigation of a failed audit, and it seems that we may be in need of industry-wide retention policies that include severe penalties for offending accounting firms.

    Your commitment today—I understand that you've been asked some pointed questions from my colleagues, and I associate myself with what Mr. Cox has requested of the Chairman, and I hope that he accommodates him, but would you be willing today to support mandatory retention, availability of all audit work papers and other audit-related documents so that the investing public can look behind those audits and make their own judgments about the financial health of companies in which they wish to invest?
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    Mr. BERARDINO. I don't know where the white line is, Congressman. I am prepared to have that discussion. We've taken a public lead there, and so in good faith, we'd be more than happy to take whatever advice to get to the right answer, but I can't be any more specific than that right now.

    Mr. FORD. Maybe I should—and there's two quick questions. You said you'd be willing to cooperate. Are you willing cooperate with—to the extent you can with the lawyers for the defrauded investors and the lawyers for those investors who believe they were defrauded and cooperate with the lawyers for the employees at Enron?

    Mr. BERARDINO. I have a feeling they'll want me to cooperate, but absolutely.

    Mr. FORD. Last question. I'm a little—I'm reading through, and everyone has sort of referenced Mr. Powers' document here, and I think this has been an education for everybody about how and what auditors do, and companies like the kind of work and the advice that you provide, but I'm slight—my understanding of these four words, and I just—I graduated from law school. I know I look like I just graduated from law school, but I did graduate a few years ago.

    But in page 5 of Mr. Powers' Report, it says in virtually all of these transactions, referring to Chewco and LJM, Enron's accounting treatment was determined with extensive participation and structuring advice from Andersen which management reported to the board. What does extensive participation and structuring advice mean in the eyes of folks in your community, because maybe I don't understand what auditors do, but my just sort of initial elementary understanding would suggest that extensive participation means you did a lot.
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    I know we come out with these words dislocation, meaning you lost your job or—but extensive participation from where I come from means you did a lot, and structuring advice means you helped them put the thing together. Maybe you didn't do that, but could you respond to maybe what those terms, in your eyes, mean, sir?

    Chairman BAKER. That's the gentleman's last question.

    Mr. BERARDINO. We're trying to communicate on this one. Investment bankers come up with these ideas, or the finance department or somebody other than us. It's not like we are running around town shopping these ideas. Our client comes to us and says here's the transaction we want to do, we think this is the accounting answer. Do you agree? And we say no a lot. OK. The company comes back and says OK, will this pass? No. OK. They come back. OK, now it passes the test. Now, to some people that's called structuring the transaction. To an auditor that's called standing up and defending what the right accounting should be. And so, I'm not smart enough to know what word to use for that kind of interactive conversation, but that's what was going on.

    Mr. FORD. But you did eventually say yes after those questions that they reported back——

    Mr. BERARDINO. Absolutely. Yeah.

    Mr. FORD. Thank you.

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    Chairman BAKER. Mr. Lucas.

    Mr. LUCAS. Mr. Berardino, do you think it's possible that your people who were on site at Enron were lured into the mystique and success and the glamour of Enron, and in my vernacular, they were just going along kind of fat, dumb and happy sort of in the land of milk and honey and human nature, being what it is that your people really lost their objectivity, even though they were well intentioned that they got involved in the glitz and glamour of the Enron environment?

    Mr. BERARDINO. Congressman, that's a good question and I'm a student of human nature and recognize why you ask that question. I certainly hope not. All I know is I've been in this business for 30 years. I know our people really well and they wake up every day trying to do the right job, trying to make the right judgments. Whether or not people went over that line or not, you know, I can't tell you.

    Mr. LUCAS. It was interesting to me that they said you had offices there and your employees wore the Enron shirts, and I just wondered if they got wrapped up in the web of that culture, and even though they were well intentioned, they lost their objectivity. One of the things, I think, Mr. Chairman, that we ought to do is if we could talk to some of the folks that were on site, and maybe if you have a chief of the audit or something and if we could talk to some of those people, because I understand you can't answer those questions, but obviously, some of the people on the site could. I think that would be very insightful. That's all I have.

    Chairman BAKER. Thank you, Mr. Lucas.
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    And Chairman Oxley and Mr. Kanjorski and I have discussed this, and we certainly will try to accommodate the committee's interest on those requests.

    Mr. CROWLEY. Thank you, Mr. Chairman. As low man on the totem pole here, it takes a while to get down to someone like myself and many of the questions that I intend to ask were asked especially by my good friend, Mr. Ford from Tennessee, but there are a number of things that still are not very clear to me. And Mr. Berardino, your firm acted as an inside accountant, an outside auditor, as well as a consultant; is that correct, for Enron?

    Mr. BERARDINO. What was the first phrase you used? Inside——

    Mr. CROWLEY. In other words, you looked on the outside, you did things on the inside in terms of accounting, you did things as an auditor looking outside as well?

    Mr. BERARDINO. We were auditors. People keep saying we did internal auditing. At one point we did, but most recently we gave an opinion on the internal control.

    Mr. CROWLEY. When was that done? What would the date on that have been?

    Mr. BERARDINO. It was reported in their year 2000 annual report.
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    Mr. CROWLEY. So between 1997 and 2000, you did do internal?

    Mr. BERARDINO. We may have done some, but it was less and less. What happened was that the early years, as they were building the company, we did internal auditing, and then that declined over time.

    Mr. CROWLEY. So in your second recommendation that you made, and we appreciate the recommendations you made, and I'll quote. It says to address concerns about potential conflicts of interest, Andersen will no longer accept assignments from publicly traded U.S. audit clients for the design, implementation, on and on. Do you or do you not admit now, after your testimony and hearing from Members of Congress, that a conflict of interest does exist, that it's not just a potential conflict of interest, that there are serious conflicts of interest here?

    Mr. BERARDINO. I guess I don't agree. I think there is a perception that there could be, and all I'm saying is that perception is important and we are responding to it.

    Mr. CROWLEY. Your firm helped to establish, the degree to which is arguable, Chewco, LJM1, and LJM2.

    Mr. BERARDINO. We did not help to establish. We reviewed the accounting that others developed.

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    Mr. CROWLEY. Did you consult on those?

    Mr. BERARDINO. We gave advice.

