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United States General Accounting Office: 

Before the Committee on Banking, Housing, and Urban Affairs, U.S. 

For Release on Delivery: 
Expected at 10 a.m. EST: 
Tuesday, March 5, 2002: 

Protecting The Public Interest: 

Selected Governance, Regulatory Oversight, Auditing, Accounting, and 
Financial Reporting Issues: 

Statement of David M. Walker: 
Comptroller General of the United States: 


Mr. Chairman and Members of the Committee: 

I appreciate the opportunity to discuss with the committee my 
perspectives on some of the issues that are now receiving extensive 
national interest following the rapid and unexpected decline of Enron 
Corporation (Enron) and the resulting huge losses suffered by Enron’s 
shareholders and employees. The rapid failure and bankruptcy of Enron 
has led to severe criticism of virtually all areas of the nation’s 
financial reporting and auditing systems, which are fundamental to 
maintaining investor confidence in our capital markets. At last count, 
12 congressional committees, the Department of Justice, the Securities 
and Exchange Commission (SEC), and the Department of Labor’s Pension 
and Welfare Administration all have ongoing investigations of Enron. 
The individuals responsible for the Enron debacle should be held 
accountable for any misdeeds. At GAO, accountability is one of our core 
values and must be a critical component of any system in order for it 
to function effectively. 

The facts regarding Enron’s failure are still being gathered to 
determine the underlying problems and whether any civil and/or criminal 
laws have been violated. Therefore, I will not comment on the specifics 
of the Enron situation and who is at fault. At the same time, the Enron 
situation raises a number of systemic issues for congressional 
consideration to better protect the public interest. It is fair to say 
that other business failures or restatements of financial statements 
have also sent signals that all is not well with the current system of 
financial reporting and auditing. As the largest corporation failure in 
U.S. history, Enron, however, provides a loud alarm that the current 
system may be broken and in need of an overhaul. 

I will focus on four overarching areas—corporate governance, the 
independent audit of financial statements, oversight of the accounting 
profession, and accounting and financial reporting issues—where the 
Enron failure has already demonstrated that serious, deeply rooted 
problems may exist. It should be recognized that these areas are the 
keystones to protecting the public’s interest and are interrelated. 
Failure in any of these areas places a strain on the entire system. The 
overall focus of these areas should be guided by the fundamental 
principles of having the right incentives for the key parties to do the 
right thing, adequate transparency to provide reasonable assurance that 
the right thing will be done, and full accountability if the right 
thing is not done. These three overarching principles represent a 
system of controls that should operate with a policy of placing special 
attention on those areas of greatest risk. In addition, an established 
code of ethics should set the “tone at the top” for expected ethical 
behavior in performance of all key responsibilities. The 1980s savings 
and loan crisis, for which this committee was instrumental in shaping 
the reforms to protect deposit insurance and the public interest, is a 
prime example of the serious consequences that can result when one or 
more components of an interrelated system breaks down. 

My comments today are intended to frame the broad accountability issues 
and provide our views on some of the questions and options that must be 
addressed to better safeguard the public interest going forward. There 
will no doubt be many views on what needs to be fixed and how to do it. 
We look forward to working with the Congress to provide assistance in 
defining the issues, exploring various options, and identifying their 
pros and cons in order to repair any weaknesses that threaten 
confidence in our capital markets and that inhibit improvements in the 
current system and appropriate actions by the key players. In 
considering changes to the current system that gave rise to Enron and 
other earlier financial reporting failures, it will be important that 
the Congress consider a holistic approach to addressing the range of 
interrelated issues. From all that has been heard from the inquiries to 
date, it is clear that there is no single silver bullet to fix the 
problems. It is also clear that many parties are focusing on various 
elements of the issues but do not seem to be taking a comprehensive 
approach to addressing the many interrelated issues. This is what we 
are trying to do for the Congress. 

On February 25, 2002, GAO held a forum on various governance, 
transparency, and accountability issues that was attended by experts in 
each of these areas. A summary of the results of the forum is being 
released today and is available at our web site.[Footnote 1] Also, we 
have completed the study of the SEC’s resources that you requested and 
the report is being released today.[Footnote 2] I will discuss the 
results of that work today as well. 

