TESTIMONY OF RICHARD J. STEGEMEIER
SECURITIES AND EXCHANGE COMMISSION
Wednesday, September 13, 2000

I am honored to be invited to testify here today; one of only a half dozen business leaders on a panel of forty.

I come on my own, as a retired businessman from California, not representing any corporation or audit firm.

I testify today because I believe very strongly in the independence and integrity of Boards of Directors.

I will not comment on the details of the 109-page draft of the SEC Proposal but rather on its fundamental premise, which is, that there is a clear and present danger to investors. To state my viewpoint at the outset, I do not believe that any such danger exists.

I worked for Unocal Corporation (a mid-sized international oil and gas company) for almost 45 years serving as its chairman, president, CEO and COO. During the past 20 years, I have also served at various times on nine other corporate boards and numerous not-for-profit boards including chairman of the California Chamber of Commerce. Altogether, I have participated in and/or chaired more than a thousand board and committee meetings including audit committees. I recognize that meeting attendance does not equate to wisdom, but I believe that I have gained a great deal of insight into the hands-on, day-by-day workings of real corporations.

I will try to be concise today and make only four main points.

1. Rule Making

Is there a need for this new set of rules and will they enhance shareholder value?

During recent years, Audit Committees increasingly have been forced to spend more and more time on rulemaking issues, in addition to their primary role of corporate financial oversight. Audit meetings have often been extended several hours in order to have extensive discussions of legal interpretations and analysis of one or more of the following proposals.

For example,

1. "The Treadway Commission Report"

2. "The Independence Standard Board ISB Standard No. 1"

3. "The Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees"

4. The subsequent SEC rules implementing the Blue Ribbon Committee's recommendations

5. The new 109-page draft of the "SEC's Auditor Independence Requirements"

No doubt there are many more rulemakings yet to come.

More often than not the draft proposals have been so vague and ambiguous that the audit committees have been compelled to seek outside legal advice to protect themselves from potential legal actions.

While I recognize and endorse the need to have rules, regulations and procedures, when does regulatory oversight become micro management and a bad substitute for good corporate governance?

To answer my initial question, there is no need for this new set of rules.

2. The Audit Problem

Is the concern regarding audit firm independence real or is it merely a perception that has no roots in reality?

We are told that the proposed SEC Auditor Independence Requirement stems from investor perceptions that audit firms will lose their independence if they conduct non-audit services for the same company. Long before the SEC brought this matter to public attention I, myself, encouraged my board colleagues to begin in-depth discussions of this potentially serious matter. However, over time I have concluded that the factual evidence has not verified my earlier perceptions and concerns. Occasionally, I have observed cases where the audit firm was given a fairly large non-audit assignment that was task and time specific. We received fair value for our money and there was absolutely no hint of audit duty compromise.

Recently, the Public Oversight Board Panel on Audit Effectiveness found no evidence of actual audit failure or loss of auditor independence. Furthermore, they found not one instance in which non-audit services had a negative effect on audit effectiveness. In fact, the panel found that almost twenty-five percent of the time a single audit/non-audit service firm actually had a positive impact on the audit process. It is interesting to note that this panel was created at the urging of the SEC.

Finally, just yesterday, the results of a study commissioned by the AICPA were released, which indicate that American investors believe the selection of auditors and other consultants is the responsibility of corporate leadership, not government regulators. A majority of the investors surveyed have confidence in the annual audit and believe the SEC's proposal to restrict services by accounting firms could actually hurt audit quality.

I am convinced that a new set of regulations designed to micro-manage audit committees is not only unnecessary but may, in fact, be detrimental to audit oversight and effectiveness.

In my earlier life as the Chief Operating Officer of Unocal, I learned two old adages the hard way. "If it ain't broke, don't fix it." and "Don't trade a devil you know for a devil you don't know." Measured against these principles, the proposed rules fail.

3. Checks and Balances

Do adequate checks and balances already exist?

There are at least five effective checks and balances already in place.

1. Ultimately, the shareholders of each company are responsible for the direction of a company. Each year in every company there is a plethora of shareholder proposals mostly concerned about corporate governance. If shareholders perceive a real problem, their voices will be heard and appropriate action taken, believe me.

2. On a regular, case-by-case basis, big institutional investors, with their large research staffs analyze the issues and vote their shares based on their professional perceptions of self-interest. It is a one hundred percent certainty that they will vote against the ratification of an outside auditor if there is even a slight perception of audit firm impropriety.

3. The board of directors has a fiduciary and ethical obligation to protect shareholder value. Failure to do so will result in shareholder revolt and certain defeat of directors and management at the next annual meeting.

4. Any audit firm so cavalier and audacious that it would jeopardize its national and even international reputation by favoring its non-audit services over its audit expertise would soon be destined for oblivion.

5. And, finally, there is the ominous threat of litigation at the slightest indication of malfeasance or bad judgment by directors, by senior management or by the company's audit firm.

A new set of rules will neither mitigate nor enhance these fundamental factors in the mind of every director. This is business reality--not academic theory.

In the real world, audit committees comply with but don't rely on rigid rules alone to implement their accumulated wisdom and common sense. If, on a continuing basis, non-audit fees are substantially greater than normal audit fees, prudent directors will question management's decisions. Directors can and will take any of the following actions:

1. Ask the audit firm to choose whether it wants to do the audit or the non-audit services for the corporation.

2. Ask management to put the non-audit service businesses out to competitive bid.

3. Replace the audit firm entirely.

4. Corporate Governance

Will this new set of rules result in improved custody and care by the directors?

Financially, most Fortune 500 Company directors are reasonably well off. They don't need the meeting fees or the aggravation of depositions and shareholder discontent. They give their time and risk their personal life savings because they love business and feel that they can make a real contribution to the growth and well being of the corporation. They are not mindless robots filling out a true or false questionnaire. Creative and independent business judgment is a priceless commodity for a successful enterprise. Many of my colleagues are seriously questioning the wisdom of being a director in today's litigious society. Some are refusing to serve on audit committees and some will not accept the chairmanship at all.

I fear that the pool of qualified directors willing to serve is shrinking. Each year CEOs get a number of unsolicited letters from "wannabe" directors. Most of these have little or no real business experience. If you read between the lines, it is easy to see that their primary goal is to seek board fees as a source of income. Their ability to make any meaningful contribution is secondary. They would not be good directors.

To answer my question, I think the proposed rules will further reduce the pool of qualified directors willing to serve, with negative consequences for corporate governance.

CONCLUSIONS AND RECOMMENDATIONS

I would caution against rules that are either ambiguous as to be impossible to apply or so rigid and unbending that there is no possibility whatsoever of director discretion. If some discretion is allowed, can we determine in advance when it crosses the line? Must we endure the unnecessary time and expense to educate new consultants merely to satisfy another set of rules addressing a nonexistent problem? Will these rules improve the experience, integrity and wisdom of the board of directors elected by the shareholders? Will these rules really enhance shareholder value? The answer is no.

I agree with two of the SEC proposals.

1. There should be some non-detailed disclosure of the comparative audit/non-audit service fees of a multi-purpose audit firm. Some companies already do this.

2. Individual auditors and the management team directly above them should not trade stock in their client companies. That is a "no-brainer."

Educate the shareholders and then let them decide for themselves whether their interests are being well served by their directors. If not, the director's tenure is in peril. You can bet your life's savings on it. I already have!

Thank you.