    Mr. CROWLEY. You gave advice. In the vernacular I come from, giving advice means to help someone, but that's another story. We'll come back to that later on. In giving that advice, your company profited from that; correct?

    Mr. BERARDINO. We were doing an audit. We answered questions. We said no a lot, and we said yes at the end of the day to those transactions. If that's advice or consultation—if you think that's what it is, that's fine. In my vernacular, it's something different. It's called part of the audit. You're always looking at transactions and assessing what the right accounting should be; so——

    Mr. CROWLEY. But you profited from giving that advice?

    Mr. BERARDINO. Yeah. We received fees for——

    Mr. CROWLEY. In essence, consent?

    Mr. BERARDINO. Yeah.

    Mr. CROWLEY. You consented to it? Through your firm you consented to it?

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    Mr. BERARDINO. Absolutely.

    Mr. CROWLEY. You okayed it? You okayed entities that the sole purpose, the special purpose, the only purpose was to defraud and to dupe. Your firm okayed that; is that correct?

    Mr. BERARDINO. I disagree with your characterization, because I don't know what was in people's mind when they designed the transactions. We saw the transactions. We applied the accounting to the extent we thought it was appropriate.

    Mr. CROWLEY. And as a result of the creation of those entities, tens of thousands of people have lost their jobs, tens of thousands of people have lost just about everything they had ever invested in their lives.

    Mr. BERARDINO. Congressman, I have stated often my sympathy, sincere sympathy to people who have lost their money. I will also suggest that this company made bad business decisions by their own admission. They made investments that didn't pay off. That's what went wrong. How they designed it is part of the conversation, absolutely.

    Mr. CROWLEY. It's not entirely all your fault—it's not personally your fault, although there may be some responsibility here. What we're trying to get to is the bottom of what caused this, the collapse of one of the largest corporations in the history of this country, and have really left the little guy and gal holding the bag, absolutely nothing in it when everyone else gets to walk away with big bucks. And the people that I represent and the State that I represent, New York, is looking at enormous losses where pension funds, as mentioned before, were looking at enormous losses and the little guys walked away with nothing because of the accounting mistakes that your firm made.
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    Mr. BERARDINO. Congressman, I can't let that stand. This company failed. Whether the accounting was appropriate, whether we had all the information, these are fair questions that we will all get to the bottom of, but at the end of the day, we do not cause companies to fail.

    Mr. CROWLEY. Mr. Chairman, I would just ask that—I believe there is more information that is needed and I would ask that you issue the requisite subpoenas to individuals that would not come forward voluntarily, as you have, and for those documents, whatever is left at Andersen, to be brought forward as well that would be pertinent information to this committee and to the findings that what we are trying to——

    Mr. BERARDINO. I will remind this committee that there are millions of documents that we still have that are relevant and we have been nothing less than forthcoming.

    Chairman BAKER. I take Mr. Berardino at his word. He has indicated his willingness to provide the committee with appropriate information under his control and access to individuals, and the committee will do so.

    Mr. CROWLEY. Mr. Chairman, I only make the point that if individuals are not forthcoming, that those individuals be subpoenaed to come before this committee. That's what I'm saying.

    Chairman BAKER. As you're aware, we've already taken an action with regard to a particular individual and the authority of the subpoena has to be specific. As we find individuals whose content and information would be helpful to the committee, we certainly will act in appropriate fashion. Thank you, Mr. Crowley.
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    Mr. Sanders, you're recognized.

    Mr. SANDERS. Thank you, Mr. Chairman. I'm not a Member of this subcommittee, and I appreciate your allowing me to participate. Mr. Chairman, if there is—and I don't know if there is, but if there is a silver lining in the whole Enron/Arthur Andersen disaster, it is that the American people I think are beginning to catch on about the need for a wide variety of reforms in the way Government does business. For a start, if my understanding is correct, Arthur Andersen has contributed some $5 million to the political process, Enron contributed more, and to a large degree, sad to say, the Congress of the United States is significantly controlled by big money interests like Arthur Andersen, who contribute huge sums of money to end up getting their way and I hope that out of this will come strong campaign finance reform.

    Second of all, in terms of the pension situation, I think, and I fear that many millions of Americans thought all they had to do was invest in the stock market and their assets would go up 15 to 20 percent a year and everybody would become rich. Well, it ain't that easy. And I know that some people want to privatize Social Security, and I think maybe the debacle that is taking place might make some people think twice about allowing Americans to invest substantial parts of their money in the stock market rather than in the guarantees that the current Social Security system provides.

    In terms of accounting reforms, let me just mention something about Arthur Andersen. You know, sometimes we think that gee, isn't it too bad that Arthur Andersen may not have done a good job with Enron, but let's look at their track record in recent years, and Mr. Berardino, you tell me if I'm missing anything here. Just last June, Arthur Andersen was fined $7 million by the SEC for fraudulently cooking the books of Waste Management. Were you fined $7 million, sir?
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    Mr. BERARDINO. Yes.

    Mr. SANDERS. A month earlier, Arthur Andersen agreed to pay $110 million to settle an accounting fraud lawsuit over the firm's audits of Sunbeam. Am I correct in that statement, sir?

    Mr. BERARDINO. Yes.

    Mr. SANDERS. In addition, your firm was in charge of auditing the largest issuer of junk bonds in Asia, a company called Asia Pulp & Paper, which is now undergoing one of the largest bankruptcies in Asian history and is $12 billion in debt. Andersen is being sued for cooking the company's books by some $220 million. Is that a correct statement, sir?

    Mr. BERARDINO. They have been a client, yes, sir.

    Mr. SANDERS. And are you being sued?

    Mr. BERARDINO. I think so.

    Mr. SANDERS. OK. In Australia, Andersen has allegedly cookayed the books of HIH Insurance to the tune of some $470 million. This company is now undergoing the largest bankruptcy in Australian history. In Britain, because of Andersen's involvement in the collapse of the luxury car manufacturer, John DeLorean, England banned Andersen for years from bidding on Government contracts. This ban was lifted in 1977.
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    Bottom line is that it's not just Enron, and it is a scary situation. I was a mayor of a city for 8 years. We had to look at the judgment of auditing firms to tell us what kind of investments were appropriate for the city. Millions of Americans look to auditing firms for independent objective judgment. Mr. Chairman, I would suggest that Americans now are going to look twice before they accept the judgment of Arthur Andersen and perhaps some of the other auditing giants in this country, and I think it's not just—everybody else here has touched on the conflict of interest situation. I absolutely agree, but I think it goes beyond that and I think Americans now have real doubts about the ability of some of these large auditing firms to tell them the truth about the financial condition of the companies that they are working for and, in fact, what we may need to do is move beyond private auditing firms and to some Government agency giving us some type of objective analysis about what a company is doing before people are going to invest in that company.