Before discussing these matters, I would like to quickly provide an 
overview of the current corporate governance system, the independent 
audit function, regulatory oversight, and the accounting and financial 
reporting framework. An attachment to my testimony graphically 
illustrates the interrelation and complexity of these systems. 

Overview of the Current Governance, Auditing, Oversight Systems, and 
Financial Reporting: 

Public and investor confidence in the fairness of financial reporting 
is critical to the effective functioning of our capital markets. The 
SEC, established in the 1930s following the stock market crash of 1929 
and the Great Depression, protects investors by administering and 
enforcing federal securities laws, and its involvement with 
requirements for financial disclosures and audits of financial 
statements for publicly traded companies. In this respect, the public 
accounting profession, through its independent audit function, has 
received a franchise to audit and attest to the fair presentation of 
financial statements of publicly traded companies. However, such a 
franchise brings with it not only the important role of attesting to 
the reliability of financial statements and related data, but also the 
concomitant responsibility of protecting the public interest and 
ensuring public confidence through appropriate independence, 
professional competence, and high ethical standards for auditors. 

The SEC, the primary federal agency involved in accounting and auditing 
requirements for publicly traded companies, has traditionally relied on 
the private sector for setting standards for financial reporting and 
independent audits, retaining a largely oversight role. Accordingly, 
the SEC has accepted rules set by the Financial Accounting Standards 
Board (FASB)[Footnote 3]— generally accepted accounting principles 
(GAAP)—as the primary standard for preparation of financial statements 
in the private sector. The SEC has accepted rules set by the American 
Institute of Certified Public Accountants’ (AICPA) Auditing Standards 
Board—generally accepted auditing standards(GAAS)—as the standard for 
conducting independent audits of financial statements for private 
sector entities. The SEC monitors the performance of the standard-
setting bodies and also monitors the accounting profession’s system of 
peer review, which checks compliance with applicable professional 

The SEC also oversees the activities of a variety of key market 
participants. It does this using the principle of self-regulation. 
According to this principle, the industry regulates itself through 
various self-regulatory organizations (SROs) overseen by the SEC. SROs 
are groups of industry professionals with quasi-governmental powers to 
adopt and enforce standards of conduct for their members. They include 
the nine securities exchanges, such as the New York Stock Exchange 
(NYSE), which regulate their marketplaces and the National Association 
of Securities Dealers (NASD) which regulates the over-the-counter 
market. In addition to regulating member broker dealers, the SROs 
establish listing standards for those firms that list on their market. 

The AICPA administers a self-regulatory system for the accounting 
profession that includes setting auditing and independence standards, 
monitoring compliance, and disciplining members for violations of ethic 
rules and standards. The Public Oversight Board, administratively 
created by the AICPA in consultation with the SEC in 1977, monitors 
public accounting firms’ compliance with professional standards and 
oversees the Auditing Standards Board. State boards of accountancy 
license public accounting firms and individuals to practice public 
accounting within each state’s jurisdiction. 

The audit is a critical element of the financial reporting structure 
because it subjects information in the financial statements to 
independent and objective scrutiny, increasing the reliability and 
assurance that can be placed on those financial statements for 
efficient allocation of resources in a capital market where investors 
are dependent on timely and reliable information. Management of a 
public company is responsible for the preparation and content of the 
financial statements, which are intended to disclose information that 
accurately depicts the financial condition and results of company 
activities. In addition, public companies registered with the SEC must 
maintain an adequate system of internal accounting control. The 
independent auditor is responsible for auditing the financial 
statements in accordance with generally accepted auditing standards to 
provide reasonable assurance that the financial statements are fairly 
presented in accordance with GAAP. The auditor’s opinion on the 
financial statements is like an expert’s stamp of approval to the 
public and the capital markets. 

U.S. stock exchanges require listed companies to meet certain corporate 
governance standards, including that boards of directors have 
independent audit committees to oversee the accounting and financial 
controls of a company and the financial reporting process. Audit 
committees can help protect shareholder interests by providing sound 
leadership and oversight of the financial reporting process by working 
with management and both internal and external auditors. 

The interrelation and complexity of the systems of corporate 
governance, auditing, oversight, and accounting and financial 
reporting, which cumulatively are the foundation for maintaining 
investor confidence in our capital markets, is graphically illustrated 
in the charts attached to this statement. The many links within and 
between the systems further illustrate the strain that can be placed on 
the overall system when weaknesses occur within any part of the system. 

