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THE
COMMITTEE ON GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
OPENING STATEMENT BY ARTHUR LEVITT
JANUARY 24, 2002
Mr. Chairman, Senator Thompson, Members of the
Committee:
Thank you for the invitation to share my thoughts on the
failure of Enron and its implications for our financial
markets.
Today, there is an emerging crisis of systemic confidence in
our markets. What
has failed is nothing less than the system for overseeing our
capital markets. We
have an opportunity to repair trust in those on whom investors
depend, and in the process, trust in the numbers that are the
backbone of our capital markets.
But our response must be comprehensive.
Healthy and resilient financial markets depend on the
accountability of every one of its key actors – managers,
auditors, directors, analysts, lawyers, rating agencies,
standard setters, and regulators.
Enron’s collapse did not occur in a vacuum.
Its backdrop is an obsessive zeal by too many American
companies to project greater earnings from year to year.
When I was at the SEC, I referred to this as a
"culture of gamesmanship" –
…a gamesmanship that says it’s okay to bend the rules,
tweak the numbers, and let obvious and important discrepancies
slide…
…a gamesmanship where companies bend to the desires and
pressures of Wall Street analysts rather than to the reality
of numbers…
… where analysts more often overlook dubious accounting
practices and too often are selling potential investment
banking deals…
…where auditors are more occupied with selling other
services and making clients happy than detecting potential
problems…
…and where directors are more concerned about not offending
management than with protecting shareholders.
Any reforms must recognize the importance of gatekeepers in
safeguarding the interests of investors and the fundamental
need to preserve and enhance these gatekeepers’
independence. These
steps are certainly not a panacea, but we must begin to
reinvigorate the financial checks and balances.
First, we must better expose Wall Street analysts' conflicts
of interest. For
years, we've known that analysts' compensation is tied to
their ability to bring in or support investment banking deals.
In early December, with Enron trading at 75 cents a
share, 12 of the 17 analysts who covered Enron, rated the
stock either a hold or buy.
Two years ago, I asked the New York Stock Exchange and the
National Association of Securities Dealers to require
investment banks and their analysts to disclose clearly all
financial relationships with the companies they rate.
That rulemaking -- still not finalized – should go
further and mandate that analysts disclose how their
compensation is affected by their firm's investment banking
relationships. And
Wall Street’s major firms – not its trade group -- need to
take immediate steps to reform how analysts are compensated.
As long as analysts are paid based on banking deals
they generate or work on, there will always be a cloud over
what they say. Analysts also should not be allowed to trade
the stock of any company for which they have issued a
recommendation in the last 30 days.
Second, company boards often fail to confront management with
tough questions. Stock
exchanges, as a listing condition, should require at least a
majority of the directors on company boards to meet a strict
definition of independence. That means no consulting fees, use
of corporate aircraft without reimbursement, support of
director-connected philanthropies, or other seductions.
In Enron's case, at least three so-called independent
board members would have been disqualified under this test of
independence.
Third, many accounting rules need to be updated to better
reflect changing business practices to give investors a better
understanding of the underlying health of companies. Because
the Financial Accounting Standards Board is funded and
overseen by accounting firms and their clients, its decisions
are agonizingly slow. This
well-meaning group must defend itself as well from
congressional pressure, which is often applied when powerful
constituents hope to undermine a rule that might hurt their
earnings. FASB's
funding should be secured not just through the accounting
firms and corporations, but also a number of market
participants – from the stock exchanges to banks to mutual
funds. And the
Financial Accounting Foundation, which chooses FASB’s
members, should be composed entirely of the best qualified
members – not merely those representing constituent
interests. The FASB should then be able to focus more on
getting the standards right, and avoiding delays and
compromises that ill serve investors.
Let me turn briefly to probably the most urgent area of
reform. Like no
other, the accounting profession has been handed an
invaluable, but fragile, franchise. From this Federal mandate to certify financial statements,
the profession has prospered greatly.
But as an edict for the public good, this franchise is
only as valuable as the public service it provides, and as
fragile as the public confidence that gives it life.
It's well past time to recognize that the accounting
profession's independence has been compromised.
Two years ago, the SEC proposed significant limits on
the types of consulting work an accounting firm could perform
for an audit client. An extraordinary amount of political
pressure was brought to bear on the Commission.
We ended up with the best possible solution – given
the realities of the time.
I would now urge – at a minimum -- that we go back and
reconsider some of the limits originally proposed – namely a
prohibition on the auditor designing or installing information
technology systems and performing the internal audit.
Auditors should also be barred from consulting on how
to structure transactions, such as the kinds of Special
Purpose Entities that Enron engaged in.
This type of work only serves to help management get
around the rules.
I also believe that the audit committee – not company
management – should pre-approve all other consulting
contracts with the audit firm.
Such approval should be granted rarely, and only when
the audit committee decides that a consulting contract is in
the shareholders' best interests. Lastly, I propose that
serious consideration be given to requiring companies to
change their audit firm – not just the partners -- every 5-7
years to ensure that fresh and skeptical eyes are always
looking at the numbers.
More than three decades ago, Leonard Spacek, a visionary
accounting industry leader, stated that the profession
couldn't "survive as a group, obtaining the confidence of
the public…unless as a profession we have a workable plan of
self-regulation." Yet,
all along the profession has resisted meaningful oversight. We
need a truly independent oversight body that has the power not
only to set the standards by which audits are performed, but
also to conduct timely investigations that cannot be deferred
for any reason and to discipline accountants.
And all of this needs to be done with public
accountability – not behind closed doors.
To preserve its integrity, this organization cannot be
funded, in any way, by the accounting profession.
The rise of the baby boom generation, changing retirement
patterns and markets that sometimes defied the laws of gravity
brought more and more first time investors into the markets.
These are our friends and neighbors, whose hopes and
aspirations became inextricably linked to the health and
resiliency of our markets. We assault those dreams if company executives sell out
shareholder faith and if those purporting to be independent
are anything but. Enron,
like every other financial failure before it, proves that
investors bear the ultimate cost.
It’s time to repair what has been lost.
Thank you very much. |