    Mr. Berardino, I want to congratulate you because I understand that your company was successful in keeping Enron from paying taxes for 4 out of 5 years, and they received, in fact, $382 million in tax refunds through the creation of offshore tax shelters. I wonder if you would be prepared to spread your wisdom to the middle class of this country, the poor suckers who actually have to work hard and pay taxes while you and your friends were able to get Enron to avoid paying taxes.

    Now, I wonder—you got some consulting fees at a time when thousands of Enron workers have lost their retirement savings. I was wondering if you feel any obligation on the part of your company perhaps to take some of those consulting fees and put it into the fund for Enron employees so that some of them can get a few bucks back rather than losing everything they had. Is that something that Arthur Andersen might consider?
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    Chairman BAKER. And that's the gentleman's last question. Please respond.

    Mr. BERARDINO. I responded to that earlier, but I would like to just put on the record two things: We have 2,500 public companies in this country. We get a lot of it right, almost all of it, and from time to time, we've had failures and we're not pleased about that. Second we did not design this company's tax position——

    Mr. SANDERS. You did not work on them with their tax——

    Mr. BERARDINO. No. Another firm worked with them on their tax. We audited the tax expense, which is very different from structuring.

    Mr. SANDERS. But you apparently thought it was Okay for them to set up these offshore companies and not pay taxes for 4 out of 5 years.

    Mr. BERARDINO. All I'm suggesting is for the record, we did not design those. We audit and report on what the results of those entities are all about. Big difference.

    Chairman BAKER. The gentleman's time has expired.

    Mr. SANDERS. Thank you, Mr. Chairman.
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    Chairman BAKER. Also with us today is Ms. Jackson-Lee, not a Member of the committee, but she has been patient in waiting her time and I recognize her for 5 minutes.

    Ms. JACKSON-LEE. Thank you very much, Mr. Chairman. And as I said yesterday, I thank you for committee's indulgence and that of the Ranking Member, Mr. Kanjorski, and of course Mr. Oxley and Mr. LeFalce.

    Let me thank Mr. Berardino for his presence here. He is here without, as I understand it, being subpoenaed. I am not a Member of this committee. Enron happens to be in my congressional district, and thereby there is a great deal of concern in our local community, and in particular among the ex-Enron employees and retirees. Just this morning, one of the employees testified before the Governmental Affairs Committee on the Senate side and noted language, Mr. Chairman, that I would like to include in the record.

    If I have it correctly, it was a theme that was used by Enron employees, and I think many of us have been struck by the enormous loyalty that these people have had or still have to the company and its mission. They use the term ''RICE'', respect, integrity, communication and excellence. As I was sitting next to one of the employees, they were able to recite it for me with great appreciation for what it means. I believe that this is what we have lost in light of the facts that have been unfolding, and let me just say to provide you the facts. You did not recall the dates. Let me say that for the record, Enron filed for bankruptcy on December 2, a Sunday, as I recall it, 2001, and 4,000, many of whom are my constituents, were fired on December 3, 2001. You were not terminated and Arthur Andersen, until more than a month later, January 17, 2002.
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    So the employees lost all the way around. I am wondering, Mr. Berardino, with respect to the question of independence. Objectivity, integrity and independence are words that I use. What was the responsibility of Arthur Andersen? Did you engage in giving advice to the board on the structures, these off-line, off-budget companies, and how much of that advice did you give?

    Mr. BERARDINO. Well, this $5 million people refer to over 5 years, we responded to the structures, the investment bankers and the finance department brought to us. We did not structure those deals. We gave, as an auditor needs to, an opinion on what the right accounting was.

    Ms. JACKSON-LEE. Do you believe that you were providing advice around 1999?

    Mr. BERARDINO. I'm sure we were.

    Ms. JACKSON-LEE. The Powers Report, which I'm sure you have read, has made it very clear that the minutes of the finance committee reflect that Arthur Andersen was giving them advice on the structures. In particular, they indicate that Arthur Andersen provided substantial services with respect to structuring and accounting for many of the transactions, that it reviewed Enron's financial statement disclosures with respect to the related party transaction including representations that the terms of the transactions were reasonable, and no less favorable than the terms of similar arrangements. You had a witness that testified some months ago that indicated that you did not have any involvement; yet board minutes reflect that you did have involvement in giving advice on these structures and transactions. Can you not recollect more clearly how intense that advice was?
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    Mr. BERARDINO. I can't right now.

    Ms. JACKSON-LEE. Wouldn't you think the board would be entitled to rely upon Andersen's involvement and as well would reasonably expect auditors to raise questions to their client, the audit and compliance committee, if confronted with transactions whose economic substance was in doubt? Do you think that's part of the responsibility in your role as an auditor?

    Mr. BERARDINO. I'm not exactly sure what your question is.

    Ms. JACKSON-LEE. My question is, is it not the responsibility of an auditor if you are, in fact, engaged in providing advice on these structures and transactions that if you see a red flag or if you believe that these transactions are, if at best, minimally weak and nonsupportable, to raise a flag to the audit and finance committee of the board?

    Mr. BERARDINO. And as I—the answer's yes and——

    Ms. JACKSON-LEE. Did you do that? Did Arthur Andersen do that?

    Mr. BERARDINO. We will supply you with information we have on what those conversations were with the audit committee.