I would now like to focus on each of the four overarching areas I 
mentioned earlier, starting with corporate governance. 

Corporate Governance: 

I want to acknowledge immediately that serving on the Board of 
Directors of a public corporation is an important, difficult, and 
challenging responsibility. That responsibility is especially 
challenging in the current environment with increased globalization and 
rapidly evolving technologies having to be addressed while at the same 
time meeting quarterly earnings projections in order to maintain or 
raise the market value of the corporation’s stock. These pressures, and 
related executive compensation arrangements, unfortunately often 
translate to a focus on short-term business results. This can create 
the perverse incentives, such as managing earnings to inappropriately 
report favorable financial results, and/or failing to provide adequate 
transparency in financial reporting that disguises risks, 
uncertainties, and/or commitments of the reporting entity. 

On balance though, the difficulty of serving on a public corporation’s 
board of directors is not a valid reason for not doing the job right, 
which means being knowledgeable of the corporation’s business, asking 
the right questions, and doing the right thing to protect the 
shareholders and the public interest. A board member needs to have a 
clear understanding of who is the client being served. Namely, their 
client should be the shareholders of the company, and all their actions 
should be geared accordingly. Audit committees have a particularly 
important role to play in assuring fair presentation and appropriate 
accountability in connection with financial reporting, internal 
control, compliance, and related matters. 

Enron’s failure has raised many questions about how its Board of 
Directors and audit committee were performing their duties and 
responsibilities. These questions include the following: 

* Did the board of directors fulfill its fiduciary responsibility to 
shareholders and protect the public interest in overseeing Enron’s 

* Did the board operate in a proactive manner and raise the appropriate 
questions designed to identify key problems and mitigate related risks? 

* Did the board have the appropriate industry, financial, or other 
appropriate expertise? 

* Did board members have personal or business relationships that may 
have either in fact or in appearance affected their independence? 

* Did the board, especially its audit committee, have an active 
interface and appropriate working relationship with Enron’s internal 
and external auditors? 

* Did the board and its audit committee have appropriate resources to 
do the job including staff and independent advisors? 

* Did the board and its audit committee report meaningfully on their 

These are fundamental questions that as I previously mentioned are 
being addressed by various investigations and, therefore, I will not 
comment on those issues. However, these issues are instructive and, as 
a minimum, call for a review of the applicable rules and regulations 
that govern boards of directors. In that respect, the Administration 
recently formed a group of top financial policymakers and regulators to 
consider corporate governance and disclosure reforms. The SEC has asked 
the NYSE and Nasdaq to review corporate governance and listing 
standards, of public companies, including the important issues of 
officer and director qualifications and the formal codes of conduct. 
The SEC Chairman recently announced that the NYSE has established a 
Special Committee on Corporate Accountability and Listing Standards to 
examine corporate governance issues, including the possibility of 
requiring continuing education programs for officers and directors, and 
the Nasdaq also is taking similar steps. The corporate chief executives 
who make up the Business Roundtable have stated that they are reviewing 
their voluntary standards for corporate governance. The AFL-CIO has 
petitioned the SEC to amend its proxy disclosure requirements regarding 
conflicts of interest reportable by Board members. The California 
Public Employees’ Retirement System (CalPERS) is also reviewing 
definitions and standards for independent corporate directors. 

These examples are not intended to be a complete listing of reviews 
underway on corporate governance requirements. We applaud these 
initiatives. Hopefully, they will provide the opportunity for a 
thorough review of corporate governance requirements. These efforts 
will help to identify and frame the issues and to serve as a basis for 
determining whether the fundamental underpinnings for effective 
performance of boards of directors and audit committees are in place 
along with controls to monitor performance. Some basic factors to 
consider in reviewing the various requirements that govern membership 
and responsibilities of boards of directors of public companies include 
the following: 

* Is there a clear understanding of whom the board is serving and its 
fiduciary responsibility to shareholders and related impact on the 
capital markets? 

* What type of relationship should the board have with management (for 
example, constructive engagement)? 

* What, if any, selection process changes are necessary in order to 
assure the proper identification of qualified and independent board 

* Is the nominating process for board membership designed to ensure 
that the board is getting the right mix of talent to do the job? 

* Do board membership rules address who other than management would 
nominate Board members? 

