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U.S. Securities and Exchange Commission

Public Statement by SEC Chairman:
Remarks at the 29th Annual Securities Regulation Institute


Chairman Harvey L. Pitt

U.S. Securities & Exchange Commission

Coronado, California

January 23, 2002

These remarks reflect solely the personal views of Mr. Pitt, and do not necessarily reflect the views of the Commission, the individual members of the Commission, or its Staff.

Good afternoon. And thank you, Jim Cheek. Remarkably, in just one brief introduction, you've exceeded the sum total of pleasant things said about me for the last month! And that includes things said by my wife and family! My cup truly runneth over. As many of you know, I used to chair this Institute. But, my tenure began with, and ended after, last year's program, when I was asked to chair a different securities regulation institution. At the time, it seemed like a fair trade!

I remember well the first San Diego conference twenty-nine years ago. I attended it, but not as a speaker. Rather, I accompanied my mentor, SEC Chairman Ray Garrett, who was a speaker here for the first time as SEC Chairman. Twenty-nine years later, I give my first speech in San Diego as the newest SEC Chairman. I think Ray is smiling someplace - at least I hope he is - as he looks down on this scene. I wish he were here.

I also wish that his closest colleague on that extraordinary Commission - Al Sommer - could be here as well. As most, if not all, of you know, Al finally succumbed to a debilitating illness, but only after battling courageously and keeping his dignity while he did so. I had lunch with Al a few weeks ago, and he was as sharp and clever as always. Al was a dear friend, a former colleague and a truly public-spirited public servant. Together Al and Ray were a formidable team and set very high standards for those who follow to try to meet.

As long as I am into wonderful recollections, I should add that the highlight for me of last year's program was when I introduced the Wednesday luncheon speaker, Commissioner Paul Carey. Paul was a very close friend of mine, and we had both looked forward to being colleagues together on the Commission. I am privileged and honored to be serving the unexpired portion of Paul's term.

Ray, Al and Paul all had enormous capacities to handle challenges with wisdom and foresight. I think of them, as well as my predecessor twice-removed Chairman Ruder, often these days as I contemplate how best to address the challenges facing the SEC. At the top of the list is Enron.

The Enron debacle is tragic, and many Americans have felt its sting. Innocent investors have been betrayed by our system of disclosure and accounting. Most tragic are the investors who entrusted some portion of their life savings to a company that seemed to be profitable, placing their trust in the company, its auditors, research analysts, and our federally mandated disclosure system. Also betrayed by these events are those who held Enron stock in their retirement accounts and made life-altering decisions based upon the stock's perceived value. It is those Americans, whose faith fuels our markets, who have no lobby and no trade associations, whose interests must be paramount.

That's why I want to talk with you this afternoon about how we can - no, how we must - improve our existing disclosure and financial reporting system, and what we are proposing at the SEC. There will be those who disagree with our prescriptions. We respect, welcome and encourage contrary views. That is the only way we will produce the best solutions.

To reassure investors and restore their confidence, we need to address the systemic flaws in our current disclosure and accounting systems. These problems have gone unaddressed for many years. But now is the time to turn to these issues and build on the Commission's extraordinary record of protecting investors.

There are two questions that I want to discuss with you today: (1) What systemic problems have been exposed by Enron?; and (2) Who should solve the problems revealed by Enron's failure? I'd like to address the latter first because my answer is shorter.

Who should solve the problems revealed by Enron's failure?   If things are awry in the system we oversee, we - the SEC - have an obligation to address and resolve them before further problems arise. The SEC's first responsibility is to protect public investors. When Enron began to implode, my fellow Commissioners and I immediately - and unanimously - ordered a no-holds barred investigation, which is still underway. Until the investigation is complete, we cannot intelligently assign blame for past events. But the public can have full confidence that our Enforcement Division will learn who bears responsibility for this disaster and those who violated the laws we administer will be appropriately sanctioned.

