Hearing on "Accounting and Investor Protection Issues Raised by Enron and Other
Public Companies: Oversight of the Accounting Profession, Audit Quality and Independence,
and Formulation of Accounting Principles."

Chairman Sarbanes, Senator Gramm, Members of the Committee. Thank you for asking me to share my thoughts regarding an issue of vital importance to our nation’s capital markets. I had the good fortune of serving as the Chief Accountant of the U.S. Securities and Exchange Commission (SEC) from July of 1998 to August of 2001. Now I have the privilege of shaping the minds of students who are the future of the accounting profession, as a professor in the College of Business at Colorado State University (CSU).

Prior to joining the Commission, I was the Chief Financial Officer (CFO) and Vice President of Symbios, Inc., an international manufacturer of semiconductors and storage solution products. I was a member of the executive management team and had responsibility for our financial reporting and disclosures as well as our audits. I also regularly interacted with our Board of Directors including the audit committee.

After graduation from CSU and the University of Nebraska, I joined the widely respected international accounting firm of Coopers & Lybrand, now PricewaterhouseCoopers. I rose through the ranks to became a partner, after spending a two-year fellowship with the SEC. As a partner with the firm, I was the leader of the national high technology industry audit practice, served as an SEC specialist, and also had partner responsibility for a number of our audit clients.

In addition to teaching today, I also do limited consulting in the accounting industry and business.

In business, we use numbers to report to investors, lenders, regulators and other users of the financial statements, the economic performance of a company. The numbers in the financial statements, just like a score on a college student’s test, tell investors how a company has performed in comparison to expectations of management, the markets and competitors. Without these historical numbers, it is difficult, if not impossible, to gauge the future prospects of a company. Without accurate numbers, investors are likely to be misled into making make wrong decisions. In essence, those who prepare or aid in the preparation of false and misleading financial statements take away from investors their ability to make their own informed choice as to whether they would invest in a company. When this occurs with increasing frequency, as we have seen in recent weeks and years, investors question whether they can invest with confidence without losing their money.

I commend the Chairman and this committee for scheduling a series of hearings on finding effective solutions to the issues that confront the capital markets today; that have caused investors to lose trust; that have unfortunately painted both the unscrupulous and the honest with the same brush. There is no question in my mind that the SEC and Justice Department, left unfettered and given sufficient resources, will thoroughly investigate and bring to justice those who are found culpable of the damage and destruction to the lives of thousands of Americans who invested in or worked at Enron. But once their job is done, it will be equally, if not more important, that the current systematic failures are corrected. And those corrections will need to be more than just a Band Aid.

While I was at the Commission, we began work on a staff report that identified concerns and issues surrounding the quality of financial reporting and the accounting profession. The report was designed to discuss not only the issues the staff had identified, but also the progress that had been made by the profession on the issues and recommendations for continuous improvement in the quality of audits and financial reporting. We wanted to be sure a report card was created against which future progress could be measured, similar to what the General Accounting Office (GAO) had done with their report on the profession in 1996. In that way, the investing public could be provided an ongoing report card, hopefully prepared by the Public Oversight Board (POB) on the progress being made towards ensuring investor protection through higher quality financial reporting. While due to time constraints, we were unable to complete the report, the SEC staff did provide some, but not all, of our materials to the GAO. Perhaps some of that may be used in their forthcoming report on the accounting profession.

The Commission asked the POB to provide an annual report card to the public on the implementation of the many recommendations of the Panel on Audit Effectiveness. This Panel had been formed at the urging of the SEC, to formulate recommendations on how audits could be made more effective. Its members included the former Chief Executive Officer (CEO) of PriceWaterhouse, two former SEC commissioners, two former CEO’s of the American stock exchange, two former CEO’s of public companies and an academic.

The POB was also to issue two reports on the progress large accounting firms had made in the implementation and operation of quality controls ensuring their compliance with the auditor independence rules. This project was undertaken due to serious concerns by the SEC with respect to the lack of compliance with applicable rules by these firms. Unfortunately, now with the decision of the POB to disband, a situation in which they were probably left no choice, there is no one left to fill out the report card.

Enron has brought to light many of the shortcomings the SEC staff had identified with various facets of the accounting profession such as peer review, the lack of an effective and timely self disciplinary process, the need for more effective auditing standards and concerns about financial conflicts that impaired the independence of auditors. As a result, the need for the full report has been somewhat mitigated.

Yet the recommendations for improving the deficiencies in the quality of our financial reporting system are even more relevant today than when I left the Commission. And it is that portion of what would have been in the staff report to the Commission, if we had time to complete it, I would like to share with you today. I will point out that many of the recommendations the SEC Staff were anticipating making were already set forth in a series of speeches last spring and summer that were titled "The State of Financial Reporting Today; An Unfinished Chapter I, II and III" as well a speech entitled "An Investor’s Bill of Rights." Some of these recommendations come from reports that are not new. They are recommendations that continue to gather dust on a bookshelf as they continue to fail to be implemented

The specific areas the recommendations in the report would have addressed include:

• The self governance of the profession,

• The quality of audits including the standard setting process,

• Auditor’s independence

• Audit committees, and

• The quality of financial reporting including the standard setting process.