* Are the independence rules for outside directors and audit committee 
members sufficient to ensure the objectivity of the members? 

* Do board membership rules address whether the corporation’s CEO 
should be allowed to be the board chairman? 

* Do board membership rules address whether independent board members 
should nominate the chairman of the board? 

* Do board membership rules address whether members of corporation 
management, including the CEO, should be allowed to be board members, 
and if so, what percentage of total board membership? 

* Do board membership rules address whether corporation service 
providers, such as major customers or other related parties, should be 
allowed to be board members? 

* Do requirements ensure that the board will have access to the 
resources and staff necessary to do the job, including its own staff 
and access to independent legal counsel and other experts? 

* Do requirements ensure that the responsibilities of board members, 
including the members who serve on audit committees and other 
committees, such as the nominating, finance, and compensation 
committees, are required to be committed to a charter that governs 
their operation? 

* Do requirements address the appropriate working relationship between 
the audit committee and the internal and external auditors? 

* Do requirements provide for the board of directors to establish a 
formal code of conduct to set the tone for expected personal and 
business ethical behavior within the corporation? 

* Do requirements provide that waivers of the code of conduct are not 
expected and should such circumstances arise, which should be extremely 
rare, that any exceptions must be approved by the board of directors 
and publicly reported? 

* Do requirements provide for public reporting on the effectiveness of 
internal control by management and independent assurances on the 
effectiveness of internal control by the corporation’s independent 

* Do requirements provide for public reporting by the board of 
directors, the audit committee, and other committees of the board on 
their membership, responsibilities, and activities to fulfill those 

* Do the stock exchanges and the SEC have sufficient authority to 
enforce requirements governing boards of directors and audit committees 
and to take meaningful enforcement actions, including imposing 
effective sanctions when requirements are violated? 

* Does the SEC have sufficient resources and authority to fulfill its 
responsibilities under the federal securities laws and regulations to 
operate proactively in monitoring SEC registrants for compliance and to 
take timely and effective actions when noncompliance may exist? 

* Is the SEC efficiently and effectively using technology to manage its 
regulatory responsibilities under the federal securities laws by 
assessing risks, screening financial reports and other required 
filings, and accordingly prioritizing the use of its available 

Boards of directors and their audit committees are a critical link to 
fair and reliable financial reporting. A weak board of directors will 
also likely translate into an ineffective audit committee. That 
combination makes the difficult job of auditing the financial 
statements of large corporations, which usually have vast, complex and 
diversified operations, much more challenging. 

Regulation and Oversight of the Accounting Profession: 

The model for regulation and oversight of the accounting profession 
involves federal and state regulators and a complex system of self-
regulation by the accounting profession. The functions of the model are 
interrelated and their effectiveness is ultimately dependent upon each 
component working well. Basically, the model includes the functions of: 

* licensing members of the accounting profession to practice within the 
jurisdiction of a state, as well as issuing rules and regulations 
governing member conduct, which is done by the state boards of 

* setting accounting and auditing standards, which is done by the 
Financial Accounting Standards Board and the Auditing Standards Board, 
respectively, through acceptance of the standards by the SEC; 

* setting auditor independence rules, which within their various areas 
of responsibility, have been issued by the AIPCA, the SEC, and GAO; 

* oversight and discipline, which is done through systems of self-
regulation by the accounting profession and the public regulators (the 
SEC and state boards of accountancy). 

The Enron failure has brought a direct focus on how well the systems of 
regulation and oversight of the accounting profession are working in 
achieving their ultimate objective that the opinions of independent 
auditors on the fair presentation of financial statements can be relied 
upon by investors, creditors, and the various other users of financial 

The issues currently being raised about the effectiveness of the 
accounting profession’s self-regulatory system are not unique to the 
collapse of Enron. Other business failures or restatements of financial 
statements over the past several years have called into question the 
effectiveness of the system. A continuing message is that the current 
self-regulatory system is fragmented, is not well coordinated, and has 
a discipline function that is not timely nor does it contain effective 
sanctions, all of which create a public image of ineffectiveness. 
Reviews of the system should consider whether overall the system 
creates the right incentives, transparency, and accountability, and 
operates proactively to protect the public interest. Also, the links 
within the self-regulatory system and with the SEC and the state boards 
of accountancy (the public regulatory systems) should be considered as 
these systems are interrelated and weaknesses in one component can put 
strain on the other components of the overall system. 