    Ms. JACKSON-LEE. I am probably more used to seeing accountants, though I respect the need for companies to get advice with those very thick eyeglasses and being the straight and narrow individuals, and I'm sure you have a great deal of respected and responsible employees, but sitting at their desks, if you will, and looking at the numbers and telling the facts, it comes to my mind that Global Crossing, a company that you advised, you got $2 million, $2.3 million in auditor fees and $12 million for non-audit work.
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    I don't know where all this money came from in the accounting business now, but how can we look to an objective assessment on the auditing feature if you have so much money in non-audited responsibilities? Isn't that an enormous conflict? Did that not raise a flag in the work you were doing for Enron that you would yield to the more important responsibility, I believe, of auditing and telling them what's going on with the books in order to protect pensioners, retirees and employees as opposed to, I guess, falling for this large sum of money in the non-audit work?

    Chairman BAKER. And that would have to be the gentlelady's last question, but please respond.

    Ms. JACKSON-LEE. Thank you, Mr. Chairman.

    Mr. BERARDINO. We take our responsibilities as auditors very seriously. I'm trained as an auditor and I'm proud of it. It's a hard job and our people are trained to do the right thing, to raise the red flags when they see them, and we do that day in and day out, but we are human beings and we may not get it right every time. I'm not apologizing for that, but I'm telling you that we take this role extremely seriously.

    Ms. JACKSON-LEE. Mr. Chairman, I thank you very much.

    I don't want you to apologize to me, Mr. Berardino, but I do think you owe an apology to the employees and the pensioners and retirees. I thank the Chairman very much.

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    Chairman BAKER. Thank you.

    Mr. Berardino, I have the intent to go a little further. I know this has gone on for quite some time, but I think it appropriate now to focus rather than on the identifiable problems, but more importantly, as to some specific elements in addition to your own recommendations of approaches the committee might consider in light of the circumstances that we have discussed here at length.

    With regard to ethical conduct, as I understand the rules at the moment and the discussion you had with Mr. Cox relative to provision 10A of the 1995 Act, that if there is a discovery by an audit team member of an action which violates the law, then there is an obligation to report and a process which is followed.

    Is it advisable to have a similar requirement when the audit team member discovers an action is to be taken by the corporation that would result in a likely deterioration of shareholder value? Now, that is a business judgment, and I understand the difficulty of second-guessing the management, but where there is a strongly held opinion sufficient for the audit member to take this to a higher level, shouldn't we require that audit member to take that action where, in the case of one of the questionable SPE's, he feels uncomfortable that the financing mechanisms in place are really to obstruct the public view of the risk the corporation really is undertaking by its creation?

    Mr. BERARDINO. Well, Congressman, Mr. Chairman, I think this gets to the heart of the matter in terms of our responsibilities as auditors. At present, we are responsible to go to an audit committee. They are elected by the shareholders. Is that enough? I think we need to have a conversation about what is appropriate corporate governance and can it be improved. These are very difficult judgments and we could be accused of prematurely raising some flags that may be inappropriate, and so we need to think that through and I——
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    Chairman BAKER. If you go to the audit committee today and you are basically outvoted and the audit committee chooses to proceed, at least the audit team then should report to someone in management of the firm and a firm determination made as to whether you should report your disagreement to an outside entity, whether it be an office within the SEC, a specially created new committee. I don't suggest we go to FASB, frankly. I would like a more timely resolution of these matters, but in concept, is that something based on the facts and management's ability today?

    And I will relate to your earlier comment, I was giving you business school philosophy where the board establishes the audit committee who engages the audit and the audit is for the benefit of shareholder protection, and your view, and I suspect the view of many, is that the audit is the property of the corporation as well as the shareholders; therefore there is a dual master. Should we not separate that dual responsibility and make, first and foremost, the obligation to report to the audit committee and have the audit committee report to shareholders?

    Mr. BERARDINO. I think there is a lot to talk about there. You know, I think that's a fair point. I would also suggest one of points that I put on the table, which is this grading system that we might develop so that not all audit opinions look the same and that the judgments that companies make from, let's say, on-the-line aggressive to very conservative, that there's a way of communicating that to the public.

    Chairman BAKER. I think it goes to the heart of whether we maintain the current corporate audit relationship or whether something extraordinarily culturally different is engaged. If you're going to be paid ultimately by management and feel a responsibility to management where management has a plan that's not consistent with appropriate corporate governance or at odds with shareholder interest, the auditors should not only have a sense of responsibility, but an obligation to make that known to someone.
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    Now, before it becomes public information, it could go to a Government office where a judgment could be made. For example, if it were the case where a manager sat across the table from one of your audit team managers and said we don't like the way you've constructed these footnotes or this financial report and unless you change it, we're going to go find someone else, what has been suggested so far is a remedy for a bad auditor.

    Let's assume the reverse. Let's assume we have a good auditor and a bad manager. Where is your relief? To whom can you go other than to be fired? We should have a place where you can seek counsel confidentially, beyond public view, and get assistance and a determination that your recommendations are appropriate and have consequences for management. Is that an acceptable structure to consider?

    Mr. BERARDINO. Mr. Chairman, I think everything should be considered and I applaud the direction you're going in. It's a little out of the box, but we need some out-of the box solutions.

    Chairman BAKER. I think we have got some out of the box problems is a real observation, and where you have management and an audit team that, for whatever reason, views the world similarly, then we either have outside folks looking at the auditing or have liability on the board and the audit committee of the board to have some corporate governance liabilities for their failure to act.

    It appears to me in this case that neither the audit committee nor the board of directors took action appropriate based on the information they should have had access to. I also like Mr. Ford's suggestion with regard to mandatory document retention. In my modest recordkeeping that the IRS requires of me, I have to keep my boxes for 7 years. It seems only fair that there should be some statutory requirement for similar retention regardless of the matter if it's pertinent or material to the financial condition of the corporation.
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    Mr. BERARDINO. I agree.

    Chairman BAKER. Another element that I have observed is that where no—cost options are granted to insiders or executives and by whatever manner the value of the stock is enhanced either by the effect of the SPE or some announcement which may not be, on all corners, accurate, stock value goes up. Six months later there is a mandatory restatement. Stock value goes down. But in between, the executive has exercised his option. He doesn't have to give his money back. The shareholder takes the full extent of the loss. What would be wrong with a requirement that if there's a restatement of earnings and an official exercises a no—cost option in any period preceding that restatement of 12 months that he gives the money back?

    Mr. BERARDINO. I think what you're getting at here, Mr. Chairman, is a rethink of corporate governance and incentives. I think we need to look at what the incentives are——

    Chairman BAKER. Well, here's the incentive.

