Testifying under oath at Congressional hearings, Harvey Pitt, Chairman of the Securities and Exchange Commission, gave his views on possible legislative actions and responded to a series of pointed questions, including “Are there any more Enron’s out there?” A quick review of the questions and answers will give you a good indication of the types of changes being discussed on Capitol Hill.
Should Congress intervene with legislative actions?
Chairman Pitt: The SEC has the regulatory and statutory authority to make most of the needed reforms. But Congress should be involved, if sweeping changes are to be made. One area of possible legislation already identified is the need to require corporate insiders to disclose their trading activities to the public more quickly. The current law, which dates back to 1934, calls for a filing to be made by the 10th day after the month in which the trading occurred. That may have been good enough in 1934, but it is not nearly good enough for our markets today.
What regulatory actions is the SEC considering?
Chairman Pitt: We’re committed to doing everything in our power to prevent another Enron-like debacle. We have been working to improve and modernize corporate disclosures and the financial reporting system. The reforms under consideration include: a system of “current” disclosure, more disclosures of “trend” and “evaluative” data, an updated and improved system of periodic disclosure, clearer and more understandable financial statements, disclosures about critical accounting policies, faster and more responsive setting of accounting standards, a more rigorous system of oversight of the accounting profession, a system safer from conflicts of interest among auditors, more meaningful protection by audit committees, and a system of more transparent analyst recommendations.
(For more details on these initiatives, see Chairman Pitt’s prepared remarks before the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, United States House of Representatives, concerning legislative solutions to problems raised by events relating to Enron Corporation.)
The Big Five firms are trying to prevent conflicts of interest by separating auditing from consulting. Will that really work? What’s the difference whether it’s $12 million in audit fees and $12 million in consulting fees or $24 million in audit fees? If a firm is hired by management, it will still want to make management happy. Would it make more sense to have the Stock Exchanges engage the audit firm instead of the corporate board?
Chairman Pitt: This is something that is on the table for discussion. I think the Big Five firms have taken a positive step in splitting consulting and auditing services. If they are taking the step to restore public confidence, then we should support it. But this has no impact on all the additional changes we need to make in our system. It will not solve the problem. There is much, much more that needs to be done. The SEC will look into this and other suggested changes and report back to the Subcommittee in 30 days.
Isn’t the SEC concerned about the way the Big Eight became the Big Five? Enron may only be 1% of Andersen’s business, but it is equivalent to 100% of a smaller firm’s annual revenues. Isn’t the size of the Big Five firms an issue?
Chairman Pitt: Yes. That’s why solving the conflict issues will not solve the problems. The independence issue is most relevant on the front lines. An audit may represent 1% of a firm’s revenues but it can still be critically significant to the individual partner in charge of the audit. Then too there is a need for greater capital in accounting firms today. The issue comes down to, “How can we achieve the desired results and still avoid dictating how much income they can generate?”
Are there any other Enrons out there?
Chairman Pitt: The system is capable of being gamed. The SEC is investigating a number of financial frauds. But keep in mind there are 17,000 public companies registered with the SEC. At the present time, no one can give you the assurance you seek. Part of the problem is that the SEC has in the past allowed the Financial Accounting Standards Board (FASB) to fail to set timely accounting standards. The FASB must act more quickly in the future.
Should the FASB be federalized?
Chairman Pitt: If the FASB won’t fix the standards, we will either find a body to do it or we will do it ourselves. One of FASB’s major problems stems from its funding, which comes from the industry it regulates. But the creative accounting that led to Enron’s demise wasn’t a system-wide problem. It’s a good system. It has flaws and we’re going to fix them.
The SEC is looking at new disclosure rules in light of Enron. We have found that Regulation FD shields executives from liability “by telling nothing to no one.” So we are working on a new proposal that would instead require companies to disclose “unquestionably significant information” to investors. To get input on this and other matters, the SEC is planning its first ever “Investor Summit” in May 2002. There are fundamental longstanding flaws in our system. But, at the end of the process, we will have a better system of corporate disclosure.
The above questions and answers have been paraphrased and are not verbatim. Listen to the Congressional hearings on legislative reforms or read Chairman Pitt’s testimony at the hearing on financial literacy.