I would now like to address some of the more specific areas of the 
accounting profession’s self-regulatory system that should be 
considered in forming and evaluating proposals to reshape or overhaul 
the current system. 

Accounting Profession’s Self-Regulatory System: 

The accounting profession’s current self-regulatory system is largely 
operated by the AICPA through a system, largely composed of volunteers 
from the accounting profession. This system is used to set auditing
standards and auditor independence rules, monitor member public 
accounting firms for compliance with professional standards, and 
discipline members who violate auditing standards or independence 
rules. AICPA staff support the volunteers in conducting their 
responsibilities. The Public Oversight Board oversees the peer review 
system established to monitor member public accounting firms for 
compliance with professional standards. In 2001, the oversight 
authority of the Public Oversight Board was expanded to include 
oversight of the Auditing Standards Board. The Public Oversight Board 
has five public members and professional staff, and receives its 
funding from the AICPA. 

On January 17, 2002, the SEC Chairman outlined a proposed new self-
regulatory structure to oversee the accounting profession. On January 
20, 2002, the Public Oversight Board passed a resolution of intent to 
terminate its existence no later than March 31, 2002. The Public 
Oversight Board’s Chairman was critical of the SEC’s proposal and 
expressed concern that the Board was not consulted about the proposal. 
The SEC’s proposal provided for creating an oversight body that would 
include monitoring and discipline functions, have a majority of public 
members, and be funded through private sources. No further details have 
been announced. 

The authority for the oversight body is a basic but critical factor 
that can influence its operating philosophy, its independence, and, 
ultimately, its effectiveness. Related factors to consider include: 

* determining whether the body should be created by statute or 
administratively, such as is the case for the current Public Oversight 

* deciding the basic scope of the body’s enabling authority, such as 
whether oversight authority should be limited to coverage of the public 
accounting firms that audit SEC registrants, which is the authority of 
the current Public Oversight Board, or whether it should be expanded to 
other public accounting firms that also provide audit services to a 
broader range of entities; and; 

* determining mission objectives clearly to ensure that protecting the 
public interest is paramount. 

Membership of the oversight body and its funding may also influence the 
body’s operating philosophy (proactive as opposed to reactive), 
independence, and resolve to actively assess and minimize risks within 
the system that affect protecting the public interest. Factors to 
consider include: 

* whether the membership should be limited to public members (exclude 
practicing members of the accounting profession), such as is the case 
for current Public Oversight Board, or whether membership should allow 
some practicing members of the accounting profession to sit on the 

* how the members will be selected, including the chair, their term 
limits, and compensation; and; 

* how the amount and source of funding will be established since a 
problem with either may present potential conflicts or limit the 
oversight body’s ability to effectively protect the public interest. 

The responsibilities of the oversight body and its powers to perform 
those responsibilities will largely define whether the oversight body 
is set up with a sufficient span of responsibility to oversee the 
activities of the accounting profession and to take appropriate actions 
when problems are identified. Related factors to consider include: 

* whether the current system of peer review should be continued in its 
present form and monitored by the oversight body, such as was done by 
the Public Oversight Board, with oversight by the SEC; 

* whether the oversight body should have more control over the peer 
review function, such as selecting and hiring peer reviewers, managing 
the peer review, and being the client for the peer review report; 

* whether the oversight body’s authority should extend to all standard-
setting bodies within the accounting profession so that accounting, 
auditing, quality control and assurance, and independence standards are 
subject to oversight (currently the Public Oversight Board does not 
oversee the setting of accounting standards or auditor independence 

* whether the oversight body’s authority related to standard setting 
should be expanded to direct standard-setting bodies to address any 
problems with standards and approve the adequacy of revised standards 
(currently the Public Oversight Board does not have such direct 

* whether the oversight body’s authority should extend to the 
discipline function (currently the Public Oversight Board does not 
oversee the discipline function); 

* whether the oversight body should have investigative authority over 
disciplinary matters (currently this function is housed within another 
component of the AICPA) or authority to request investigations; and; 

* whether the body within the self-regulatory system responsible for 
investigations of disciplinary matters should have power to protect 
investigative files from discovery during litigation to facilitate 
cooperation and timeliness in resolving cases. 