These recommendations essentially are about one vitally important principle, INDEPENDENCE. Independent oversight of the accounting profession, independence of the accounting and auditing standard setting process, independent auditors and audit committees and independent analysts. Independence is a word that has served this country well for the past two hundred and twenty-five years and it will also serve to protect the interests of the investing public. It is a concept that will overcome the fears of investors arising from the arrogance, ignorance and influence they have listening to with respect to Enron and other financial failures.

The quality and reliability of financial statements and disclosures provided to investors are ultimately determined by whether there is compliance with the applicable accounting rules. You can write all the accounting rules you want to; you can require sufficient disclosures to fill up a phone book; but unless someone assures investors the established rules are being followed, they are meaningless. That is why we have independent audits. Independent audits provide investors with confidence that the numbers are accurate and reliable.

Since the financial frauds and failures arising from the 1972-73 bear market, including cases such as Penn Central and Equity Funding, the profession has attempted to ensure audit quality through a self-governance process. While some argue that 99.9% of the audits each year are okay, remember that Enron was once one of those 99.9%. The fact is we really don’t know how many more audits are like the iceberg below the water level, unseen until it is too late.

What we do know today, is that the increasing number of earnings restatements, the number of massive financial frauds, the tens and hundreds in billions of losses to investors and now Enron, accompanied by the almost daily parade of financial reporting issues, highlight a serious question in the minds of investors with respect to the quality of audits. They also strike at the very heart of the credibility of my once esteemed and proud profession. Yet the multitude of organizations often referred to in the press these days as "alphabet soup" do not yield an efficient or effective quality control process. A diagram of this confusing and ineffective structure is attached hereto as appendix.

It is well past time to establish an SEC supervised public accounting oversight board in light of:

• The American Institute of Certified Public Accountants (AICPA) and profession having cut-off the funding for the POB in spring of 2000 when it attempted to fulfill its mandate to the public and carry out an investigation of the lack of compliance with independence rules.

• The AICPA having a weak, if not totally ineffective self-disciplinary group called the Professional Ethics Executive Committee or PEEC. A group that conducts its meetings behind closed doors, that often defers taking action on cases for years at a time, that has no subpoena powers, and that has failed to take action in a number of instances after the SEC has. The AICPA and firms had stated to the SEC and public in press releases towards the end of 2000 that they would work towards increasing the public membership of this organization from the current three out of twenty members. Andersen publicly said it would support an increase in public membership to half of the committee’s total membership. Unfortunately, this has become a broken promise.

• The AICPA creating a for-profit portal and web of business relationships called CPA2Biz, and along with a failed attempt at establishing a business consulting credential. It is difficult to understand how a not-for-profit organization can enter into this web of for-profit relationships and not create conflicts with the notion of being a public interest self-regulatory organization.

• The POB itself has no disciplinary powers.

• The POB has limited capabilities to ensure auditing standards are written based on meeting the needs of the public for effective audits, as opposed to being written by, and for, the general legal counsels of the firms.

• The Quality Control Inquiry Committee or QCIC that is often trumpeted as investigating alleged audit failures in fact has no subpoena powers. It only has members from the profession, often retired partners from the Big Five "club", lacks members from the public and only looks at documents that are already publicly available. It has recommended cases to the PEEC or Auditing Standards Board (ASB) for further action. Action that too often fails to materialize.

• We may now be faced with an unfortunate outcome of Enron, one I truly hope does not become reality, of having four major accounting firms. As I have previously expressed to the POB, this in and of itself will result in the need for major revisions to the existing system as the concentration of the public audit function becomes extremely concentrated in just four global and large firms. From small firms with a few offices at the time the Securities Acts were passed, these businesses have grow to global organizations that employee in some cases in excess of 100,000 on a global scale.

In light of these and other recent events, today we need to establish an independent public accounting regulatory oversight body for the accounting profession under the supervision of the SEC. That body needs to have these critical elements:

1. It is conducted by an adequately funded independent organization,
2. Its members are drawn from the public rather than the profession,
3. Timely and effective disciplinary actions against those who fail to follow the rules, regardless of whether they are small or large firms,
4. It has the authority to issue auditing and quality control standards that establish a bench mark for the performance of quality audits and its disciplinary process, thereby serving and protecting investors as opposed to the interests of the profession, and
5. It inspects the work of auditors on an ongoing basis to ensure they have made the investing public, not the amount of consulting fees they can generate, their number one priority.

I have heard some say that unless practicing accountants serve on the board it will not have the necessary expertise. Yet in the United Kingdom the accounting profession itself recommended a new framework for the independent regulation of the profession that has an independent oversight board, called the "Foundation," without any practicing accountants among its members. I believe you can get many well-qualified public servants who understand audits and will protect investors by drawing from the ranks of former auditors such as Charles Bowsher, the former Comptroller General of the United States or some of these distinguished gentlemen who sit next to me, today.

