Written Testimony Concerning
Accounting and Investor Protection Issues Raised by Enron and Other Public Companies

The third phase of our MD&A rulemaking will improve MD&A disclosures relating to trend information. We believe investors will be better able to see a company through management's eyes if MD&A includes information about the trends that a company's management follows and evaluates in making decisions about how to guide the company's business. This disclosure would in many cases entail certain forward-looking information. Thus, with the envisioned improvements in companies' financial trend disclosure, we will need to address lingering issues relating to when a company needs to update disclosure that is forward-looking and viable in the marketplace. With expanded disclosure obligations, we also are mindful of liability issues and the liability standards associated with new disclosures. Our goal is to assist investors by providing more meaningful and understandable information, but not to convert our disclosure system into an attractive nuisance for increased litigation.

1.1.2. Clarity and Accountability

In addition to these planned MD&A disclosure reforms, we have in mind two very different initiatives, both of which would improve the quality and utility of the corporate disclosure system. These are still in the conceptual planning stage.

First, we believe investors would benefit if companies could produce clear and concise financial statements. This would not be an initiative to "dumb down" or omit the complete picture that current financial statements are intended to provide. Rather, it would be an effort to give companies the flexibility to produce and disclose financial information in "layers" ranging from those with a general "big picture" focus to those that encompass the minutest detail, all of which would be readily accessible to investors electronically. This would permit investors to "drill down" to whatever layer they wish. The layers would allow companies to explain financial statement disclosure to investors in ways that are more clear, concise and understandable.

The second initiative is to improve the corporate disclosure system by increasing the CEO's individual accountability for his or her company's disclosure. As the President noted in his March 7^th speech on corporate ethics and disclosure,¹⁷ it is unacceptable for the CEO of a company to disclaim responsibility for, or deny awareness or understanding of, the financial disclosures that his or her company makes. We are committed to addressing and reinforcing that responsibility. Our vision is a rule that would require CEOs to certify to shareholders that any significant information of which the CEO is aware has been disclosed to shareholders, and that the disclosures made are not misleading, inaccurate or false. We believe this "sign on the dotted line" approach will focus CEOs' attention very acutely on responsibilities that already exist under current law. We are also considering rulemaking that would call for the establishment of procedures designed to bring significant information to the attention of top management.

1.2. More Timely Disclosure

In addition to improving MD&A and other initiatives to improve the quality of the corporate disclosure system, we also intend to take other steps to modernize and improve the timeliness of corporate disclosures. We are working on three sets of proposed rules that would do this.

1.2.1. Accelerated Annual and Quarterly Reports

We are considering proposing rules that would shorten the filing deadlines for annual reports from 90 to 60 days after a company's fiscal year end and would shorten the filing deadlines for quarterly reports from 45 to 30 days after a quarter's end. The current secondary market disclosure system under the Exchange Act requires companies to provide updated information to investors at annual and quarterly intervals, with a small number of specified significant events reported somewhat more timely. The SEC has not changed its annual and quarterly report deadlines for more than 30 years. Thirty years ago, companies still were dependent on paper and pencil, adding machines, carbon paper and the U.S. mails to prepare and file their reports with us. Significant technological advances in the intervening decades, including computers, remarkably quick and sophisticated financial and other software, speed-of-light communications, e-mail, video conferencing and the like, have enabled companies to capture, communicate and evaluate information and prepare their reports more rapidly.

The revolution in information technology and communications that allows companies to disseminate and collect information broadly and swiftly also has both increased investors' demand for, and provided the means for companies to supply, corporate disclosures on a more "real time" basis. Many public companies have adopted the practice of routinely issuing press releases to announce their annual and quarterly results significantly in advance of the due dates for their Exchange Act reports.¹⁸ This is concrete empirical evidence that a more rapid time line for corporate disclosures is feasible and achievable. For all of these reasons, it is long overdue for us to modernize our periodic reporting system by significantly shortening report deadlines. The Commission for years has recognized the critical need for such reform.¹⁹ We are committed to implementing those reforms.

1.2.2. More Accessible Filings

Today, the first and most obvious resource for many investors trying to find information about a company is through that company's website. We want to assure that investors can find companies' reports there. We therefore intend to move toward a system where public companies with Internet websites will post their periodic reports there no later than the same day they are obligated to file reports with the Commission.

1.2.3. Accelerated Disclosure of Corporate Insiders' Trading Activities

Under current law, corporate insiders are not required to file reports of their trading activities with the Commission until ten days after the end of the month in which the trading occurred.²⁰ Six years ago the Commission adopted a rule that allows insiders who sell their holdings back to their companies to postpone disclosure of those transactions for up to an additional year.²¹ Under current law, we cannot accelerate statutory reporting requirements applicable to insiders. But, we can and intend to impose obligations on companies to report immediately any transactions by corporate insiders, including those with the company. Legislation is currently pending that would amend Section 16 of the Exchange Act to require the reporting (by electronic media) of securities transactions by officers, directors or other affiliated persons of the issuer within a much shorter time frame (a business day or two). While there are practical issues to work through regarding electronic filing, the concept of requiring insiders to report their trades more expeditiously is unassailable. Legislation of this nature is worth consideration, but we do not think it is critical. We intend to act by rule in order to expedite the flow of this important information to the market.

1.2.4. More Current Disclosure

We also intend to solicit public comments soon on a significantly expanded list of items to be disclosed by companies between their current periodic reporting periods. In addition, we intend to accelerate the filing deadline for these disclosures. At present, only five corporate events trigger mandated intra-period disclosure on Form 8-K. These include a change in the company's independent auditor; resignation of a director; a change in control; the acquisition or disposition of a significant amount of assets not in the ordinary course of business; and bankruptcy or receivership.

The proposals being drafted would add approximately a dozen new significant events requiring companies to make expeditious Form 8-K filings. In addition to transactions by insiders in company securities, described above, companies would be required to report the following events on a current basis:

• changes in rating agency decisions about a company;

• defaults and other events that could trigger acceleration of direct or contingent obligations;

• transactions that result in material direct or contingent obligations not included in a prospectus filed by the company with the Commission;

• offerings of equity securities not included in a prospectus filed by the company with the Commission;

• waivers of corporate ethics and conduct rules for officers, directors and other key employees;

• material modifications to rights of security holders;

• departure of the company's CEO, CFO, COO or president;

• notices that reliance on a prior audit is no longer permissible, or that the auditor will not consent to use of its report in a Securities Act filing;

• definitive agreements that are material to the company;

• losses or gains of material customers or contracts;

• material write-offs, restructurings or impairments;

• movement or de-listing of the company's securities from an exchange or quotation system; and

• any material events, including the beginning and end of lock-out periods, regarding the company's employee benefit, retirement and stock ownership plans.