    Mr. BERARDINO.——versus what they might be.

    Chairman BAKER. If I run this company well, I have an option. The value's going to go up. I'm going to make a bunch of money. Here's the dilemma. If I run this company poorly and obfuscate the facts and inflate the value, I'm going to make money. Let's make a penalty. If you don't run it properly and you're inflating earnings and stock prices arbitrarily out of manipulative reporting, you're going to have to give the money back, and if we find that it's fraudulent, you're going to have to give back more than just the money.
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    Mr. BERARDINO. And if you mislead your auditor intentionally——

    Chairman BAKER. I'm for that one.

    Mr. BERARDINO. ——withhold information, and there ought to be a qualitative assessment as to how rigorous the accounting is.

    Chairman BAKER. I've got that one down. That was my next one. Withholding material information from the audit team is a felony. I think if we keep the records, we know that there's going to be a consequence for withholding. We know there's going to be a consequence for artificially pumping up the stock price. If we say to the board of directors, you're responsible for managing the audit team member, if you're intimidated or told by management to do something you think is not only in contravention with GAAP, but is materially adverse to the shareholders' interest, you have an obligation to report that fact to somebody, and we'll create that somebody in some office somewhere so you can go speak to them and get advice, and if it is not corrected, then they can take action against the corporate board. You get your fee, and we get the financial statement in the appropriate fashion that it should be for the best public interest. Now we're starting to get a legislative package that makes some sense.

    Mr. BERARDINO. Well, Mr. Chairman, and I'd just remind you, one of the suggestions I've made for my firm is that if anyone is uncomfortable with the decisions being made on the audit that there will be a separate office that they could go to on a no-name basis to make sure we get to the bottom of it quickly.
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    Chairman BAKER. I think if we do this in a statutory mode in a corporate governance manner, that the consequence of this would be to have exactly that occur within that corporation, within the audit community, and to have the board of directors of a corporation understand their liability should they not get it right. I see what has happened here is that a lot of people made decisions for which there was no downside risk other than the bankruptcy of the corporation. If it is, in fact, true that Mr. Lay's pension buildup insulates him from the loss of his $475,000 for the remainder of his life and all these shareholders and employees lost everything, I have a view that resources were being improperly managed for the benefit of a handful of people and information flows were curtailed, and it may be worse than that.

    So there's one other step. One way to have audit independence is to put all these blockages, warnings, prohibitions and disclosure requirements. Another way, which is not my suggestion, but one I have read and found very intriguing, is to have the external audit engaged by the exchanges and have the auditor report simultaneously to the corporation and to the exchange to be paid by fees collected on stock transactions. You are not then engaged by the corporation. You are clearly engaged by a third party for the benefit of the shareholders who have their investment in that corporation. This is a relatively old idea, but I have read recently people discussing the advisability of that. Do you have a comment about that approach?

    Mr. BERARDINO. I'd need to think about that a little bit. One of the concerns you need to consider is each firm has, over the years, developed areas of expertise and whether or not you'll be able to make those assignment so that the best expertise is available to a client would be one question I'd ask, but I think this kind of thinking is appropriate and I'd like to give it a little more thought. That would be my first reaction, though.
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    Chairman BAKER. I will include that on the long list of inquiries, to get the best professional advice possible on a cultural change in the way the corporate/audit relationship is structured or the best way if we maintain the current methodology to ensure that there is transparency and disclosure recordkeeping and most importantly, liability for not conducting your professional obligations appropriately. I've gone on for a bit, but if your folks are hanging in here, Mr. Kanjorski, did you have another series?

    Mr. KANJORSKI. Other than those on the list that you have already expressed, there are other things that I am certainly interested in. In the policy area, Mr. Berardino, I am particularly worried about how far the Government should get into being the final determiner of how the private market operates. Should we be attempting to find some way to put a Good Housekeeping Seal of Approval on either audits or company activities?

    I am actually more interested in the whole theory of these off-balance sheet transactions and how prevalent they are. Obviously if they are for the purposes of spreading risk, I can see the advantage to operations like these, but are they now being misused and abused in your estimation?

    Mr. BERARDINO. Well, Congressman, I haven't done a study of that; so with that caveat, there are billions of dollars of off-balance sheet transactions. Most of them are very benign. Where there is very little risk to the asset, the asset will pay off the liability and many of us could quickly agree that it's an appropriate transaction. The question is really evaluating the risk of that asset being able to pay off the liability and I'm just not smart enough, I don't have enough context to tell you to what extent that is a risk out there. I think it's a relatively minimal risk, but that's not based on any scientific analysis.
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    Mr. KANJORSKI. How far do you think the Government should get into the accounting profession and into corporate governance of public corporations?

    Mr. BERARDINO. Well, I've always come from the camp that our profession should be self-regulated, and recognize the need to have some outside influence beyond accountants to discipline and oversee the profession. No question this body represents the people and the people have gotten engaged in this issue in a way that they've never engaged before, and I would hope we could come out with a better answer.

    I've given you some of my ideas. I worry about the Government being too intrusive, because I do think the shareholders elect their representatives to sit on a board and understand what's going on and to protect them, and upon occasion that will not work; and the question is whether or not we need more Government involvement to reduce that. But I'd say in this context, this is a fair conversation and I'm not going to sit here telling you that I've got a firm point of view. I'm agnostic. I want a better solution, because I, as I started to say earlier, we have lots of different bodies regulating us, and I'd like to have one do it right rather than this piecemeal patchwork approach that we have now. It's just not helpful. So I'm agnostic. I could get to a different answer. I think today's conversation hopefully gives us a little more information so that we can collectively come up with something that makes sense.

    Mr. KANJORSKI. Well, do you look at Enron as an aberration or is it systemic? I am sure we are not going to see anybody else here today who is fully aware of corporate governance issues as to what has happened. We are always closing the door after the horse has run away. Is there a way that we can close the door before the horse leaves the barn, or is that just a false hope?
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    Mr. BERARDINO. I think there is some serious corporate governance issues in this country. As I said earlier, the vast majority of companies and boards get it right. The thing that is so shocking about this is its rapid ascent and incredible quick collapse on a scale, a magnitude we will hopefully never see again. So I would put this in the aberration category, but I do think whenever you have a natural disaster, it's an opportunity to rethink everything and come up with a better solution. I think we can come out of this with a better solution and that's why my glass is half full as painful as all of this has been.