I have also heard some say we should consider using one of the existing self-regulatory structures that exist today. However these may well involve organizations where the members themselves have a vested interest in the outcome of accounting and auditing standards. For example members of a stock exchange have a vested interest in the numbers they must report, the disclosures they must make, and the outcome of their audits. This creates a conflict that will not ease investor’s fears about the current lack of independence.

One reason for creating a private oversight board is the need for an active inspection program that can discipline auditors when substandard work is identified. An inspection requires very experienced personnel who are typically partners and managers and who have significant practical experience. These people would be no lower than a GM-15 or Senior Executive Service in the government personnel scale. For a typical accounting firm office, it may take on average of ten reviewers working seven to ten days to perform an inspection. Large offices like those located in major metropolitan areas will take significantly more staff. Given the large accounting firms today have a hundred offices in just the U.S., one can quickly see where it will take significant manpower to perform timely and effective inspections. Being able to attract, competitively compensation and retain such staff will be a challenge for the oversight board. However given today’s budgetary pressures, this is probably easier accomplished in the private board as opposed to the SEC.

Audit quality will be enhanced through effective independent inspections by the oversight board I just described. Performance of annual on-going independent inspections of the large accounting firms, with perhaps no less than tri-annual inspections of smaller firms who tend to audit fewer public issuers, should overcome the current system of "backslapping" peer reviews. It is interesting to note that today it is perhaps the smaller firms that face the most rigorous reviews. This system of firm on firm reviews by the large firms reminds one of grade school where the rule was "I won’t tell on you so long as you don’t tell on me." A system that time and time again I questioned the credibility of the reviews being performed. A process that did not examine audits such as Enron or Global Crossings where investors had alleged a failure occurred, and did not mandate that all audits in which a restatement had occurred to be inspected

And when the SEC staff raised questions with the peer reviewers, meaningful and satisfactory responses were generally not forthcoming. The responses we did receive continually sounded like a rationalization of whatever had been done. Yet the public continued to be provided with the blue ribbon seal of approval by the very profession under scrutiny. Eventually this led to the SEC removing the "endorsement" of the peer review process from its Annual Report to Congress in 1999.

Further recommendations continue to need to be implemented to improve audit quality. They include:

• The 200 plus recommendations the Panel on Audit Effectiveness made to the profession and accounting standard setters in August 2000 need to be adopted as proposed, without being watered down. This includes a substantial rewrite of many of the auditing standards to require certain forensic audit procedures be incorporated into each audit, and to put sufficient detail into the standards to ensure they can be enforced. The POB was charged with overseeing the implementation of the Panel’s recommendations. I would encourage the GAO or an independent oversight board to undertake that charge, as the POB will soon cease to exist.

• Auditing standards need to be established by an independent standard setting body.

No doubt some will argue that you need to have a knowledgeable body of auditors to set auditing standards if you are going to be effective. But keep in mind that for the past twenty plus years, the ASB has been drawn almost exclusively from "knowledgeable" auditors with the major accounting firms. And yet the Board’s Statements on Auditing Standards:

• Result in an audit report to investors that fails to provide an adequate explanation of an audit, such as the fact the auditor may not even have tested internal accounting controls, or while generally accounting rules are followed, aggressive accounting practices have been employed by the company to meet earnings expectations.

• Today still don’t require auditors to look at large unusual adjusting journal entries that are a common characteristic of many financial frauds.

• Do not provide guidance to auditors on factors an auditor would need to consider in assessing materiality until after the SEC staff issued guidance on this subject in August 1999.

• Still have not provided an auditing standard with authoritative guidance on auditing "cookie jar" reserves despite the request of the SEC staff over two years ago to provide such guidance to help reduce the incidence of improper earnings management.

• Still permit auditors to consult on the design and structuring of transactions which reduce, rather than improve the transparency of disclosures, despite two previous requests from the SEC as well a renewed request in recent weeks to address this abusive practice.

• Have recently adopted a new standard that will set the requirements for auditors documenting their work that still does not require sufficient documentation to permit an independent third party to validate the work auditors have performed.

Simply put, auditing standards today, which are often reviewed and edited by the legal counsels of the firms, are written to protect the interests of the firms, not ensure quality audits that will protect investors. Perhaps the greatest chief accountant of all times, Sandy Burton was way ahead of his time in 1978 when he testified before Congress stating that the current system would not serve investor protection.

I do give the current chairman of the ASB credit for trying to improve recently the quality of the auditing standards. Guidance has been forthcoming on topics such as auditing revenues in selected industries as well as financial instruments many companies have invested in. However it has been the age-old story of too little, too late. We need to change the process to one that will develop standards for auditors and provide them with timely guidance before they and investors hit the iceberg. Again I point out that in the new system in the United Kingdom, the establishment of auditing standards has been lifted from the profession itself and been given to a new organization under the auspices of the new independent oversight board.