Under existing Form 8-K requirements, companies must file a Form 8-K within five business or 15 calendar days after the triggering event, depending on the nature of the event. Given the significance of these disclosures to participants in the secondary markets, we intend to propose that companies be required to file their Form 8-K reports no later than the second business day following occurrence of the events. We also will consider whether some of the events should be disclosed by the opening of business on the day after the occurrence of the event. The need for more current disclosure of a broader range of significant corporate activities is something the Commission recognized several years ago.²² We are committed to having companies provide better current information.

Over a longer term, we also will consider amendments to the basic framework of the reporting system to require public companies to disclose vital information on a "current" basis. We intend to formulate revisions to our rules that would impose a duty on companies quickly to disclose events that are unquestionably significant to investors. This would include, but not be limited to, the updating of the trend information that we envision adding to the MD&A disclosure requirements.

1.3. Corporate Governance Reforms

As discussed, there are a number of ways current corporate governance standards can be improved to strengthen the resolve of honest managers and the directors who oversee management's actions and make them more responsive to the public's expectations and interest. In considering these reforms, it is important to keep in mind that, traditionally, corporate governance issues and standards have been left to the states to develop and enforce. We do not recommend a change in that basic division of responsibilities between the states and the federal government. Nonetheless, because our markets are national and international, not solely intrastate, and because the consequences of a lack of meaningful and cohesive corporate governance reform are dramatic, we are devoting considerable attention to the ways in which our system can be improved. Other witnesses have raised similar concerns.²³ We support the "race to the top" of best practices on corporate governance.

To this end, last month we asked the New York Stock Exchange and Nasdaq to review their corporate governance and listing standards, including important issues of officer and director qualifications and codes of conduct of public companies. We also separately asked Financial Executives International to review its code of ethics in light of recent developments. Both the NYSE and Nasdaq responded quickly to our requests. Both have commenced reviews of existing requirements, and have appointed committees to assist that effort. We expect to receive results of their reviews shortly. And, this past Tuesday, FEI presented us with a series of recommendations, as well as revisions to its acclaimed code of ethics.²⁴

We also intend to implement the President's directive to us to require CEOs to certify their company's annual and quarterly filings in a meaningful way. As we envision this, we believe that CEOs should be able to attest to the fact that anything they consider important in running their companies has been disclosed to investors. In addition, the President called upon us to seek disgorgement from corporate officers and directors of compensation and bonuses predicated on corporate performance that turns out to have been illusory or fraudulent. In fact, on March 13, we filed an action seeking exactly such disgorgement from the former president and chief operating officer of IGI Inc. for violations of the antifraud, periodic reporting, record keeping, internal controls and lying to auditors provisions of the federal securities laws.²⁵ We intend to proceed similarly in other appropriate situations where principal corporate officers and directors can disgorge to investors and their companies unearned or undeserved bonuses, stock options and compensations.

1.4. Capital Raising Reforms

Finally, contemporaneous with this renewed focus on the corporate disclosure system, we will pursue our plan to implement long-needed reform in the regulations governing capital raising. Our capital markets need to be strengthened by revising many of the communications restrictions imposed under the Securities Act and its regulations and by modernizing the delivery system for information, including prospectuses. In addition, once the Commission truly has put in place a current disclosure system, it will then be both possible and appropriate to provide accelerated access to the public markets for seasoned reporting companies with the largest market capitalization.

These offering initiatives remain a priority and the work on them is well underway; they should go hand-in-hand with some of the other initiatives I have already mentioned. In prior years, the Commission recognized the need for this kind of reform, but did not implement these improvements.²⁶

1.5. Legislative Assistance

I have highlighted some of the items on the Commission's agenda for improving the quality and timeliness of corporate disclosures and modernizing the offering process. There are a few areas where we believe we need the assistance of Congress to implement fully some of the initiatives I have discussed, and to take other important steps in improving the integrity, quality and timeliness of the corporate disclosure system.

1.5.1. Additional Enforcement Tools

As noted, the President has called upon us to improve the system of personal accountability for corporate disclosures on the part of corporate officers and directors. The President also endorsed our need for administrative authority to bar officers and directors who seriously violate their duties to public shareholders. At present, the securities laws authorize us to seek officer and director bars in court in appropriate cases.²⁷ But some courts have taken an inhospitable approach to the plain legislative language, thwarting our ability to prevent some officers and directors who inflict serious harm on investors from repeating that kind of conduct.²⁸ We will continue to press for a more enlightened and hospitable reading of the statutory language, but we believe the Commission should have the ability, administratively, to effect such relief promptly, subject of course to subsequent judicial review of the Commission's action. We also think the Commission should have the authority to impose penalties in these instances. By removing existing judicial restraints, and by providing for judicial review of the Commission's imposition of such a sanction, you will be giving us a tool we need to address and deter corporate malfeasance and misfeasance - akin to our authority to do the same with brokerage firm personnel, stock exchange officers and directors and others, and akin to the authority of the banking regulators to bar future service by banking officers and directors. A recent edition of BusinessWeek reported that a significant majority of chief financial officers polled by Business Week and Financial Executives International favored harsher penalties for officers and directors who fail to discharge their duties properly.²⁹

In addition, as I noted during my confirmation hearings, the amount of recidivism in the securities field is alarming. We believe that both the Commission and the courts should be under an obligation to impose officer and director bars in any case of repeat fraudulent misconduct by officers and directors.

Another tool we seek to enable us to deal with recidivists is statutory flexibility for the Commission to seek civil contempt penalties for those who violate prior judicial or administrative sanctions and restrictions. The Commission believes that the Department of Justice also should be given the ability and the resources to pursue instances of criminal contempt, on its own or at the Commission's urging, with a simplified statutory test that will not bog these cases down in endless proceedings.

Under existing law, the civil liability provisions for violation of disclosure requirements include disgorgement of all gains, but for those without gains the maximum civil liability is $120,000 or the "gross amount of pecuniary gain" for each violation, even for fraudulent disclosure violations. We seek legislation that increases the sanctions for defective disclosure. Legislation was passed in 1984 to address the previously insufficient sanctions under the securities laws for insider trading.³⁰

A similar need exists today to increase the sanctions for violation of disclosure requirements without regard to trading. Investors can be harmed by disclosure that violates applicable requirements to the same degree, whether or not those responsible for the violations are trading. Since the purpose of these sanctions is to deter future misconduct, and redress past misconduct, looking at this problem from the vantage point of defrauded investors is the appropriate approach. While large monetary sanctions will not, by themselves, rid us of misconduct, they will give all those involved in our capital markets a greater incentive to abide by the statutes and rules administered by the SEC.

1.5.2. Increased Emergency Powers

On November 13, 2001, the House of Representatives passed H.R. 3060, the Emergency Securities Response Act of 2001, to augment the emergency authority of the SEC by revising Section 12(k) of the Exchange Act, to allow emergency powers for 30 business days. We had found, in the wake of the business repercussions from the significant damage and loss of life inflicted on lower Manhattan following the horrific events of September 11^th, that the existing provision of 10 business days was not sufficient. I commend this legislation to the Committee's attention and ask for your support to present such legislation to the Senate.