    Mr. KANJORSKI. You are the head of one of the huge top five accounting firms. I am also beginning to look at this problem a little differently, like whether or not we should tier the profession. I think for us to put into place very stringent rules and regulations and statutes, that apply across the board, may be onerous. It seems to me that not everyone in the accounting profession has lost their balance here, not to suggest that your firm or others in the Big Five have.

    Mr. BERARDINO. Thank you.

    Mr. KANJORSKI. Clearly, you are in an entirely different category of accounting than most accounting operations in this country, especially when we are talking about separating auditing from consulting. I do not have any doubt as to where my vote would be in regard to separating auditing from consulting with the major corporate structures in the country and the major accounting firms. I just think it is too conflicting. But, I will also be very practical. There are smaller companies and smaller accounting operations where the cost of having separate auditors and separate consultants would be prohibitive. In some ways, we would be injuring the middle-sized businesses and the middle-size accounting firms. They would be paying a terrible price for an aberration. How do we get balance there?
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    Mr. BERARDINO. Well, Congressman, I think that's a very thoughtful point, because you do have smaller firms working with our entrepreneurial small businesses that are very different space. But before you go too quickly, let's look at these big firms. Let's look at my firm. We are $9 billion around the world in revenue. That's awfully big.

    Mr. KANJORSKI. $9 billion.

    Mr. BERARDINO. $9 billion. We've got a billion or so of equity in our firm. You're asking five firms with several billions of dollars of individual partners equity; right? We can't go to the stock market to raise capital. Individual partners who grew up with nothing and built these firms to underwrite trillions of dollars of shareholders equity.

    And what happens when there's the a next big surprise? Who's going to underwrite that? So although we are big in absolute terms and although we are bigger than some of these middle size firms, when you look at our capacity relative to the wealth of this country and the stock market, we're a small fraction, and that's a significant concern.

    We've gone from eight firms to five already, because firms have not been able to compete and stay in business because they weren't big enough. And the question is, do you want to go to four, three, two or one, or have the Government take over? I think that's a good question. I'm not suggesting that I have the answer.

    Mr. KANJORSKI. Are there those in the accounting profession that think maybe the Big Five are too big? Ought we encourage many smaller size firms? I was talking to an accounting firm over the weekend in preparation for this hearing. I believe they are the 25th largest accounting firm in the country. Their entire revenues for the year are not equal to what your income was from this one audit report. So, the disparity from the huge to the average, or the medium, is gigantic.
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    I was thinking in terms of legal firms. I am after all, a lawyer by profession. I would hate to think we would have four or five huge law firms in the country or in the world that handle all the big transactions. It is pretty hard for me to understand. One, why that situation does not become a business as opposed to a profession. Two, only four or five guys have to sit around the golf club to divvy up clients and you have got a conspiracy. It just seems to me that the rest have are not participating. Whatever happened to the substantial medium-sized accounting firms in the world that do good auditing and good accounting? Why are they not out there doing it?

    Mr. BERARDINO. Because they can't compete and they can't stand the legal liability when one of their clients goes out of business.

    Mr. KANJORSKI. Well, if that is true, they cannot compete. As one of the firm's partners told me: When the company that they were involved with, for about 15 or 20 years, was going on for its first IPO, Wall Street said it could not use that small accounting firm. You have to use one of the Big Five. Is that the pressure that is coming from the investment banking community?

    Mr. BERARDINO. Yeah, absolutely. Absolutely. But I'm suggesting if you go from four to eight or ten, you're going to dilute competence, you're going to dilute the amount of equity in these firms.

    Mr. KANJORSKI. Do you think bigness and competence are——
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    Mr. BERARDINO. I'm sorry?

    Mr. KANJORSKI. Bigness and confidence are synonymous?

    Mr. BERARDINO. They don't have to be, but I would suggest in a proper profession they are.

    Chairman BAKER. Mr. Kanjorski, if I may——

    Mr. BERARDINO. But these are very fair questions, Congressman. I wanted to just not so much challenge you, but to give you some context in terms of where this might go. These are not easy questions, and the answers will be even more difficult, but I think they're fair questions, and I want to just make sure you were just aware of where I was coming from.

    Chairman BAKER. Mr. Shays.

    Mr. SHAYS. Thank you. Mr. Chairman, I had wanted to get on this committee because I figured that it was probably one of the most important committees that I could serve on, and particularly it impacts my district and Mr. Berardino, for instance, is a constituent of mine. And so in some ways, it's a little awkward to be in this position. I want to say that I think you've done a very fine job coming before this committee in many respects.

    The one area that I'm wrestling with is when you spoke last time, I felt you had given the committee the impression that the non-auditing side of the equation was a lesser source of revenue from Enron, and then I'm realizing that it was pretty 50/50, and I am somewhat haunted by that memo that makes reference to $100 million, and, you know, because it's in a memo that says do we continue to do business, and let me just be very upfront here. I mean, I was contacted by a number of accountants who were saying, you know, we need to be able to do consulting work and auditing work.
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    And so I wrote a letter to Arthur Levitt saying, you know, postpone this decision, give more time, and he called me back because he happens to be a constituent. He said, Chris, postponement means death. So then I went on the floor of the House the next day and said I didn't want anyone to make an assumption that this letter asking for a postponement meant we should kill this regulation. But I wrestle with this and I'm wrestling with this now, because I'm seeing $100 million in a document that was basically to decide whether or not to continue serving, and then I see this document that then later results in—I mean, the real failure was the Raptor and the failure to disclose $800 million of liability or overstating income by that amount.

    Tell me what this $100 million was all about.

    Mr. BERARDINO. Congressman, you know, it's very hard to answer that question. On the one hand we have very complex global clients that have hundreds and hundreds of CPAs on their staff that are doing very complex things, and I think you would agree you would want us to do a very thorough job and to get a fair income from that. Enron was in one of the elitist category, seventh largest in the country. We don't have any $100 million clients, and Enron never became a $100 million client. We have many in the $25- or $50 million range, but we are a $9 billion organization.