Auditor’s independence has long been a hotly contested issue to the profession and the SEC. But after cases such as Waste Management and Enron, no longer are people asking, "where is the smoking gun." Disclosures of consulting fees that run into tens of millions of dollars and multiples of the audit fees are generating an outcry for action.

Once and for all, we need to adopt rules that will truly protect the independence and integrity of the audit, and gain the public’s confidence that the auditor’s are working for them, not management. Rules that will ensure investors that when they get the auditor’s seal of approval, they can trust the numbers. To accomplish that we need to:

• Close the revolving door between the audit firm, its partners and employees, and the company being audited.

• Require that in order for the auditor to be considered independent, the firm must be hired, evaluated and, if necessary, fired by the audit committee.

• Adopt a rule that allows auditors to provide only audit services to an audit client, unless the audit committee makes a determination and discloses that the services provided by the audit firm are (1) in the best interest of the shareholders, and (2) will improve the quality of the company’s financial reporting. This is sometimes referred to as the exclusionary ban approach to auditor’s independence.

• Prohibit an independent auditor from assisting a company design and structure transactions, then provide their accounting or tax opinion on what the appropriate accounting is for the transaction, and then audit the accounting for that transaction. This was discussed in the original SEC rule proposal. However, companies and their auditors should be permitted to consult on the proper accounting for a non-hypothetical transaction that the auditor has not designed and structured, as that is a normal and important process in any audit.

• Require mandatory rotation of the audit firm every seven years.

Some will argue that the exclusionary ban will have a negative impact on the quality of audits or the financial strength of an accounting firm. Others argue that tax services are an integral part of performing an audit. To that I respond that if the service is integral to the audit, then no one should be better situated to make that assessment on behalf of investors than the audit committee. Under the proposed recommendation the audit committee will have the option of agreeing to those services that are in the best interests of the investors.

Trying to make an across the board cut on which of these services will or will not impair an auditor’s independence, in a quickly changing business environment, is not a long term solution. As soon as a new statute or rule is adopted, new services will be developed and the issue will reappear.

The fact that auditors are paid by the management of the companies they audit has also been brought up time and time again in recent months. Some argue that the auditor would never risk their reputation for the fees from a single audit. Yet at the Commission we saw situations, some of which are now public, where the auditors identified the problems with the numbers in the financial statements, discussed them and still issued their unqualified reports. In fact, it is not the magnitude of the fee to the firm that matters as much as it is the magnitude of the audit and consulting fees to the profitability of the office or the engagement partner’s portfolio of business.

Ellen Seidman, then Director of the Office of Thrift Supervision or OTS, testified before this committee on September 11^th, 2001 regarding the audit of the failed Superior Bank. In her opening statement the Director stated "Congress or the FBA’s [Federal Banking Agencies] could also encourage the AICPA and SEC to establish an ‘external auditor rotation requirement’…its adoption would result in a ‘fresh look’ at the institution from an audit perspective, to the benefit of investors and regulators."

But others will argue that there is greater risk in the first year of an audit, as the auditor has to get an understanding of the business to ensure the proper issues are identified and dealt with. I don’t dispute the fact the auditor has a higher learning curve on the first year of an audit. But in all my years in public accounting, I never once heard my former firm or any other firm for that matter, say they did not do what they needed to do, to get the necessary background to perform a proper audit. Perhaps the real fact is that in some cases, auditors propose a lower fee in the first year of an audit relationship in order to gain the account, and this has a negative impact on the quality of the first year audit.

Remember that investors have suffered their largest losses on audits of companies that did not involve an initial audit, but rather an ongoing relationship. Examples include:

• Enron

• Microstrategy

• Cendant

• Rite Aid

• Livent

• Informix

• WR Grace

• Sunbeam

• Lernout and Hauspie

• Xerox

• Lucent

• Oxford Healthcare

• Superior Bank

• HBO McKesson

• Waste Management.

One final argument you will hear against the rotation of audit firms is that they already do an internal rotation of audit partners on the companies they audit. That will probably also be true for some of the above companies. But once a firm has issued a report on the financial statements of a company, there is an inherent conflict in later concluding that the financial statements were wrong. This is especially true if the company has accessed the capital markets using those financial statements and as a result, the accounting firm has significant exposure to litigation in the event of a restatement of the financial statements. By bringing in a new firm every seven years, you get an independent set of eyes looking at the quality of the financial reporting that have no "skin in the game" with respect to the previous accounting.

Engaging Audit Committees

It was in 1940, after the discovery of a large fraud at McKesson Robbins that the Commission first encouraged the establishment of independent audit committees. More recently in 1999, with the strong support of the stock exchanges and the accounting profession, audit committees adopted new rules effective in 2001, to enhance the oversight of the financial reporting, disclosure and audits of public companies.

