I am honored to appear before you this morning as I have done a number of times in the past: first back in the early 1970's as Chairman of an SEC landmark study of the effect of institutional investors on securities markets, later as Chairman of the Securities Industry Association and also as Co-Chairman of Goldman Sachs on various matters, still later as Deputy Secretary of State and again on one occasion as Chairman of the Federal Reserve Bank of New York. I appear today, however, as a former non-management director and audit committee chairman of more than a dozen public companies, not all of them, I assure you, at the same time.
I have always championed the importance of our securities markets and the competitive structure of the institutions that serve them. They are a national asset and an important part of our leadership position in the world economy. The confidence that investors have in the system must be protected at all costs. I have also championed the importance of diligent independent non-management directors who represent the stockholders effectively and the public interest.
The Enron disaster is a severe blot on the generally good record that the system has had over the years. Indeed, it is an embarrassment to those of us who have been involved in that system. It is still hard for me to believe that what was coming to be considered one of America's great companies could collapse so rapidly in such an ignominious way, with such huge losses to employees, to lenders, to stockholders, and to the reputations of everyone involved: the management, the board, the audit committee, the auditors, the bankers, the security analysts and the customers. It would seem to me that grounds for criticism exist in many places and that a thorough public review and investigation, including these hearings, is absolutely desirable and necessary. I am knowledgeable enough about the system, however, to be quite confident that most companies act responsibly and that there are not a lot of Enrons out there.
The only good result of the collapse is that it is causing companies now to look closely at their practices and at their disclosure policies, causing boards to review their attitudes, causing auditors to be more independent and more thorough, lenders to be more careful, security analysts to be more thorough, etc. I can assure the Committee that there is now a self-cleansing process going on out there which is very healthy. It might be fruitful for the hearings to begin to focus not only on what actually happened to Enron but on what the various institutions are doing now to keep it from happening again somewhere else. It may be wise to let this self-cleansing process go on for a while without being too precipitate with legislative action.
It is clear to me that there were many signs that a more alert or even a more curious board might have recognized as fair grounds for questioning. Certainly any request to the Board to waive the Board's ethics rules to exempt a transaction that otherwise would have violated them should have been enough to bring a lot of questions. However, the Committee should realize that it is very difficult these days to find and successfully recruit good board members. Many top experienced executives who would make excellent non-management directors feel that their hands are full handling their present job, that their lives are already too full of other responsibilities and that the doubtful prestige and unimportant extra compensation from taking on one or two outside directorships is not worth the increasing legal risks and the necessary time commitments. It would be a very unfortunate result of the Enron disaster if it became impossible now to recruit to board membership the kind of experienced, capable people that the system increasingly requires. The Committee should be careful about unnecessarily increasing the financial risks and the time commitments of non-management corporate directors.
Having said that, I do believe some things can and should be done now.
1. Having given the matter a lot of thought in recent years, particularly when I was Co-Chairman with Ira Millstein
(who testified before you a few weeks ago) of the Blue Ribbon Committee on Improving the Effectiveness of
Corporate Audit Committees, I have reached the conclusion that the accounting firm that does the audit should not do
other advisory work for the company. Without that, the independence of the auditor's work will always be suspect. I
reach that decision reluctantly but I don't see that it is possible now to restore public confidence in the independence of
the auditors without it. The auditing firms should understand that this certainly does not require them to spin off or
close down their advisory services. They would still be free to do advisory business with any company, excepting
those they audit. Thus for any one firm what business they lose to others could be offset by business that others would
lose to them, with no loss to the industry as a whole. As an alternative way of accomplishing the same purpose, it
might be worth considering whether the restriction might be placed on the company rather than on the auditors by
requiring that a public company should not employ their auditing firms for services other than the audit. It would be
preferable if this all could be accomplished by SEC action or action of the exchanges rather than by legislation. Of
course, it might be appropriate to except from the rule fees for minimal advisory business and in any case a reasonable
phase-out period should be allowed.
2. An unfortunate practice has developed in the relationships between management, auditors, and board audit
committees on the setting of auditor's fees. Fees are set annually by negotiation between management and the auditor
and then approved by the audit committee. Management's objective, as it is with all expenses, is to keep the fees as
low as possible. The auditor, at that stage, has no idea of how much time it will take, or how much extra work might
be required to complete the audit and is often pressured to accept a lower fee and agree to a shorter time schedule than
might be necessary in case questions arose. Audit committees often agree to the fee and the time schedule, unwilling
to question what seems reasonable in relation to last year. If the auditor later does find questionable practices, he may
have neither time nor money to pursue them under the terms of his agreement. A better practice would be to allow the
auditor, at his option, to do work and charge fees up to a limit of, say, twice the original fee. This would tend to make
management more aware of the authority of an independent auditor.
3. Over the years accounting rules, something like the income tax code, have become increasingly complex and
arcane with the result that in combination they can often obfuscate the simple facts and obscure full disclosure. Rules
that permit these results, such as hiding off-balance sheet debt, transactions with related parties, alternative accounting
for acquisitions, etc., evade the principle of full disclosure and undermine the foundation stone of our free market
system. The National Accounting Standards Board should be asked to review these matters promptly and recommend
appropriate changes in the interest of full disclosure.
4. Rules now require that the chairman of a public company's audit committee have considerable financial
background and experience. Those rules should be amended to require all members of the audit committee to have
such backgrounds. This will encourage the recruitment to the board of more experienced and qualified people and
recruitment to the audit committee those with the most financial experience.
5. Since the principal purpose of audits is to provide public information to investors and the financial community, I
believe the self-regulating authority of the SEC over the securities industry and the stock exchanges should be extended
to the auditing firms. This would be an important addition to the present self-inspection system of the auditing
companies. The authority of the SEC should also be extended to create a new self-regulatory entity charged with
drafting a voluntary code of best corporate governance practices linked to an SEC disclosure requirement. Companies
would then disclose whether they comply with the voluntary code, and explain areas of non-compliance.
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