1.5.3. Increased Shareholder Powers over Option Plans

To ensure that shareholders are both aware of, and have some right to evaluate, the proposed issuance of securities of a public company to its officers and directors, we believe all national securities exchanges and national securities associations should adopt listing rules in the next 6 months that require companies to seek shareholder approval for plans that allow corporate officers or directors to acquire company securities. We intend to ask the exchanges and associations to implement such proposals, and we believe, based upon our excellent working relationships with them, that they will do so, but we would like to make this a matter of law, rather than a matter of choice.

1.5.4. More Timely Access to Reports

To ensure the greatest degree of investor access to corporate disclosure, we seek clear authority to require public companies to maintain corporate websites, and to post corporate disclosures and other documents on their websites. While we believe that we can effect this result, clearer authority would move us quickly and easily to the desired result whereby all corporations recognize that the time has come for them to understand that constant and immediate communications with shareholders are essential.

Also, to ensure the ability of the Commission to modernize the delivery of corporate information, the Commission needs unambiguous authority to permit delivery of corporate disclosure through electronic means subject to such conditions as the Commission requires for the protection of investors.

1.5.5. Private Securities Litigation

Even though more must be done to minimize the likelihood that future Enrons can occur, it is also important to recognize that there is neither enough money, nor people, to prevent hucksters from defrauding innocent investors. The SEC has a critical role to play in protecting investors. But, private litigation, when properly formulated, is a very necessary supplement to the SEC's mission. To be effective, however, private litigation must be designed to help investors, not their lawyers. Though not a principal focus of concern, some have suggested that the Private Securities Litigation Reform Act of 1995 (P.L. 104-67) is somehow responsible for, or contributed to, the collapse of Enron, and that reforms, or even outright repeal of the Act, are warranted.³¹ Because this Committee took the lead in promoting the PSLRA, we think it appropriate to express the Commission's position with respect to these issues surrounding the PSLRA.

The PSLRA was the subject of, literally, years of debate and consideration by the Congress. In 1995, after numerous hearings, exchanges with the Commission, and debate, the bill was initially approved by a vote of 320 to 102 (with one abstention) in the House of Representatives, and by a vote of 65 to 30 in the Senate. After President Clinton vetoed the bill, the Congress moved to override the President's veto message, voting 319 to 100 (with one abstention) in the House, and 68 to 30 in the Senate, after which the bill automatically became law.

Just prior to Congress' consideration of the bill, then-Commission Chairman Levitt wrote to then-Senate Banking Committee Chairman D'Amato on November 15, 1995, on behalf of the Commission:

At the outset, let us express our appreciation for your willingness to heed the concerns of the Commission . . . [W]e believe the [current] draft . . . responds to our principal concerns. We understand the need for a greater flow of useful information to investors and the markets and we share your desire to protect companies and their shareholders from the costs of frivolous litigation.³²

Since the enactment of the PSLRA, the dollar amount of class action awards and settlements have increased substantially, while the number of issuers sued has not changed significantly.³³ In addition, by requiring courts to consider who the plaintiffs should be in any class action, one intended beneficial result of the PSLRA is that larger, and more thoughtful, institutional plaintiffs have become more involved in the shareholder litigation process, rejecting cases that are frivolous, but pursuing vigorously those cases that reflect serious misconduct. We should all be alert to possible unintended consequences that may arise from any legislative enactment; but, in the absence of any empirical data suggesting a nexus between the PSLRA and situations like Enron, we strongly urge the Committee to refrain from making any changes in that legislation.

2. Accounting Reforms

2.1 The Public Accountability Board

The number of sudden and dramatic reversals of public companies' financial conditions has called into question the regulatory system currently used to oversee the quality of the audits of financial statements that are filed with the Commission and relied on by investors. In particular, it appears that the current system of firm-on-firm peer reviews, overseen by a Public Oversight Board that lacks the power to direct the conduct of those reviews or to discipline auditors for unethical or incompetent conduct, has not produced a credible result. The current system does not provide investors with sufficient confidence in the efficacy of the audit process.

We are proposing "private sector" regulation, not "self" regulation. Self-regulation implies that the accounting profession would regulate itself. We are suggesting regulation by the private sector, but not by the profession. Rather than a body that functions under the aegis of the American Institute of Certified Public Accountants, which represents the accounting profession, the Commission announced on January 17^th our intention to create a new, private sector, independent body that can direct periodic reviews of accounting firms' quality controls for their accounting and auditing practices and discipline auditors for incompetent and unethical conduct. We believe there is substantial consensus on this approach.

This private sector body would supplement our enforcement efforts, by adding a layer, or tier, of new regulation. There should be no misunderstanding. In the first instance, we, and our Division of Enforcement, will continue vigorously to investigate and pursue instances of illegal conduct. The SEC has had a successful history with two-tier regulation that involves the private sector. Such two-tier regulation has been largely successful with the brokerage industry. Private regulation presents major advantages, in terms of available resources, quality control and discipline. The SEC is best suited to bring actions for civil violations of law - fraud and such. Private regulation can govern conduct that may not be unlawful, but reflects ethical lapses or deficiencies in competence. It allows quality control that is more flexible, but also more effective. And discipline can be applied more quickly and therefore more effectively. The accounting profession and the investing public both would benefit from such an approach.

In order to understand how the Commission's proposal regarding oversight of the accounting profession is a substantial improvement over the present system, it is important to understand what has been misunderstood by many who have commented on this issue - the structure of the AICPA's Public Oversight Board. The POB was created by the AICPA in 1977 and charged with overseeing and reporting on the programs of the AICPA's SEC Practice Section (SECPS), created that same year. The SECPS is comprised of accounting firms that audit the financial statements of public companies, and establishes quality control requirements for those firms. While intended to be autonomous (the POB could set its own budget, establish its own operating procedures, and appoint its own members, chairperson, and staff), the POB relied on voluntary dues paid by SECPS members for its funding. In addition, the POB lacked the ability to organize and implement its own quality control reviews. And, the POB was not given disciplinary authority. All of these deficiencies will be remedied in the private-sector regulatory regime we have proposed.

Another issue receiving a great deal of attention is whether legislation is needed to implement our proposed private sector regulatory body. First, it is critical to separate the regulatory model from the issue of whether there is a need for legislation. We think there is substantial agreement on the model we have proposed, and that is the first step in moving toward a more effective regulatory system. Legislation is not required to establish private sector regulation with SEC oversight. If Congress determines that legislation is appropriate, however, we are committed to assist that process. Whether or not Congress acts, it is incumbent for the SEC to move forward with the most responsible proposal it can.

The new body we suggest, which we refer to as the Public Accountability Board or PAB, must have certain attributes, and its mission must be based on certain immutable principles.

2.1.1 Private Sector Regulation

Today, we are even more convinced than we were when we initially proposed the PAB in January that there must be private sector, not self, regulation of the profession in the areas of discipline and quality control. The AICPA's Public Oversight Board has not been as effective as it could have been, and the disciplinary process has not been sufficiently swift or transparent. There is near total consensus on this point. Indeed, the AICPA and the major accounting firms have recognized this is a needed change to restore public confidence.