In light of Enron and questions surrounding the oversight of its audit committee, recommendations that can further enhance the vital role and quality of audit committees include:

• The audit committee should directly hire, evaluate and, if necessary, fire the auditor. This process should not involve the management team making the selection or recommendation to the audit committee. It needs to be a truly independent process.

• The exceptions provided for in the rules of the stock exchanges, which permit an audit committee member who is not independent, should be eliminated.

• The definition of an independent director should be modified to prohibit the company from engaging the director for any services other than those provided as a director, and ban financial payments on behalf of the director, such as contributions to charitable organizations or similar types of payments.

• The audit committee, consistent with the recommendations of the Panel on Audit Effectiveness, should be required to pre-approve all non-audit services.

• The audit committee, consistent with the recommendations of the Panel on Audit Effectiveness and legislation previously passed for financial institutions, should require the CEO and CFO to provide to the audit committee a report by management that clearly states managements responsibility for establishing, maintaining and ensuring an effective system of internal accounting controls exists. In the Rite-Aid and Xerox cases, investors learned that there had been material weaknesses in internal controls but only when the auditor was fired and a report filed with the SEC, months after the audits had been completed. The report on internal controls should be audited by the independent auditor and provided to investors in the annual report. The investors have a right to know whether adequate controls exist to ensure that the financial statements and disclosures comply with generally accepted accounting standards. If the executives are nervous about signing such a report, I suggest investors should be nervous about the numbers.

• As in some foreign jurisdictions, the CEO and CFO should be required to sign and certify to the audit committee and investors that the financial statements comply with the applicable rules and include disclosure of all material information. There should be criminal and civil penalties for intentional misrepresentations to the public or to the auditors.

• Companies should be required to provide their audit committees with appropriate training and understanding of the business and its financial reporting to ensure their ability to carry out their obligation to investors.

Let me shift gears and switch to the topic of accounting standards. I believe our financial reporting system, including the accounting standards we use in assembling the numbers, remains the best in the world. That is difficult to comprehend in light of Enron, but one only has to examine closely the Asian crisis of a few years back to appreciate the quality of our financial reporting. The SEC staff report did include a section on international issues affecting the quality of financial reporting. Many of the recommendations that would have been in that section are included in the 2000 Annual Report of the SEC to Congress or a paper I presented in November 2001 presented at the SEC Major Issues conference and published in Accountancy Regulation. As that paper notes, there have been many earnings restatements required for foreign issuers. In fact, the SEC staff will review a draft of the financial disclosures of foreign issuers in part to help them facilitate getting the numbers right the first time.

I would like to digress a moment to thank the Chairman and his staff for their unyielding support of our efforts during the recent years, as we at the SEC tried to improve the quality of financial accounting standards and reporting with initiatives on earnings management and auditor independence. The SEC and its staff became the targets of a constant barrage of criticism from some members of industry, the accounting profession and congress for issuing Staff Accounting Bulletins that would hopefully stem the tide of restatements from improper Big Bath charges, recognition of revenue before it was earned, and intentional misstatements of earnings while hiding behind the disguise of "materiality." Yet Senator Sarbanes and his staff never wavered in their commitment and stood by us in getting these changes made to protect investors. He also stood with us on the proposed rules on auditor’s independence. For that I am very grateful.

But the job of improving accounting standards is not complete. Our rules and standard setting process here in the U.S. requires significant improvements to provide investors and regulators with greater transparency. Improvements that need to be made include:

• Revising the structure of the Board of Trustees to bring it in line with the Trustees of the International Accounting Standards Board (IASB), chaired by former Federal Reserve Chairman Paul Volcker. Currently the majority of the members of the Financial Accounting Foundation (FAF), who serve as the trustees for the Financial Accounting Standards Board (FASB), are selected based upon their representation of a particular constituent group. As with the IASB, these selection criteria should be changed to one where the board members are all representatives of the public rather than any particular special interest.