By the same token, if major and sweeping changes are to be made, even by rulemaking, Congress should, and must, be an active participant in the process. Ever since Enron replaced 9/11 and terrorism as the lead news story, we have been working with Congress, the Justice Department, the Labor Department, and the President's Working Group to review the causes and cures for the disclosure lapses that may have occurred in Enron. We do not have a monopoly on wisdom nor do we have definitive answers to the problem. What we do have is an undeniable obligation to think about the issues, search for answers, lead constructive debate, and to move on behalf of investors to try to prevent future Enrons - even before all these investigations and analyses are concluded.

What systemic problems have been exposed by Enron?   There are many systemic problems that need repair in the wake of Enron. In my view, these include at least the following:

  • an outdated disclosure model that does not provide timely disclosure when it is most needed, and focuses on historical information while neglecting current and trend information;
  • the lack of clear and transparent financial statements;
  • a system that encourages disclosure directed more at averting liability than at informing;
  • a private-sector standard setter that has a long and critical agenda, but takes too long to address critical accounting issues and is slow to finalize the principles it does address;
  • an audit model misfocused on a nonexistent "thaumaturgic" or magical number that diverts attention from a company's trends and unfolding, dynamic situations;
  • analysts whose name sometimes belies the failure to apply sound analysis to difficult financial models;
  • an insufficiently strong and effective quality control and vigorous and transparent professional disciplinary procedure for accountants and accounting firms that engage in unethical or incompetent accounting and audit practices;
  • audit committees that often do not understand the accounting principles employed by management, or the consequences of using different principles or different assumptions.

Even before Enron's collapse, we had identified, and were working to address, many of these deficiencies. We are committed to making disclosures more meaningful, and intelligible, to average investors. The SEC is extremely fortunate to have Alan Beller, one of the world's foremost authorities on corporate and securities laws, as our new Director of Corporation Finance, and Bob Herdman, whose depth of experience at the Commission and in the private sector is an unprecedented and invaluable resource, as our Chief Accountant, to lead us in this critical endeavor. I am fond of saying that there are two types of people who surface in the face of a crisis: those who seek to solve problems and those who seek to take advantage of them. Alan, Bob and the Commission's Staff are problem solvers. We do not seek to take advantage of the current situation, only to remedy it.

I do not know what the ultimate results of our reform efforts will be - except to say that we will not throw out our current system, and we will be sensitive to the costs and benefits of any changes. The linchpins of the new disclosure system we envision should include:

  • Supplementing periodic disclosure with "current disclosure." In the system we envision, public companies will be required affirmatively to disclose unquestionably significant information when it arises and becomes available, even if the information is learned between scheduled periodic reports.
  • Making use of technology to simplify disclosure documents, without sacrificing the wealth of information investors are accustomed to receiving.
  • Encouraging the use of so-called "trend" information, to give investors the same kind of view of the companies in which they invest as is available to the managers of those companies.
  • Making financial information comprehensible to the average investor.

I'm sure you'll hear a lot more about these concepts during the conference.

While we try to revamp the system, we need to continue to give guidance to those subject to it. In Bob Herdman's first two months on the job, he reported that no public company, and no audit firm, asked for a meeting to seek the Staff's advice on difficult accounting issues. I find that shocking. A principal goal of ours is to interact with these constituencies so we can help resolve problems before they arise. This is the same philosophy as preventative medicine. It's not as exciting as E.R., but it sure is effective.

As of late, I'm pleased to say, Bob reports his phones are ringing off the hook, and both companies and auditors are willing to come in and discuss with us what proper accounting principles should be applied, and how. This is part of our view that government is a service business. It also reflects our view that trying to prevent problems from arising is the most effective way to protect investors.

Last month, we alerted companies and their audit committees to the need for transparent disclosure of critical accounting policies in annual reports. Yesterday, we issued a statement on MD&A disclosure that seeks to promote greater consideration of the intent of MD&A, which is to give investors a view of the company through the eyes of management on critical financial issues. We encourage companies, their audit committees, and their auditors to review these statements and to contact us if they have any questions or concerns. Our Staff is committed to working with all of our constituencies to assure that investors receive the most meaningful information they can and that forthcoming filings are reliable, accurate and comprehensible when filed.