This new entity is a means to assure that accountants conform not merely to the law, but to the highest ethical and competence standards as well. In the details of our proposal that follow, such as an assured source of funding, and a required super-majority (at least) of public board members unaffiliated with the accounting profession, our guiding principle was to avoid the shortcomings of the current system, and to learn from those shortcomings. The POB was a good idea a quarter century ago, but it does not meet the needs of today.

2.1.2. Predominately Public Membership of the Board

For the same reason that we believe that public oversight, rather than self regulation, is needed to restore faith in the accounting profession, we believe that it must be clear that the PAB places the public interest and the interest of investors above all else. This means that representatives of the public must be in the position to make all significant calls on quality control and disciplinary issues. At its core, we believe the board should be composed predominantly of independent public members, unaffiliated with the accounting profession. This would help ensure oversight of the accounting profession that is free from undue influence from the accounting profession. In the Roundtables we have held so far, there has been general agreement that our proposed composition of the board - predominantly public members, not from accounting firms - was appropriate. During this Committee's recent hearings, virtually every witness endorsed the notion of a new regulatory structure of the kind we are proposing.

At the same time, we believe the public will benefit if the PAB also includes a small minority of members from the accounting profession. They bring necessary expertise and an understanding of current accounting issues. We think it ill advised to exclude them completely. As we consider reforms for oversight of the accounting profession, we need to take into account the likely effects of new initiatives - intended and unintended. If those with expertise are excluded from providing any oversight of their own profession, the PAB is likely to devolve into a board known more for its lack of understanding of issues than for its vigorous oversight. If we had to construct a board to oversee the structural integrity of a bridge, we would not exclude bridge builders or engineers. Having a small minority of members who are affiliated with the accounting profession will assure necessary expertise.

In order to obtain independence without sacrificing expertise, we believe that the PAB should be composed of public members and members associated with the accounting profession. Whether the board has a two-thirds majority of public members or three-quarters or some other super majority is an important detail, but should not detract from the underlying principle that the board must be independent, and must function independently.

To assure the quality and independence of the members, the selection of the initial group of PAB members, and the appointment of a chairperson (who should be a public member), should be made by the Commission. After the appointment of the initial members through a selection process directed by the SEC, the PAB itself should have the responsibility of choosing new members, and new chairpersons, to replace those who depart. Those selections should be subject to Commission approval. The PAB chairperson should always be selected from among the public members. The PAB should meet frequently, as distinguished from the current Public Oversight Board, and all of its members should be required to devote substantial time to the PAB and directly manage the entity.

The PAB appointment process should operate solely under the aegis of the SEC. The Commission has statutory authority to set accounting principles.³⁴ We have direct oversight responsibility for the quality of financial reporting, including enforcement powers. We recognize some witnesses and some legislative proposals would include other government officials, such as the Secretary of the Treasury, the Chairman of the Federal Reserve Board or the Comptroller General, in the selection process on an ongoing basis. We think this involvement by additional government officials with no direct responsibility for the governance of the accounting profession could dilute clear lines of oversight responsibility and unnecessarily complicate the selection process. In addition, we believe that the Commission, as an independent agency, should be protected from the appearance of pressure from other government sectors and agencies.

2.1.3. Diverse, Involuntary and Independent Funding

One of the most important steps to restore public confidence in the discipline and quality control of the accounting profession is to assure a funding source that is secure and independent. If all funding comes from the accounting profession, and voluntarily at that, as was the case with the POB, the PAB could operate under a cloud in the public's opinion. Well meaning legislative reform proposals that keep the funding source solely from the accounting profession are not as viable as those that spread the funding burden to all users of financial statements. We see funding coming from a variety of sources. First, membership in the PAB should be mandatory, in which case the PAB would be able to impose membership fees on accounting firms and their members. But, more importantly, additional funding should come from issuers whose financial statements are filed with the SEC and certified by independent public accountant members of the PAB. We believe, in contrast to a POB that is wholly dependent on voluntary funding from the accounting profession, the involuntary, broad-based funding from all users of audit services would protect the PAB from even the appearance of undue influence. We believe we have the authority under existing law to implement our funding concepts for the PAB.

2.1.4. Mandatory Membership

No matter how well conceived, the PAB will be effective only if all accountants, as well as all accounting firms, that audit public companies are required to abide by its directives. An auditor should not be able to circumvent the quality control and disciplinary mechanisms of the PAB simply by declining to register with the PAB. Therefore, we propose that membership in, and being subject to the PAB's processes, must be a prerequisite to an auditor's ability to supply audit opinions on which a registrant may rely to satisfy its filing obligations under the securities laws. We propose to implement this requirement by making membership in the PAB a condition for certifying financial statements, as required under our Regulation S-X.³⁵

Remaining in good standing with the PAB must also be a prerequisite to the ability to continue to audit the financial statements of public companies. As discussed in more detail below, PAB discipline, and the possibility of that discipline, must be meaningful, and to be meaningful, the failure to be in good standing with the PAB (reflected in a PAB-imposed suspension or revocation of registration, or limitation of functions) must have significant consequences.

2.1.5. Improved Quality Control Reviews

While individuals within accounting firms generally take firm-on-firm peer reviews seriously, investors and critics of the program often consider it to be a "one hand washes the other" approach to regulation.

To avoid this perception, we believe that quality control reviews should be directed and principally conducted by PAB staff, and PAB staff should make all key decisions during the conduct of the reviews. The PAB should be sufficiently staffed to carry out this responsibility, although it should be feasible for the PAB to draw upon professional personnel from the profession to assist in the reviews, as long as any such personnel are subject exclusively to PAB direction.

The PAB should promulgate standards for its quality control review process. It should publish those standards for public comment, and the standards ultimately adopted must be subject to Commission approval. The current system provides for reviews only every three years, which we believe is insufficient. Therefore, along with promulgating review standards, the PAB should determine how frequently to conduct routine reviews and should determine what events or circumstances will trigger non-routine reviews. The firms that audit the vast majority of public companies should be reviewed annually.

While we believe that the Auditing Standards Board (ASB), the entity tasked with promulgating quality control standards for audits, has performed that task well, we expect that the PAB, through its work in conducting quality control reviews, will be well positioned to make very useful recommendations about those standards. We therefore believe that the PAB's mission must include the expectation that it will, as it deems appropriate, influence the agenda of the ASB and make public recommendations about quality control standards. We also believe that the ASB should have a formal mechanism for considering, and obtaining public comment on, those agenda items and recommendations.

Many commentators, and prior witnesses before this Committee, have offered suggestions on the structure of the accounting firms themselves, and how these firms could change their internal governance structure to better reflect the public interest needs. Improving risk management, improving internal controls over audit quality, enhancing the supervision of the audit process are all laudable goals. We believe many of these issues, as they reflect competency and ethical standards, could be addressed more quickly and effectively by the PAB.