• Create an independent "no strings attached" funding mechanism for the FASB. This again could be accomplished by a fee charged to issuers and/or members of the exchanges, all of who greatly benefit from the work of the FASB.
• The FASB needs to develop accounting standards that reflect the reality of the actual economics of the underlying transactions. Senator Allard from my own state of Colorado has recently highlighted the need for timely issuance of such standards and I, as I am sure other investors do, commend him for that position. Standards that permit hundreds of billions of dollars in synthetic lease financing off balance sheet liabilities to be hid from the eyes of investors; that permit companies to avoid consolidation of special purpose entities for which the company itself has the majority, if not practically all of the risks and rewards of its operations; and that result in the value of compensation in the form of stock options to be excluded from the income statement are not transparent standards. They are better described as a chapter from Grimm’s Fairy Tales.
• The FASB needs to develop and implement a project management system that prioritizes the needs of investors, and then establishes accountability and responsibility for meeting those needs in a more timely fashion. For example, in the mid 70's the SEC asked the FASB to address the issue of whether certain equity instruments like mandatorily redeemable preferred stock are a liability or equity. Investors are still waiting today for an answer. In 1978 the Cohen Commission requested the FASB to require disclosure in a single footnote of all the transactions that were affecting the comparability of the financial statements from one period to the next. This is a disclosure that would have gone a long way towards addressing some of the problems created by pro forma earnings but again nothing has been done. In 1982, the FASB undertook a project on consolidation. One of my sons born that year has since graduated from high school. In the meantime, investors are still waiting for an answer, especially for structures, such as special purpose entities (SPEs). In 1985 the SEC asked the FASB to provide guidance for financial instruments, a project still underway today. In 1998 the FASB was asked to provide guidance to reduce some of the abuses of "big bath" charges, but they continue to this day unmitigated. Time and time again the FASB has asked the SEC to defer to it to establish standards. Yet the standards never come. As a result, in the future the SEC should give the FASB a timetable for completion of these standards and if that timetable is not met, the SEC should act promptly to protect investors.
• The FASB Trustees should undertake to restructure the Emerging Issues Task Force (EITF) of the FASB. The EITF establishes generally accepted accounting principles for many of the new and emerging types of accounting transactions but does not have investor protection and transparency as a key part of its mission statement. Rather it often establishes rules that "grandfather" past accounting practices that are questionable at best. This should surprise no one as the EITF comprised solely of members from industry and the accounting profession. The EITF needs major revisions to its charter, should require public representation, and as with the IASB, should not be able to pass a new rule without the explicit approval of the FASB.
• The SEC should require that companies disclose key performance indicators or KPI’s. KPI’s, such as backlog, plant utilization rates, revenues generated from new product introductions, etc. provide a very powerful useful tool that gives investors greater predictive capability with respect to trends in the business.
• The SEC proposed new rules to increase the transparency of "reserves" and large write-downs in the value of assets such as plant and equipment and goodwill. As the Association for Investment Management and Research (AIMR) has recently requested, the SEC should quickly issue final rules similar to those proposed.
• The SEC should ensure financial statements are written using "Plain English" through its review and comment process. While complex financial instruments transactions may be beyond simple descriptions, there are plenty of opportunities to improve the readability of financial statements.

In recent weeks the AICPA has seemingly laid the problems associated with Enron at the doorstep of the FASB. They have argued that the lack of transparent accounting standards was the cause of Enron’s financial reporting standards. They fail to acknowledge there were problems with the audits while stating the financial reporting model is broken. But as Jack Bogle, the highly respected founder of the Vanguard funds has stated, perhaps it has been the markets and not the model that were wrong. Perhaps the ostrich is once again placing its head in the sand.

Another issue being bantered about involves the issue of whether today’s accounting standards should be principles based rather than detailed rules. This is not the first time this issue has been raised, and I can assure you it will not be the last. The predecessor to the FASB, the Accounting Principles Board (APB) did write some principles based standards. For example, in 1964 the APB issued a standard on accounting for leases. That standard stated in principle when a lease, as many are, is an installment purchase of the equipment, it should be reported as a liability on the financial statements. But this standard was no more successful than the current detailed FASB rule on getting this off balance sheet debt back on the balance sheet. We also have broad guidance on accounting for property, plant and equipment and the associated depreciation. But that has not stopped the abuses of understating depreciation and then taking large write-offs of assets when it is convenient. The predecessor to the APB issued what some consider broad principles standard for reporting of inventories. But a recent survey by Andersen and a 1999 report by the Committee of Sponsoring Organizations (COSO) illustrate that overstatement of inventories continue to be a major source of earnings misstatements and SEC enforcement cases. And finally, the FASB standard that establishes when many liabilities are to be reflected in the financial statements, Standard No. 5, is a very broad principle standard that has been responsible for such aggressive accounting practices like "big bath" charges and understatement of liabilities for environmental costs. The real issue is not simply one of broad versus narrow detailed rules. It is a cultural issue of a lack of compliance with both the spirit and intent of the standards. It is an issue of professionalism.

One stark reality today is that before the ink dries on a new FASB standard, the investment banking community and accountants are joining forces to find ways to structure transactions to get around the new rules. And while the spirit of a rule may clearly say no, I have heard time and time again from a CFO or auditor, "where in the rules does it say I can’t do it." It is time to get away from this mentality and a good starting point would be to prohibit auditors from designing and structuring transactions, such as SPE’s, that result in less, rather than more, transparency for those they are reporting to.

Let me move on to perhaps one of the most important thing for the markets today. That is ensuring we have an adequately staffed and resourced securities regulator. Today, that does not exist.