Accountability requirements can provide for stewardship of resources, 
help to set the operating philosophy of the oversight body, and provide 
a means of monitoring the oversight body’s performance. The current 
Public Oversight Board issues an annual report and its financial 
statements are audited. Related factors to consider include: 

* whether the oversight body should prepare strategic and annual 
performance plans; 

* whether the oversight body should have an annual public reporting 
requirement and what information should be included in the report, such 
as whether the report should be limited to the oversight body’s 
activities or whether the report should provide more comprehensive 
information about the activities of the entire self-regulatory system, 
and whether the oversight body should have audited financial 
statements; and; 

* whether and, if so, how the Congress should exercise periodic 
oversight of the performance of the self-regulatory system and the 
performance of the oversight body. 

At this time, the outcome of the SEC’s proposal to establish a body for 
overseeing the accounting profession that would include monitoring and 
discipline functions is uncertain. There is considerable overlap in the 
functions of the current self-regulatory system and the functions of 
the SEC related to the accounting profession. For example, the AICPA 
sets auditor independence rules applicable to its membership, and the 
SEC sets auditor independence rules for those auditors who audit SEC 
registrants. Also, the AICPA disciplines its members for noncompliance 
with independence rules or auditing standards. The SEC, through its 
enforcement actions, disciplines auditors of SEC registrants who 
violate its laws and regulations, which include noncompliance with 
independence rules and auditing standards. In addition, the SEC also 
conducts various activities to oversee the peer review function of the 
self-regulatory system. 

As proposals are considered for reshaping or overhauling the self-
regulatory system, the overlap of functions with the SEC’s 
responsibilities should be considered to provide for oversight of the 
accounting profession that is both efficient and effective. Related 
factors to consider include the following: 

* whether current independence rules are adequate to protect the public 

* whether independence rules for auditors should be consistent and set 
by the government or private sector, or whether the status quo is 

* whether the current system of peer review is acceptable or whether 
the SEC should play a role that exercises more direct control or 
oversight of the accounting profession’s compliance with standards; 

* how the investigative/enforcement functions of the self-regulatory 
system and the SEC can be jointly used to efficiently and effectively 
achieve their common objectives to resolve allegations of audit 

Similarly, the discipline functions of the SEC and the self-regulatory 
system overlap with the state boards of accountancy, which are the only 
authorities that can issue or revoke a license to practice within their 
jurisdictions. The communication and working relationship opportunities 
for efficiency and effectiveness that exist between the SEC and the 
self-regulatory system also exist for their relationship with the state 
boards of accountancy in resolving allegations of audit failure. 

The Independent Audit Function: 

For over 70 years, the public accounting profession, through its 
independent audit function, has played a critical role in enhancing a 
financial reporting process that facilitates the effective functioning 
of our domestic capital markets as well as international markets. The 
public confidence in the reliability of issuers’ financial statements 
that is provided by the performance of independent audits encourages 
investment in securities issued by public companies. This sense of 
confidence depends on reasonable investors perceiving auditors as 
independent expert professionals who have neither mutual nor conflicts 
of interests in connection with the entities they are auditing. 
Accordingly, investors and other users expect auditors to bring to the 
financial reporting process integrity, independence, objectivity, and 
technical competence, and to prevent the issuance of misleading 
financial statements. 

The Enron failure has raised questions concerning whether auditors are 
living up to the expectations of the investing public; however, similar 
questions have been repeatedly raised over the past three decades by 
significant restatements of financial statements and unexpected costly 
business failures. Issues debated over the years continue to focus on 
auditor independence concerns and the auditor’s role and 
responsibilities, particularly in detecting and reporting fraud and 
assessing the effectiveness of and reporting on internal control. 

Auditor Independence Concerns: 

The independence of public accountants—both in fact and in appearance— 
is crucial to the credibility of financial reporting and, in turn, the 
capital formation process. Auditor independence standards require that 
the audit organization and the auditor be independent in fact and in 
appearance. These standards place responsibility on the auditor and the 
audit organization to maintain independence so that opinions, 
conclusions, judgments, and recommendations will be impartial and will 
be viewed as being impartial by knowledgeable third parties. 