Similarly, calls for a statutory imposition of an affirmative duty of supervision of audit personnel, similar to the supervisory duties that arise from the defense available under the Federal securities laws to broker dealers, may overshoot the mark.³⁶ The Commission already looks up the chain of command on any defective audit, when seeking to enforce the law, and we are concerned that a statutory provision may limit, rather than expand, the potential reach of the existing proscriptions.

Finally, ideas concerning the restructuring of the governance of the audit firm, requiring public members, or a majority of public members, or an independent oversight board, such as that adopted by the Andersen firm and chaired by Paul Volcker, are interesting and productive suggestions, but may be best left to individual firm consideration. The market has a large appetite for improved audit governance, and enhancements in this area should be supported by the SEC, but not mandated. We should encourage a "race to the top" in the adoption of best practices, but should be careful not to impose a one-size-fits-all solution.

2.1.6. Disciplinary Powers

The SEC has long had power to discipline accountants for failing to meet their professional standards of conduct. Rule 102(e) currently embodies that authority. The PAB should have parallel authority, such that the SEC could refer cases to it, and could take back investigations from it, at any time. This is similar to the current enforcement relationship the Commission has with NASDR and the NYSE.

Principal criticisms of the current system are that it takes too long to discipline an errant accountant, and that the sanction is not sufficient. Through mandatory membership of both firms and individual accountants in the PAB, the PAB could remove the accountant or the firm from practice before the SEC. If individual and firm membership in the PAB is a prerequisite to conducting audits of public companies, the temporary or permanent removal of an accountant or firm from the PAB's membership would operate to prevent the accountant or firm from practicing before the Commission. Additional remedies, such as limitations on the firm taking on new business, or specific quality control changes and other undertakings, should also be the subjects of PAB authority. The PAB would be required to take immediate action on any matter referred to it from the SEC. The public members of the PAB would oversee that immediate inquiry, and the public members would determine the sanctions. A further sanction would allow the PAB to require the rotation of auditors, that is, to force a public company to obtain a new firm, in light of the misconduct found on the part of the present auditor. This sanction we view as more meaningful than the wholesale call of some for automatic rotation of auditors, without any showing that there was misconduct, or a need for such rotation.

A further concern about private sector regulation is the lack of authority to compel production of documents and testimony. Due to the required membership in the PAB for both firms and individuals, and supplemented through contractual requirements with any issuer using financial statements prepared by a PAB member, we believe the PAB could conduct rapid inquiries, with the right to revoke or suspend for a time the registration of any member firm or individual, thus providing the clout necessary to get discovery of the facts in any investigation. This could work as effectively as if the PAB had subpoena power. In fact, the SROs regulating the brokerage community do not possess subpoena power, but through the available sanction of throwing the broker out of the business can nonetheless effectively compel cooperation in investigations. Moreover, we believe that, in cases in which the PAB was denied certain information, the Commission could assume responsibility for a particular accounting enforcement matter, and use its own subpoena enforcement authority to make sure that a full record is developed.

Persons subject to PAB disciplinary decisions should be able to obtain meaningful review of those decisions. The PAB should routinely and promptly transmit its disciplinary decisions to the Commission, and those decisions should be reviewable by the Commission either at the request of the disciplined person or on the Commission's own initiative. That review process would, of course, be public. These procedures could all be implemented under the Commission's existing statutory authority.

2.1.7. Commission Oversight

Although the Commission's relationship with the POB was based on the desire to assure Congress and the public that the peer review process and related programs were working well, the Commission had limited ability to affect the work of the POB or the peer review program.

For the PAB to be credible, the Commission must have a direct role in the operation of the PAB's regulatory programs by exercising effective and rigorous oversight of its membership, rules and activities. In addition, in order to promote an understanding of its processes and to inform the public of the results of its programs and proceedings, the PAB should be required to issue periodic reports.

2.1.8. Method of Formation

We believe we must act quickly to restore faith in the accounting profession and our markets that rely on it. The Commission can, through its existing authority, effectively establish a PAB with all of the attributes described above quickly. In our Roundtables regarding the proposed PAB structure, all panelists seemed to agree that integrity and competence of auditors was crucial, and that these characteristics likely cannot be legislated into existence.

We view authority for the PAB to flow from our authority to determine the nature of financial statements filed with the Commission, and the nature of the certification required on those financial statements. Just as the independence requirements of the SEC flow from its ability to define the term "independent" as used in the securities laws, so, too, do the competency and ethics requirements of Rule 102(e), and indirectly of the PAB, flow from the Commission's authority to determine the nature of the filings made to it. The Commission's authority to create an administrative disciplinary system, presently embodied in Rule 102(e) has already been judicially recognized.³⁷

2.2. Auditor Independence Requirements

There has been considerable debate concerning what, if any, changes to the Commission's auditor independence rules are necessary to restore investors' confidence in the integrity of the audit process. The Commission's current rules on auditor independence were adopted less than 18 months ago, and were targeted to address problems about which there had been considerable study, discussion and debate. The Commission's approach at that time should be tested by practical application, over a reasonable period of time. If problems are empirically shown to exist in this area, any needed reforms can be tailored to address the precise problems uncovered. Some of the restrictions on non-audit services adopted in those auditor independence rules have not yet even taken effect, due to the rules' phase-in provisions. With this in mind, we are considering these matters carefully, in light of the rules adopted previously by the Commission, the additional evidence before us, and legislative proposals that have already been made.

Most Roundtable panelists expressed the view that critical independence issues occur in the relationship between engagement personnel and the audit client. Audit firms must play an important role by ensuring that audit teams adhere to the highest standards of auditing, including their independence. By focusing independence concerns on those who perform the audit, in the first instance, we can resolve the real issues confronting the profession. An individual audit partner whose income increases even by relatively modest sums of money from cross-selling consulting services may lose proper perspective in resolving difficult accounting issues. To be effective, independence restrictions must deal with both levels of concern - first, the engagement auditors should be precluded from receiving any compensation for cross-selling any non-audit related services to an audit client. Second, firms must be incentivized to ensure that every audit meets the highest standards of the profession, and must be subject to meaningful sanctions where audits are not performed at those levels.

This is the analysis reflected in an AICPA policy paper I helped prepare in 1997 for submission to the then newly-created Independence Standards Board, a body formed in by the SEC and AICPA to address independence issues in the profession.³⁸ In recent years, independence reforms have primarily focused on the independence of the firm. Narrow rules focused mainly on this area can give investors and members of Congress the false sense that the problems that gave rise to Enron's collapse effectively have been eliminated. The Commission's responsibilities do not permit us to accept simple solutions for complicated issues. In the area of independence, we must move to a system that recognizes that true independence lies not only with the firm, but also with the engagement team, and any conflict, external or internal, that might impair the team's independence, must be addressed.