There are approximately 12,000 actively traded public companies who file 12,000 annual reports, 36,000 quarterly financial statements, and thousands of initial public offerings, registration statements, proxies, and tender offers. In recent years, the Division of Corporation Finance has been staffed with approximately ninety accountants to review these documents. In the Division of Enforcement, the typical caseload is around two hundred to two hundred and fifty cases. There are approximately twenty to twenty five accountants in the Washington D.C office and maybe another thirty or forty around the country to investigate these cases. In the private sector, it is not unusual that three to four accountants assist in preparing for testimony on a financial fraud case. In a case such as Enron, many more staff would be dedicated to such a project. Finally about twenty to twenty five accountants are working in the Office of the Chief Accountant. This office provides a service to the public accounting firms and companies, similar to what the national accounting and auditing offices of each of the Big Five accounting firms provides to their own audit clients and offices. They also have oversight responsibility for all the activities of those entities in the alphabet soup. Comparatively speaking, the national offices of the Big Five accounting firms are each typically a multiple or two larger than the Office of the Chief Accountant.

As you can plainly see, it is physically impossible within their current budgetary handcuffs for the SEC staff to carry out their mandate to ensure full disclosure and timely enforcement of the laws and regulations. The Panel on Audit Effectiveness recommended the SEC provides additional resources to combating financial fraud. I hope Congress will respond to the Panel report and provide the necessary funding for doubling the size of the accounting staff in the Division of Corporation Finance and the Office of the Chief Accountant, as well as reasonable compensation levels for existing staff. The SEC Division of Enforcement should also double or triple the number of accountants and attorneys involved with combating financial fraud. Its Financial Fraud Task Force needs to become a permanent fixture within the Division.

The SEC also needs to be provided with the resources to acquire technology that can aid in the electronic screening of filings for potential issues and unusual trends in financial performance. SEC Chairman has indicated he wishes to hire a highly qualified Chief Information Officer. This is long overdue and will require additional funds. But new and enhanced technologies can be a powerful, efficient and effective tool in identifying problems at an earlier date.

The statutory authority of the SEC to undertake certain types of actions should also be evaluated. Recent cases involving Baymark and California Micro Devices have raised serious questions as to whether the standard of recklessness the SEC applies to Rule 102(e) proceedings against accountants, is too high a standard by which to measure unprofessional conduct by an accountant or auditor. Rule 102(e) is the regulation by which the SEC may censure an accountant in a public company or an auditor and deny them the right to practice before the Commission. The rule is used to protect the integrity of the system and processes that are key to efficient markets. It requires that an accountant must be reckless, or have multiple incidences of improper professional conduct in order to be sanctioned. As a result, in cases involving negligence or other unprofessional behavior that is less than recklessness, a 102(e) sanction baring the practice of the accountant before the commission or in a public company cannot be pursued.

It should be noted that some professionals have challenged the SEC with respect to whether a Rule 102(e) proceeding may be initiated against an accountant within a public company, if they are not a currently licensed CPA. Today, many of the CFO’s, Controllers and key financial reporting people do not have, or have not maintained a current CPA license. In essence, the lack of current SEC actions pursuant to Rule 102(e) against non-licensed accountants sends a strong message. I think it is the wrong message that CFO’s and Controllers are better off without their licenses than they are with them.

Let me switch briefly to the subject of the chief financial and principal accounting officers. Today, CFO’s at the major American corporations turn over approximately four times faster than they did at the beginning of the 90’s. And while the turnover ten years ago was often tied to one’s retirement, it is much more likely today to be tied to a company missing an earnings estimate. Way too often today the CFO becomes the "fall guy" for such misses while the CEO’s, Chief Operating Officers, vice presidents of manufacturing, marketing and other key management positions stay on. And as surveys have shown, it is all too often the CFO who is pressured by these other members of management to stir the pot and cook the books. And when the CFO doesn’t like the recipe that is handed to him or her, they are shown the door.

As a result, I also believe the SEC should make a change to its rules for Form 8-K. A Form 8-K should be required to be filed whenever a chief financial officer or chief accounting officer is terminated. The report should require disclosure of whether the audit committee approved the termination and whether there were any disagreements regarding financial accounting or disclosure matters. Perhaps a similar disclosure should be required for audit committee members.

Another challenge to the authority and ability of the SEC to enforce the securities laws involves access to the work papers of auditors of foreign issuers, or U.S. issuers with operations audited by a foreign affiliate of the U.S. firm. Time and time again I watched as the public accounting firms failed to provide timely access to the foreign work papers, thereby dragging out the case and hoping it would be dropped due to turnover in the assigned SEC staff. In its international concept release issued in 2000, the SEC noted this was a significant issue it faced in enforcing the SEC’s rules. And the SEC is not the only regulator to have been confronted by this issue. In the BCCI case the federal banking regulators also had to endure difficulties in gaining access to the work papers of the foreign affiliates of the accounting firm. With foreign registrants now comprising approximately ten percent of all actively traded companies, either the Congress or SEC should act quickly to protect investors before investors are unwittingly exposed to greater risk.

Finally Section 10A of the Securities Act needs to be modified. Currently auditors are only reporting a small handful of violations of the law. They define their responsibility very narrow to require reporting only when they have identified an illegal act, have unquestionably proved it is an illegal act, and did not resign before they had to report it. As a result, when financial reporting is questioned as it has been at Enron, this narrow definition of the rule will not result in a Section 10A report to the SEC. I think most investors would agree that is a definition that is too narrow and that fails to protect the public.