We are also committed to the vigorous and robust pursuit of accounting misconduct. Last week, we brought the first pro forma financial reporting case in the Commission's sixty-eight years against Trump Hotels & Casino Resorts, Inc. for making misleading statements in an earnings release. We alleged that the company fraudulently used pro forma figures to exclude bad news to enable it to tout positive results that were primarily attributable to an unusual one-time gain, rather than to operations. I especially want to draw your attention to this case because I know there are a lot of lawyers here - some of whom I'm sure counsel public companies about their press releases. The Financial Executives Institute and the National Investor Relations Institute have done corporate and investor America a good and useful turn by suggesting "best practices" public companies should consider before making their own "pro forma" disclosures. I commend these best practices to you.

We are firmly committed to taking a lead role in assuring that the accounting profession functions properly, expeditiously and in the public interest. To that end, last week we announced that we were starting a public discussion of how best to restructure the regulatory system that governs the accounting profession. You might think, given some of the criticism our announcement generated, that I am disappointed. But, to the contrary, I'm delighted. As long as people debate the substance of our proposals, we are pleased to consider a multiplicity of views. As Treasury's Under-Secretary for Domestic Finance, Peter Fisher, pointed out in a speech last week, accounting and disclosure issues usually don't generate public or journalistic interest, which has been unfortunate. Now that they are front-page news, we want to generate interest, ideas and dialogue.

One key issue on which there has been and will doubtless continue to be extensive comment is whether there should be private regulation of the accounting profession with vigorous SEC oversight or direct SEC regulation.

I strongly believe - though as I have said we will listen carefully to all points of view -- that private regulation presents major advantages, both in quality control and discipline. It allows quality control that is more flexible, but also more effective. 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 and deficiencies in competence. And that discipline can be applied more quickly and therefore more effectively. The accounting profession and the investing public both would benefit from such an approach.

I have mentioned cost as one reason the SEC should not have immediate and direct regulatory responsibility for the accounting profession. But let me be clear - my principal concern with giving government the direct responsibility is that the process will not work as well. It will be slower, of necessity more bound up in process, and less flexible. The suggestion that the federal government get in to the audit business - for the SEC to employ and pay auditors to audit all public companies - is simply not viable. Think of the resources that would be required for the federal government to take over the audit work that private accounting firms now do. Moreover, this kind of large-scale endeavor is not something that government is good at. Of one thing I am certain - people who are unhappy with audits today will be downright despondent if the government were to undertake the job.

And the cost issue is not inconsequential. In last year's proxies, approximately 800 of the largest Fortune 1000 companies reportedly spent at least $1.4 billion on pure audit services. This number understates the actual cost of audit services, of course, since it does not include all companies who are subject to the disclosure requirements this year, and it does not include audit-related, but non-consulting, services. Effective private regulation paid for by the private sector (broadly defined) and not just by the accounting profession and subject to thorough SEC oversight is a preferable approach.

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. SEC oversight has been strengthened over the years to make that process more effective, and I have proposed the strongest possible oversight of private sector accounting regulation. Let me also emphasize that this would be "private sector" but not "self" regulation. Self-regulation implies that the accounting profession would regulate itself. We are suggesting, without always being clearly heard, regulation by the private sector but not by the profession.

Another issue receiving a great deal of attention is whether legislation is needed. First, it is critical to separate the regulatory model from the issue of whether there is a need for legislation. Legislation need not dictate a model of direct government regulation rather than private regulation with SEC oversight. Second, as noted above, we are working with Congress and, if Congress determines that legislation is necessary, we are committed to assisting that process. Whether or not Congress acts, it is incumbent for the SEC to consider the issues, put forward the most responsible proposal it can, and open a dialogue with all interested parties willing to participate.