Some have suggested firewalls as a means to separate the financial and personal aspects of the consulting engagement from those who perform the audit. In its recent rulemaking the Commission did not require that auditors and their audit clients forsake all non-audit service arrangements; those of us currently on the Commission do not believe that it is necessary to propose such a ban at this time. Information gained through consulting engagements may be useful in performing an audit. In fact, auditing literature requires auditors to ask firm personnel who have provided consulting or other services to the client if they have any information that would be relevant or useful during the audit.³⁹

The Commission's existing independence requirements provide a conceptual framework to be applied to any proposed non-audit service to determine whether that service is inconsistent with independence. We believe this framework, adopted in late 2000, will, over time, serve investors better than would a blanket ban on the receipt of non-audit services from the auditor that certifies the financial statement. Indeed, that was the precise reason that former Chairman Levitt, in endorsing the existing rules as they had been revised, claimed that they were better than an absolute ban.⁴⁰

It is useful to recall that there were large audit failures before accounting firms had any significant consulting business.⁴¹ It should be apparent, therefore, that merely mandating the separation of consulting from auditing - to create an "audit only" firm - does not guarantee an "audit failure free" future. And, there are costs to be weighed. An "audit only" firm might lack certain expertise, especially if tax consulting were eliminated, necessary to perform high quality audits. An "audit only" firm would be more dependent, not less, on their audit clients, and a single, large audit client could exert far more influence on such a firm than is the case with firms that have multiple sources of revenues.

We believe that limiting those services that create an inherent conflict with auditing, barring inappropriate compensation mechanisms (such as compensation for cross-selling services) and penalizing firms whose aggregate and individual audit performance is substandard (most likely by limiting the ability to take on new clients for significant periods of time and compelling termination of client relationships) are more likely to prevent audit failures than the suggestion that we increase the reliance of all audit firms on their audit clients. We believe it is appropriate to pursue, and we intend to pursue, the following changes in this area.

2.2.1. Change of Auditors

As discussed above, allowing the PAB to exercise judgment, subject to prompt Commission review, to direct auditors to step down from an engagement could address risks that auditors that have worked with a client for a number of years may become either complacent or too dependent on the audit client.

Some have suggested the possibility of requiring that public companies replace their auditors after a specified number of years. The Commission believes that this approach, often referred to as "mandatory rotation," would be unwise. Studies over the last three decades suggest that the number of financial frauds in the first years of a new auditor's engagement is unacceptably high.⁴² Mandatory periodic rotation of firms also could lead to "opinion shopping" in the decision on which new firm to select. Another concern is the unique strengths particular audit firms bring to clients in certain industries. Large accounting firms are not fungible; one firm is not identical to another, and there can be valid market-driven reasons, such as expertise in a certain industry, for selecting and retaining one firm over others. This freedom of choice should lie with the corporation; it should not be a government-imposed mandate or a decision delegated to the stock exchanges.

Required rotation of the lead audit engagement partner (every seven years) could be reviewed by the PAB to determine whether a deeper rotational requirement, affecting more members of the audit team, would be advantageous. This is an area where it may be useful for the PAB, over time, to evaluate different quality control approaches to the issue and eventually make appropriate recommendations.

2.2.2. Compensation for Cross-Selling

Because the engagement partner learns a great deal about a company during the audit process, he or she might be in the best position to suggest services that a company needs and help the company find credible people to provide those services. Some firms provide additional compensation to audit engagement partners who sell non-audit services to audit clients. The Commission believes that such compensation practices could cause serious conflicts and should be stopped.

2.2.3. Undue Influence by Clients

As discussed above, conflicts can occur if an auditor becomes overly dependent on a client, even if there is no cross-selling of services. For example, over the years the argument has been made that, since the company hires the auditor and pays the auditor's fee, the auditor can never be really independent from management. But the proposals that attempt to address this issue offer a cure that is worse than the disease. For example, there have been suggestions that the exchanges select the auditors of listed companies' financial statements. Significant practical difficulties would impede implementation of this suggestion. As discussed above, there may be very legitimate business reasons for management to prefer one auditor to others. It may be beyond the exchanges' current expertise to chose auditors, negotiate a reasonable fee, evaluate the auditor's performance, or determine if a complaint by the company about an auditor was legitimate or was made because the auditor was taking tough positions on accounting and auditing issues.

There has also been a concern that engagement partners would subordinate their judgment to that of the client merely to retain the business. Firms uniformly have required consultation and review procedures to assure that engagement partners are not compromised. We would strengthen these protections by calling on audit committees to provide the necessary counter-weight to management to avoid inappropriate pressure of the accounting firm.

Finally, some have suggested that there should be either a ban on auditors going to work for audit clients or a "cooling off" period ranging from one to five years between the time the individual provided any services for the audit client and the time that he or she becomes an employee of that client. As a general matter, especially for smaller companies that have more limited options for hiring seasoned accounting personnel, this could work a serious hardship. The Commission rule adopted in 2000 provides that if a person takes on "an accounting role or financial reporting oversight role" at an audit client, then independence is impaired unless he or she does not influence the accounting firm's operations or financial policies, has no capital account at the firm, and has no financial arrangements with the firm other than a fully funded retirement plan that pays a fixed dollar amount (which is not dependent on the firm's revenues or earnings). Again, this is a rule that we believe should be evaluated after it has been given time to work. The first place we would look is to provide additional comfort against risks to independence is the audit committee. Certainly audit committees should closely examine and approve any decision to employ individuals that have provided audit services to the company.

2.3. Accounting Standard-Setting

While the SEC has statutory authority to establish financial accounting and reporting standards for publicly-held companies, for over 60 years the Commission historically has looked to the private sector to provide the initiative in establishing and improving accounting principles.⁴³ The high quality of our accounting standards and our capital markets can be attributed in large part to the private sector standards-setting process, as overseen by the SEC.

Since 1973, the Financial Accounting Standards Board (FASB) has been the designated organization in the private sector for establishing standards of financial accounting and reporting. The FASB was designed to be an independent body, insulated from political pressure, to provide it with the opportunity to focus on creating neutral accounting standards that are transparent to the underlying economics. An oversight body appoints the members of FASB. This oversight body, the Financial Accounting Foundation (FAF), is composed of investors, business people, and accountants. The FASB's standards are designated as the primary level of generally accepted accounting principles (GAAP), which is the framework for accounting. The interpretative body of FASB, the Emerging Issues Task Force (EITF), meets every other month to provide interpretative guidance, or develop new guidance, on narrow, new or emerging issues that arise under existing GAAP and when GAAP does not exist.

The secondary standard setter is the Accounting Standards Executive Committee (AcSEC), which provides guidance in the form of Statements of Position (SOPs), subject to the affirmative concurrence by FASB at every step in the process. The principal purpose of AcSEC, which is a committee of the AICPA, is to develop standards for specialized industries.

Some have opined that the public interest at stake in establishing accounting standards is too important for that function to be left to a nonpublic body not responsible to Congress. Those who make this suggestion apparently have lost confidence in FASB's processes. However, we believe that the accounting standard-setting function should remain in the private sector. When done properly, standard setting in the private sector is the best option for our capital markets as it provides a number of advantages over federalized standard setting. Private sector standard setting has greater flexibility to complete rules more quickly than accounting standards set by the government.