    All these clients are less than 1 percent of our fees. What was in that memo, if you want to take an innocent point of view, and you may be critical of this, is a recognition by our people that the objects of these fees being so big would be problematic as you've just suggested. That's what was written in that memo. And what the counter to that was, well, let's look at what we're doing, and I'd suggest to you when you get underneath the facts on that $50-something million, something like three-quarters of that you would only hire your accountant to do.
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    Mr. SHAYS. I guess the question that it leads me to is basically, the $52 million in the year 2001, $25 million was auditing, and $27 million trumped the auditing. It was non-auditing fees, consulting, and so on; is that correct?

    Mr. BERARDINO. I've just had somebody give me the facts. Would you mind if I read this quickly?

    Mr. SHAYS. No.

    Mr. BERARDINO. The basic——

    Mr. SHAYS. As long as these are your words, because you're the one under oath. No, I'm serious. In other words, as long as you believe what you're reading here.

    Mr. BERARDINO. I would never say anything I didn't believe was accurate, plus I'd get back at these guys if I was wrong. But anyway, $25 million was the basic audit. $3 million was due diligence work where we went in and helped the company investigate companies they might buy. $3 million was taxes, $3 million was reviewing internal controls. $4 million was actually Andersen Consulting. That's no longer part of our organization; so that $52 really is $48, and the $14 million is lots of small special projects and consulting jobs.

    Mr. SHAYS. But basically the $25 million is the auditing and the $27 million is non-auditing?

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    Mr. BERARDINO. I'm not trying to be a pain in the neck, honestly.

    Mr. SHAYS. No, I understand.

    Mr. BERARDINO. What I'd suggest is a lot of the other work you would only go to your auditor for anyway.

    Mr. SHAYS. Let me ask you, though, how do you then jump up theoretically to $100 million? What was being said—but it's in a memo that basically——

    Mr. BERARDINO. Yeah, I understand.

    Mr. SHAYS. Is it non-auditing?

    Mr. BERARDINO. Clearly any other work to get beyond this number would have been non-auditing services that never occurred.

    Mr. SHAYS. What that says to me in a big way, I mean, I had to look myself in the mirror as well and all the other accountants who came to me and say this was a figure that was being dangled in front of your organization that, in my judgment, distorted judgment, and what this says to me is your organization had a moment of truth then to say good-bye and that was the moment of truth, and I bet that's the moment all of you regret, and sadly, the person this memo was sent to is the person accused of shredding documents.
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    So yeah, I'm a little suspicious, and I have to look at myself in the mirror as well. This really is an indictment at the non-auditing side of the equation.

    Mr. BERARDINO. Congressman, I think that's a fair question, and I've addressed that in the points I put on the table both in how decisions are made to retain clients by bringing in some outside advice into our organization so that we can really think these through. I will promise you one thing. This firm will learn a lot of lessons from this and we will come through it stronger, because we are willing to challenge everything we've done historically, and I put on the table some initial ideas.

    I've heard some other ideas here I hadn't thought of before. Mr. Volcker will give me other ideas that I haven't thought of before as well as his board, and I just want to leave this committee with that impression. We are deadly serious. We will take a lead, and as I have talked to many of our clients around the country, they have all said we went through a crisis and we got through it because we were willing to change.

    My profession has put some issues on the table that you heard from Chairman Pitt yesterday. Whether that's the right answer or not isn't important. What's important is we're willing to change and we're willing to work with this committee, and I want to thank this committee for its thoughtful way—I said this last time. You're trying to understand. I apologize I can't answer all those questions about what happened, but I'm not going to do that irresponsibly. But that does not mean that we're in denial. That does not mean that we're not willing to work hand in hand with whoever's interested, this committee, SEC, other members of the financial appointing process to get to a better answer and that's what we all ought to be about, and I want to applaud you for that leadership.
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    Chairman BAKER. Thanks, Mr. Berardino.

    Mr. Sanders wants to be recognized one more round.

    Mr. SANDERS. Thank you very much, Mr. Chairman. I think that you and Mr. Kanjorski and others are wrestling with the nub of the issue and as understand it, this is what it is, and, Mr. Berardino, maybe you can help me out here. There are millions and millions of investors in this country who need a referee, need an objective source to say that which company should I invest in? There are trillions of dollars of workers' money in pension funds.

    In my small State of Vermont, we lost $4 million in the Enron debacle. And it seems to me, Mr. Chairman, that the essence of the issue is to whom is the auditor loyal? Where is your first loyalty? If firemen in New York City put their retirement savings in a pension fund, is it your primary responsibility to tell their investment counselors the truth about the company, or is it your primary responsibility to work with the company to earn as much profit as possible for the company, some of which you share?

    And this touches on—I don't want to get back to the conflict of interest issue, because everybody has raised it and I agree with that, but it even goes beyond that and I think maybe the Chairman raised that issue. If you look at a set of books by a company and you said, hey, this is a bunch of crap, it is not the truth, it is very likely that the company will say well, thank you very much for your opinion, you're fired, we will find somebody else who tells us our books are very, very good.
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    And I think that's another conflict situation which auditors are in, and I think ultimately the investors of their country, the workers of this country who put money into pension funds have got to know that there is somebody out there who is telling them the truth. Investment is always risky, but at least you've got to have all of the facts and——

    Chairman BAKER. Mr. Sanders, if I can interrupt on that point just because, you know, as friends here know, I think there's another element to this that goes to the heart of that institutional investor's goal, and to some extent, small investors. We all sat around and watched the market go crazy. People were getting 20 percent rates of return. Management sits there and is told by the board and by shareholders if you don't beat the expectations for earnings next quarter by a penny or two—if you beat it by 3 cents, that's questionable. Beat it by a penny or two, you're smart. And you not only have to beat the written analyst estimates of your return, but the whisper numbers, that people really say, oh, that's not the accurate number.

    The end of the process is that management then is forced to take on risk to keep the earnings where they should be to enhance shareholder value, and we find ourselves replicating the 1980s and S&Ls in Louisiana who were buying broker deposits and giving away toasters to have returns look good for shareholders.

    So this is a cultural problem. And I don't lay fault on any one participant, but I want to respond to you by saying I think we should make the audit team, the audit committee, and the board of directors responsible first and primarily to the shareholders. Once that's done, everything else should flow appropriately, and I thank the gentleman for yielding.
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    Mr. SANDERS. I mean that's kind of the direction that I was going.