As I noted last week, the discussion we have begun is not intended to be a final proposal, but merely the beginning of a dialogue. To those who say our proposal is inadequate, I remind them that we are at the starting point, their views are welcome, and they should criticize what we propose, not what they choose to characterize us as having proposed. We will seek out the views of all our constituencies with an interest in these issues - including the President's Working Group, members of Congress, individual and institutional investors and their representatives, public companies, mutual funds, professional accounting organizations, state accountancy boards, bar groups and many others. And, we are committed to obtaining as many views as possible before we put anything out for comment.

Because much of the criticism our proposals received reflects a misunderstanding of what we have put forth, I want to specify some of the details of this proposal, and the process by which we seek to proceed. As I mentioned earlier, two critical components of the regulatory system we envision are discipline and quality control, although these are not the only components of the system. As to discipline, we are concerned that the current process does not provide transparency and efficiency. As a result, it is our view that we need to create a new Public Accountability Board that will assume responsibility for auditor and accountant discipline and quality control.

At present, these functions are performed by the American Institute of Certified Public Accountants and overseen by the Public Oversight Board, a group of able, independent and public-spirited directors who function under the aegis of the AICPA. The POB, and its members, provide a useful model for erecting a meaningful system of private-sector regulation and discipline. It is my hope that many of the current members of the POB will be willing to contribute to the creation and running of the new Public Accountability Board.

While we believe that the POB provides a good model for us to use to transition to a new disciplinary system, we oppose any regulatory system that is directly under the control of a profession it is designed to discipline, as the POB-overseen process presently is. A substantial majority of the members of the new disciplinary body we envision would be unaffiliated with the accounting profession.

With respect to quality control, generally referred to as "peer review" in the context of the current model, there is a need for a major overhaul that takes the best from our present system. As with disclosure, this reform would build upon the current system. But we do not believe this component should be subject to the control of the profession either, nor do we have much comfort with the current firm-on-firm review process. In our view, our enforcement program and this new form of private sector discipline will, collectively, handle those who have violated the law, ethical prescriptions or competency standards. Quality control needs to be guided by an independent, permanent group of senior people with no ties to any firm. We need a group that can look at accounting failures from the perspective of how to learn from any mistakes that occurred, and how to improve, firm-by-firm, the way the profession continuously upgrades its methodologies, systems and approaches.

We are also addressing the funding of this new group. One problem inherent in the current POB-oversight model is that the profession is the sole funding source. As I mentioned earlier, our proposal calls for the oversight body to be funded not by the accounting profession but from the private sector. There are many people who use and benefit from our disclosure and auditing system, and all of them should be contributing to its maintenance. For example, corporations and marketplaces, in addition to the accounting profession, rely on it. The fact that some funding comes from accounting firms is a positive, not a negative, but only if the funding doesn't give the profession influence or control over the operations or decisions of the new Board.

I hope some of the dialogue that we seek will occur at this conference. We are confident that with input from all sectors we can erect a system of corporate disclosure and financial reporting that will restore public confidence. You, who counsel clients, have an important role to play in this process. We encourage you to give us your feedback and ideas. We also need you to advise your clients to comply with our established policies, and to interpret our rules and the relevant statutes, to provide maximum protection for investors. We need to bring our existing disclosure and financial reporting system into the twenty-first century.

I end where I began - with Ray Garrett. Toward the end of his tenure at the Commission, Ray was asked by Fortune how he hoped to be remembered when his tenure as SEC Chairman was over. In typically understated fashion, Ray said he'd like to be known as "someone who worked hard and, on balance, did more good than harm." Those are lofty goals to which all of us should aspire.

There is much to be done, and it will not be easy. But, working together with all constituencies, I believe the sound ideas we are proposing will, and must, prevail. Put another way, the problems are too serious, and the consequences of failure are too dramatic, for us to delay addressing the issues here and now. To do that, we need everyone to assume the role of solving the problem rather than taking advantage of it.

Thank you.



Modified: 01/23/2002