Federalization of the FASB not only would require substantial increases to the federal budget, but also might disenfranchise those who are best qualified to address the highly complex business and accounting issues that must be resolved. The FASB is composed almost entirely of accounting experts and has a greater ability to attract and retain qualified personnel. Similarly, AcSEC and the EITF are composed of members with accounting expertise.

Moreover, Government agencies may be more susceptible to political pressure than private bodies. This political pressure could result in the development of accounting standards that are not solely designed to meet the needs of those who use financial statements in economic decisions. For example, many question whether the FASB's proposal to expense stock compensation would have been better for investors. This concept was set forth in 1994, when it was the sense of the Senate that FASB's private sector nature should be respected and safeguarded and that Congress should not impair the objectivity or integrity of FASB's decision making process by legislating accounting rules. We believe the concept remains sound today.

We do believe, however, that FASB's processes can and must be improved. In fact, even before Enron's collapse, we recognized that FASB needed to address concerns about timeliness, transparency, and complexity, and we asked FASB to address these concerns. The markets and investors simply cannot wait a decade or more for standards regarding such important matters as revenue recognition and consolidation of special purpose entities. Moreover, the work of the standard setters must result in standards that ensure illumination and not obfuscation in financial reporting.

From the beginning of my tenure as Chairman, I have recognized that the SEC historically had abdicated too much of its obligation to ensure that accounting standards meet the objectives of the federal securities laws. The SEC consequently plans to take a more active role than it has in the last decade to ensure that standards are implemented and benefit our markets and investors. I believe that with strengthened Commission leadership and cooperation by FASB, FASB can be effective, and confidence in the process can be restored. Private-sector standard setting can work in our current business environment, even as financial transactions become more complex.

As discussed in more detail below, we plan to use our existing statutory authority to oversee the standard-setting process to ensure that it functions in the best interest of investors, including by: (i) broadening funding sources to decrease FASB's dependence on revenues from the accounting profession; (ii) providing SEC input to the selection of projects on FASB's agenda; and (iii) ensuring that FASB's standards evolve to become general principle-based standards instead of overly complex, rule-based standards.

2.3.1. Involuntary funding for the private-sector standard setter

Currently, the Financial Accounting Foundation (FAF) is responsible for selecting the members of FASB and its Advisory Council, funding their activities, and exercising general oversight. FAF receives contributions to fund FASB and approves FASB's budget. To enhance FASB's independence, we believe that its funding source should be more secure and should strengthen both the reality and the appearance of independence. Funding should be made involuntary. This funding change will help to ensure that FASB continues to be independent so that it can continue to be objective in its decision-making and to ensure the neutrality of information resulting from its standards. We also believe that the Commission must have a direct role in the selection and approval of the members of FASB.

2.3.2. FASB's Agenda

FASB at times has operated too slowly to be responsive to changes in the market place. For example, while FASB's Emerging Issues Task Force (EITF) has provided limited guidance on unique issues related to special purpose entities, FASB has been working on its overall consolidation project, which includes the consolidation of special purpose entities, for many years.

In addition, FASB has not always added critical or significant projects to its agenda on a timely basis. For example, revenue recognition is usually the largest single item in financial statements; studies indicate that it is the single largest category of financial statement restatements, and our recent experience with actions brought by our Division of Enforcement involving financial statements indicate this is the core issue in over 50% of our actions. While certain narrow industry specific guidance exists, it was only on January 28, 2002, twenty-seven years after its inception, that FASB issued for public comment a proposal to broadly address revenue recognition. Because there is no general standard on revenue recognition, issues involving revenue recognition are among the most important and the most difficult that accountants face. A final revenue recognition accounting standard could take several years to complete without a fundamental change to FASB's current processes.

The SEC plans to work with FASB to develop a mechanism that will ensure that each project on its agenda is completed on a timely basis. Moreover, FASB must ensure that its agenda is responsive to those issues facing investors and accountants. To help achieve that goal, the SEC will provide more input to the selection of projects to FASB's agenda, and direct FASB to address promptly priority items.

In addition, we will actively oversee the standard-setting process to ensure that it functions in the best interest of investors. The SEC has exercised, and should exercise, its authority over the accounting standards it will accept for filings made with the agency. We should not use this power indiscriminately; it should be reserved for those exceptional situations where the public interest demands it. The reason for this approach by the SEC is clear: FASB has acted in the public interest and has brought a level of sophistication and professionalism to the accounting standard setting process that we should not heedlessly shunt aside.

2.3.3. Principle-Based Standards

Much of FASB's recent guidance has become rule-driven and complex. The areas of derivatives and securitizations are examples. This emphasis on detailed rules instead of broad principles has contributed to delays in issuing timely guidance. Additionally, because the standards are developed based on rules, and not on broad principles, they are insufficiently flexible to accommodate future developments in the marketplace. This has resulted in accounting for unanticipated transactions that is less transparent and less consistent with the basic underlying principles that should apply.⁴⁴ The development of rule-based accounting standards has resulted in the employment of financial engineering techniques designed solely to achieve accounting objectives rather than to achieve economic objectives.

The SEC believes that FASB's standards, at least going forward, should evolve to become general and principle-based, instead of encyclopedic and rule-based, standards. While principle-based standards can also be subject to abuse, and some level of standardization is necessary for comparability and verifiability, we believe that principle-based standards in general are better suited to the sort of rapidly changing financial landscape in which many companies operate. Moreover, the abuses should be minimized if our other suggestions are adopted, especially those regarding emphasis on overall accuracy and completeness of financial reporting and other disclosures, rather than disclosure based merely on compliance with specific rules. Of course, FASB and the SEC should continue to provide appropriate specification where the circumstances require and should use professional groups, like the EITF, to fill in the interstices of broad principles-based pronouncements.

SEC FUNDING NEEDS

Let me conclude with a point that may be last but is certainly not least. We need legislative assistance in increasing our funding for both this and subsequent fiscal years. The SEC regulates industries and markets that have grown enormously, in both size and complexity. The Commission currently oversees an estimated 8,000 brokerage firms employing nearly 700,000 brokers; 7,500 investment advisers with approximately $20 trillion in assets under management; 34,000 investment company portfolios; and over 17,000 reporting companies.

The President's budget for fiscal 2003 requested an appropriation of $466.9 million for the Commission, an appropriation that I supported when it was first formulated. But, since the time that appropriation was formulated, pay parity legislation has passed, and the Commission has had to respond to three crises. As a result of those recent events, we critically need additional funds to enable us to phase-in a modest pay parity plan. We also need authorization to add new staff to address pressing immediate needs. We have discussed our interim personnel and resource needs with OMB, and they have indicated their receptivity to our request for an additional $15 million to fund 100 new lawyers and accountants.