    Chairman BAKER. I hoped.

    Mr. SANDERS. And I was going to ask Mr. Berardino this question. If there needs to be somebody, some institution that the shareholders and the pension funds can look at who don't have a conflict of interest who are telling them the truth, who are not going to get fired when they tell the truth, who are not making money and profits with the company if it is doing some of the things that the Chairman indicated, who's going to be that institution, and what is the proper role in that process for the Government? That's number one, who presumably does not get rich or poor, based on the activities of the company? And second of all, as I understand it, Mr. Berardino, Arthur Andersen has the dubious distinction of having received the largest fine from the SEC, which was $7 million with regard to Waste Management. You are a company that has $9 billion in revenue in a given year.

    So the two issues that I want to know is, number one, $7 million is the largest fine, and yet compared to the $9 billion in revenue, it ain't nothing. If you screw up or another auditing firm screws up, is a paltry fine like that enough of a disincentive so that you don't do it again, and second of all, in terms of the broad issue of conflict of interest so you can look your company in the eye and say, sorry, we are not going along with that, and what is the proper role of the Government in that situation?

    Mr. BERARDINO. Congressman, I am going to answer that in two ways. I don't know what the proper role of the Government is. I am prepared to engage you in debate, as we are now, because I think a lot of smart people can get to a lot of different answers and collectively we get to a better place. But I will tell you one thing. All those big numbers were floating around. I grew up with nothing. Most of my partners grew up with nothing and we only care about our reputation, which—we only care about our reputation and we have been working as hard as we have been these last 2 months as we have been criticized left and right, as things have been leaked and put in the news that are half truths. We have been a stand-up firm that's gone out time and time again, come to this committee, come with ideas, made our people and documents available, self report the destruction of documents. This has all been very painful. I'm not asking you for your sympathy, but I'm telling you the real firm you are looking at is a stand-up firm that wants to get it right and any fine that impugns our reputation hurts us.
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    Mr. SANDERS. I take a little bit of offense when you suggest that the only thing you care about is your reputation. I grew up without any money. You grew up without any money. You have a lot of money now. I am sure they are paying you quite handsomely. In all due respect, you're in the business to make money as well. In terms of the reputation of Arthur Andersen, I don't think I'm telling anything out of school here, it does not have a good reputation. I listened to you time after time after time when your company was either fined or you settled. You don't have a good reputation.

    But you see, you are not answering my question. My question was I see an inherent problem that if, in fact, and maybe it's so and maybe it's not so, based on your track record I think Arthur Andersen has had a lot of problems in recent years. But assuming you wanted to do the right thing and you also wanted to make money, which is fair enough, and you came to a company and you said, company, you are not telling me the truth and the company says you're fired, I don't want to hear that, what is the recourse of that conflict right there? How can you be honest and make money at the same time?

    Mr. BERARDINO. Well, I have given you my ideas and my testimony. I think if we have had an ability in our report to distinguish gradations of quality reporting that would provide incentive for every registrant to have the highest degree of standards in its accounting and not achieve the bare minimum not to get the clean opinion, let's look at the incentives, and I think that is where Chairman Baker is going. Let's look at those incentives and challenge whether or not we've got the right ones. And I'm not going to sit here and tell you I've got all the answers, but I am making suggestions that I think can make a difference.
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    Chairman BAKER. I wish to just get perhaps a little bit of balance in the hearing record from your perspective of the annual revenues you received for accounting services. Can you give me an approximation of the number of clients that represents?

    Mr. BERARDINO. We have 2,500 public companies here in the U.S. Worldwide, with all the services we render, we have 100,000 clients.

    Chairman BAKER. So that with 100,000 clients, the reported concerned cases are less than 10 or perhaps less than 5.

    Mr. BERARDINO. And some of the cases that have been cited have happened over a long period of time.

    Chairman BAKER. We could multiply that by some number of years. My point is that the failure rate for corporate activity as it relates to accounting standards and professional product is less than one—tenth of 1 percent now. There is an egregious case with Enron because of its unfortunate demise on many fronts. I wish to make it clear I think the accounting profession is that, a profession, and that most diligent people labor and long to provide an honest service for their clients who are trying to run a business honestly.

    What we now find ourselves with, however, is clear identification of conflicts and conflicts which are not of your own making. We are operating in 2001 with a SEC Code written in 1933 and 1934. There is an inordinate need for this committee to move beyond the current crisis of reforming accounting principles and move to the broader question, what is the proper governance in today's technological world. When you had typewriters and White-Out and people were a great deal more contemplative, when I was in the real estate business many, many years ago and you had to do a purchase agreement and it was with carbon paper and you had to have an amendment to that purchase agreement and you had to run it back and forth, there was time for people to think about making the deal. Today, billions of dollars move by computer transaction in microseconds. It's a different environment. However, in this environment, or in the old one, there is always the necessity for ethical conduct and professional judgment, and what this committee needs to do, in my opinion, is to provide the accountant who's on the site making the evaluations of the financial practices of a corporation, is to report the facts as he sees them.
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    There's a question in my mind as to whether or not the environment today enables that to happen in every case, and I want to ensure the members of the accounting profession, who are I am sure listening to your testimony quite anxiously today, that we will work to achieve professional standards that serve the public interest well.

    We do now have a crisis of confidence. There are people in my hometown in Baton Rouge this morning who are working at a corporation wondering if its books are being accurately reflected and is their job at risk. There are people who are relying on their pension to pay their monthly living expenses wondering if there is going to be a restatement of earnings and their stock price is going to deteriorate. There are people who hold large investments hoping to buy their first home or their child's education. This goes to the core of our capital market's structure, and the confidence that people have in the ability that they're receiving the facts to make educated judgments about their economic future cannot be allowed to be put at risk, and that is what the committee will do. That is the answer we will seek, and we hope with your good counsel and cooperation that we can achieve a remedy within days, if not months, that is responsive to this crisis and forever puts it in a manner that it cannot reoccur.

    To that end the committee is committed, and I want to thank you for your second voluntary appearance. The hearing is adjourned.

    [Whereupon, at 2:15 p.m., the hearing was adjourned.]