Since the mid-1970s, many observers of the auditing profession have 
expressed concern about the expanding scope of professional services 
provided by the public accounting profession. Specifically, questions 
have been raised by the media, the Congress, and others concerning the 
propriety of performing both audit and certain nonaudit services for 
the same client. While these services and their perceived impact on 
accounting firms’ independence have been the subject of many studies 
and while actions have been taken to strengthen auditor independence, 
the Enron failure has brought this issue once again to the forefront 
and has sparked new proposals to prohibit or limit auditors from 
providing nonaudit services to audit clients. A common concern is that 
when auditor fees for consulting services are a substantial part of 
total auditor fees, this situation can create pressures to keep the 
client happy and can threaten auditor independence. 

Auditors have the capability of performing a range of valuable services 
for their clients, and providing certain nonaudit services can 
ultimately be beneficial to investors and other interested parties. 
However, in some circumstances, it is not appropriate for auditors to 
perform both audit and certain nonaudit services for the same client. 
In these circumstances, the auditor, the client, or both will have to 
make a choice as to which of these services the auditor will provide. 
These concepts, which I strongly believe are in the public interest, 
are reflected in the revisions to auditor independence requirements for 
government audits,[Footnote 4] which GAO recently issued as part of 
Government Auditing Standards. [Footnote 5] The new independence 
standard has gone through an extensive deliberative process over 
several years, including extensive public comments and input from my 
Advisory Council on Government Auditing Standards.[Footnote 6] The 
standard, among other things, toughens the rules associated with 
providing nonaudit services and includes a principle-based approach to 
addressing this issue, supplemented with certain safeguards. The two 
overarching principles in the standard for nonaudit services are that: 

* auditors should not perform management functions or make management 
decisions, and; 

* auditors should not audit their own work or provide nonaudit services 
in situations where the amounts or services involved are significant or 
material to the subject matter of the audit. 

Both of the above principles should be applied using a substance over 
form determination. Under the revised standard, auditors are allowed to 
perform certain nonaudit services provided the services do not violate 
the above principles; however, in most circumstances certain additional 
safeguards would have to be met. For example: (1) personnel who perform 
allowable nonaudit services would be precluded from performing any 
related audit work, (2) the auditor’s work could not be reduced beyond 
the level that would be appropriate if the nonaudit work were performed 
by another unrelated party; and (3) certain documentation and quality 
assurance requirements must be met. The new standard includes an 
express prohibition regarding auditors providing certain bookkeeping or 
record keeping services and limits payroll processing and certain other 
services, all of which are presently permitted under current 
independence rules of the AICPA. 

The focus of these changes to the government auditing standards is to 
better serve the public interest and to maintain a high degree of 
integrity, objectivity, and independence for audits of government 
entities and entities that receive federal funding. However, these 
standards apply only to audits of federal entities and those 
organizations receiving federal funds, and not to audits of public 
companies. In the transmittal letter issuing the new independence 
standard, we expressed our hope that the AICPA will raise its 
independence standards to those contained in this new standard in order 
to eliminate any inconsistency between this standard and their current 
standards. The AICPA’s recent statement before another congressional 
committee that the AICPA will not oppose prohibitions on auditors 
providing certain nonaudit services seems to be a step in the right 
direction.[Footnote 7] In 2000, the SEC considered a principle-based 
approach for auditor independence rules applicable to auditors of SEC 
registrants, but decided in the end to set specific rules by types of 
nonaudit services. We believe a principle-based approach is more 
effective given the wide variety of nonaudit services provided by 
auditors and the continuing evolution of the market. 

The new independence standard is the first of several steps GAO has 
planned in connection with nonaudit services covered by government 
auditing standards. In May 2002, we plan to issue a question and answer 
document concerning our independence standard, and I will ask my 
Advisory Council on Government Auditing Standards to review and monitor 
this area to determine what, if any, additional steps may be 
appropriate. In addition, the Principals of the Joint Financial 
Management Improvement Program, who are the Comptroller General, the 
Secretary of the Treasury, and the Director, Office of Management and 
Budget, have agreed that the 24 major federal departments and agencies 
covered by the Chief Financial Officers Act should have audit 
committees. The scope, structure, and timing of this new requirement 
will be determined over the next several months. This will include 
determining what role these audit committees might play in connection 
with nonaudit services. 