1. Pay Parity

The Commission has been subject to extremely high attrition, principally because our employees earn substantially less than their counterparts in the other financial service regulatory agencies. The "Investor and Capital Markets Fee Relief Act" (P.L. 107-123), enacted this January, authorized pay parity, but the Administration's proposed fiscal 2003 SEC budget provides no new money to implement this vitally important program. Once pay parity was a reality, however, the failure to provide funding was a disappointment to our most valued employees. We estimate that an additional $76 million is needed to provide a modest implementation of pay parity for the agency in fiscal 2003.⁴⁵ At this critical time for the Nation's financial markets, we must rely on our most experienced, talented, valuable and productive employees. The only way to do that is for us to be able to provide our staff with pay parity at levels comparable to those with whom they regularly work at the other federal financial regulatory agencies. If we receive funding for pay parity, I assure you that the SEC intends to make responsible increases in staff salaries and benefits, with a significant component of the increases subject to true merit pay.

The failure to fund pay parity now would only exacerbate the problems that the legislation passed by Congress last December was intended to cure. By raising expectations and hopes in anticipation of finally achieving pay parity, we will face even greater employee losses and suffer greater irreparable harm to morale if pay parity is not funded in fiscal 2003, and thereafter. Even if we can cobble together a pay parity program for the remainder of this fiscal year, which OMB has said it supports, the threat of either terminating the program in fiscal 2003 or terminating approximately 700 employees - the number we estimate would have to be cut from the agency to continue the program - would cripple many of the projects we have underway, which are important for the protection of investors and Americans whose retirement accounts are invested in the securities of public companies.

As I mentioned before, we are extremely grateful to have bipartisan backing from this Committee. We especially appreciate Chairman Sarbanes' and Senator Gramm's calls for full funding of pay parity. The SEC cannot afford to continue suffering the staffing crisis it has endured for the past decade at such an important juncture. Pay parity provides benefits we truly need to meet the increasing regulatory challenges we face. We continue to work closely with OMB to persuade them of the need for these funds. In the interim, I am committed to proceeding with our implementation of the reforms the President has directed us to effect.

2. Additional Personnel

In addition to the absence of any funds to implement pay parity, we were also given a "no-growth" budget, which means that we cannot add any new personnel. Indeed, under current funding levels for 2002, we are effectively precluded from hiring any new personnel. The solution to every problem does not start and end with larger and more expensive government. I have started a thorough review of our deployment of personnel, to see whether we can effectuate some meaningful efficiencies.

But the tragedy of 9/11 and the very issues we are discussing here today made any contemplative review of our needs impossible. Given the enormous surge in our enforcement activities, the desire to do a better job than has been done previously at reviewing public company filings, and overseeing a restructured accounting profession, the SEC must seek a staffing increase of 100 positions in fiscal 2003 even before looking for efficiencies. This would allow us to add:

• 35 accountants and lawyers in the Division of Enforcement to deal with the increasing workload from financial fraud and reporting cases;

• 30 professional staff, including accountants and lawyers, in the Division of Corporation Finance to expand, improve and expedite our review of periodic filings; and

• 35 accountants, lawyers, and other professionals in the other divisions - including the Office of Chief Accountant - to deal with new programmatic needs and policy.

These are the minimum staffing levels required to deal with our immediate post-Enron needs. Under a pay parity system, this increased staffing level will require an additional $15 million. The Commission has not received a staffing increase in the last two years, despite the additional responsibilities we have received as a result of the Commodity Futures Modernization Act and the Gramm-Leach-Bliley financial services modernization act. A staffing increase is even more critical in light of recent events.

3. Additional Resources

In addition to the initiatives discussed in my testimony above, which will take substantial resources, there are other important initiatives we are undertaking in the areas of enforcement, investor education and technology that will require additional resources in the coming years.

• One of our major new initiatives - "real-time" enforcement - is an important component of our fiscal 2003 budget. Our goal is to provide quicker, and more effective, protection for investors, and better oversight of the markets with our limited enforcement resources. As recent experience has reinforced, the SEC must resolve cases and investigations before investors' funds vanish forever; that means we must act more quickly, both in identifying violations and taking prompt corrective action to protect investors. These efforts necessarily require resources, the most important of which is appropriate staffing.

• Even with our shift toward real-time enforcement and our current efforts to improve financial disclosure, the first line of defense against fraud is always an educated investor. The Commission works with numerous public and private organizations to foster investor educational programs. Our staff gives presentations to countless schools, religious organizations, and investor clubs, explaining basic investing concepts and answering questions. We also host "Investor Town Meetings" across the United States that bring together industry, federal, and local government officials to educate investors on basic financial concepts. And this spring we will host our first "Investor Summit," to discuss policies and proposals that impact them. We want to give all Americans an opportunity and an avenue to weigh in on the broad policy objectives that ultimately could impact their ability to send their children to college or retire comfortably. We plan to use the Internet to broadcast the summit so that anyone can participate. We also are asking people to write us and call us so that we can hear the broadest possible range of viewpoints. We want to hear the concerns and aspirations of America's investors.

• Like the rest of the government, our needs in the area of information technology continue to increase. Given the critical and increasing role of technology in the financial markets, the President's budget requests $4.0 million to fund the SEC's e-government initiatives. This is an area where the Commission needs to improve, both internally and externally. Technology is constantly altering the landscape of our markets, and SEC staff must have the necessary tools at their disposal to successfully meet the increasing demands that we face. In particular, funds proposed for fiscal 2003 will allow the SEC to get better and more timely enforcement information from the markets, enhance our intrusion detection capabilities, and meet the President's security requirements for information technology. These initiatives are a small, but important, first step toward meeting the Commission's technology needs.

• With the advent of alternative trading systems that have grown from only a handful to over 60 today, and as a result of the Internet, the SEC also must consider what effect our regulatory actions and decisions have on the industry's use of technology. To respond to this need, I have created a new position of Chief Technology Officer to provide the Commission with the technical expertise and advice necessary to improve the Commission's oversight of the markets. Generally, this office will be responsible for ensuring that the SEC's regulatory, disclosure, examination, and law enforcement programs are implemented with the benefit of a state of the art understanding of technology. Through this process, the agency can be confident that what we implement or approve is technologically sound and cost effective to the private sector.

CONCLUSION

While it remains strong, our system has shown signs of strain over the last five to ten years, resulting in unacceptable and potentially avoidable losses to those who believed in the truth of what they were told and took comfort that what they did not know would not hurt them. The present financial reporting and disclosure system for public companies has not changed significantly in many decades. Investors should continue to have confidence in our present system, but there must be determination to make improvements.

I take quite seriously my stewardship responsibilities and the Oath of Office I took when I became Chairman of the Commission. I look forward to continuing to work with you to make sure that we discharge our obligations prudently, generously and in the spirit with which the federal securities laws were adopted: to protect investors and maintain the integrity of the securities markets.

Thank you for the opportunity to testify today. I am pleased to respond to any questions the Committee may have.

Footnotes