I have discussed recommendations for standard setters, regulators and preparers. Let me shift for a moment to a group that all too often is missed in the equation. That is the educators and the all-important role they play.

The most valuable asset of the accounting profession and public accounting firms is the people who make up our organizations. Great people who are talented, well educated and motivated make for great organizations while "weak" people are nothing less than as the television show aptly calls it, the weakest link!

Accordingly, I give credit to the current leadership of the AICPA for its efforts to boost enrollment in our colleges and universities of the best high school students and its efforts to interest them in the accounting profession. It is important that accounting firms and industry provide support for this initiative.

During the recent debate on auditor's independence we noted that the salary gap between the starting pay for accounting college graduates entering the profession, and those who chose other fields of study or employment opportunities in business, had grown very significantly over the past ten years. This salary differential sends the wrong signal to students about to choose a major field of study. Clearly, we need to correct this problem in addition to considering the level of investment going into those who choose to enter the accounting profession as auditors as well as the tools they need to perform effectively.

Today we also need to bring down the "silos" that still exist in the business colleges. Educators need to take concrete steps to change the all too typical dinosaur of an accounting curriculum that is based on the accounting silo. They need to stop competing with the finance, management, marketing or computer science "silos" and seek to integrate these programs in a broad-based accounting curriculum. Today, these ingredients need to be blended together to meet the needs of students and the profession.

Good auditors and financial managers need a broad spectrum of knowledge. For example, to be a good auditor today, you must understand marketing and distribution channels, how risk management is effectively and efficiently achieved through the use of various financial as well as managerial techniques to develop effective strategic and tactical plans. And of course, each of these areas of study is affected by the rapid change in technology.

Universities need to reflect these changes in their curriculum now. Certainly this will in all likelihood require more than what a student is able to learn in a four year program. Keep in mind, while many of us were in college, technology meant punched cards fed into a computer, management was done in an environment of paper and calculators, not in a real time on-line mode, and almost all of the financial instruments used today had not yet been created. In the past, we talked about interstate business and commerce, now it's the integrated global economies. In simple terms, this means we must also realize that if our new hires are to have the basic understanding they will need to be successful in their respective roles, they will need an enhanced course of study. The enhanced program must be both more broadly based in business, more integrated and still steeped in the accounting contribution unique to our discipline. At the same time, it is imperative that the basic skills taught in financial accounting and theory, income tax and auditing courses today, must continue as part of the curriculum. Accordingly, I do not believe this can all be accomplished in four short years. I believe we need advanced programs. The result will be students who leave the university with a better education, as compared to the body of knowledge new graduates had ten or twenty or thirty years ago. However, the accounting firms and business must be willing to compensate the students who invest in this greater body of knowledge.

The last piece to ensuring quality financial information is provided to investors is to reestablish the independence of analysts. I would encourage the committee to gain a clear understanding of how analysts are evaluated and ranked, how and by whom their compensation is set, and who has access to, edit privileges or control over their research reports. As long as the investment-banking arm of Wall Street has influence over the work of the research analysts or their compensation, analysts will not be able to provide independent research.

I would also encourage the committee to ask the question of what role the investment bankers played in structuring the off balance sheet partnerships of Enron, what access to nonpublic information they received, and whether any of that information was used in an improper or illegal fashion.

One last piece of the Enron puzzle that has received increasing public attention, is the role the attorneys played. As the general counsel of the SEC so eloquently stated just last week, the legal profession is the one profession engaged in the business of justice. Lawyers are the instruments of justice.

Yet the investing public and employees of Enron are wondering how justice has been served. Those who have lost their jobs or their life savings see a system blind to justice.

I hope this committee will explore this important issue, and consider if the influence of a few, through the power of the dollar, won out over truth and justice for all.

Hopefully the recommendations I have made to day have given you an understanding of what the SEC Staff was striving for in their report to the Commission. As you can see, it provides a benchmark for measuring the progress, or lack thereof, by the profession in making substantive, meaningful change. As you can also see from the attached chart, these recommendations for a new system of regulation will also result in a much simpler, reliable and effective system of oversight of financial reporting.

So let me finish as I began, with independence. One out of every two adult Americans have invested in the U.S. capital markets that are the crown jewel of our economy. They have done so because they had trust and confidence in a system that provides the numbers investors need to make wise investment decisions. They have trusted that an independent public watchdog was on the beat.

But that trust now lies shattered and will not be easily restored. In the two hundred plus year history of the markets, every time that confidence has been shattered, our markets have sustained losses, investors have fled to safer havens and the capital vital to funding American business and job opportunities has dried up. We cannot let that happen again. We must act quickly to make real, not just cosmetic changes that will restore the confidence of investors and the American public. The public deserves nothing less from congress, the accounting profession, regulators, analysts and other members of the financial community.

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