Another auditor independence issue, which also existed with Enron, 
concerns the employment by the client of its former auditor. The 
revolving door between auditors and the companies they audit has 
existed for years. This is due in part to the mandatory retirement of 
partners from public accounting firms, often before the partners are 
ready to leave the profession. Another contributing factor that entices 
auditors to work for audit clients is the lucrative compensation for 
executives in public companies. Employment by the client of its former 
auditor can have a clear implication on the quality of audits and has 
been cited as a factor in the savings and loan scandal of the late 
1980s. The AICPA asked the SEC in 1993 to prohibit public companies 
from hiring their audit partner for a year after an audit. The SEC 
rejected the proposal as too difficult to enforce. However, Enron has 
resurfaced the issue. One congressional proposal would prohibit an 
accounting firm from providing audit services to a company whose 
controller or chief financial officer had worked for that public 
accounting firm. This issue again raises the auditor independence 
perception problem and provides another opportunity to further enhance 
auditor independence. A factor to consider in this debate includes 
mandating a “cooling off period” in which a partner or senior auditor 
from a firm cannot go to work for a former audit client for a period of 
time after separating from their firm. 

A related issue is whether an audit firm should be allowed to serve as 
the client’s auditor of record without a limit on the period of time. 
Currently, there are no time limits for rotation of audit firms, 
although the AICPA requirements for member firms that audit SEC 
registrants require partner rotation every 7 years. The concerns are 
that the auditor may become too close to management over a period of 
years and, therefore, threaten the auditor’s objectivity. Also, the 
auditor’s familiarity with the business operations of the client may 
result in a less than thorough audit. Opposing arguments against 
auditor rotation include that there is a significant learning curve for 
a new auditor and, during that time, there is a greater risk of the 
auditor overlooking transactions that may result in misleading 
financial statements. Also, auditor rotations can increase audit costs 
for the client.[Footnote 8] Building on the current AICPA requirement 
for rotating the audit engagement partner every 7 years, rotating 
addition key members of the audit team is another alternative to 
consider. Rotating addition key members of the audit team should have 
less of an impact of the auditor’s learning curve and not increase 
audit costs, although this option would still leave open the appearance 
of an independence issue for the firm. 

Study groups over the years have recognized that corporate boards and 
their audit committees could and should play a more significant role in 
strengthening the independence of audits. The situation with Enron and 
its auditors is another event that highlights the necessity to 
reexamine relationships of boards of directors, audit committees, and 
management with the independent auditor in order to strengthen the 
objectivity and professionalism of the independent auditor and to 
enhance the independent audit. Factors to consider in making changes 
include the following: 

* Who should be the client for the audit? 

* Should the audit committee be actively responsible for hiring, 
determining fees, and terminating the auditor? 

* Should there be more required communication and interaction between 
the auditor and the audit committee? 

* Should the audit committee preapprove the provision of certain 
nonaudit services by audit firms? 

* Should the audit committee be required to review and approve the 
staffing of audit firm personnel? 

Auditor’s Roles and Responsibilities for Fraud and Internal Control: 

Under current auditing standards, auditors are responsible for planning 
and performing the audit to obtain reasonable, but not absolute, 
assurance about whether the financial statements are free of material 
misstatement, whether caused by error, illegal acts, or fraud. As 
stated over the years by many who have studied the profession, no major 
aspect of the independent auditor’s role has caused more difficulty 
than the auditor’s responsibility for detecting fraud. In August 2000, 
the Panel on Audit Effectiveness concluded that the auditing profession 
needs to address vigorously the issue of fraudulent financial 
reporting, including fraud in the form of illegitimate earnings 
management.[Footnote 9] The study expressed concern that auditors may 
not be requiring enough evidence, that is, they have reduced the scope 
of their audits and level of testing, to achieve reasonable assurance 
about the reliability of financial information that the capital markets 
need for their proper functioning. The study recommended that auditing 
standards be strengthened to effect a substantial change in auditors’ 
performance and thereby improve the likelihood that auditors will 
detect fraudulent financial reporting. The AICPA is working on a new 
auditing standard to improve auditor performance in this area, which it 
expects to issue by the end of this year. 

We have long believed that expanding auditors’ responsibilities to 
report on the effectiveness of internal control over financial 
reporting would assist auditors in assessing risks for the opportunity 
of fraudulent financial reporting or misappropriation of business 
assets. Currently, the auditor’s report on a public company’s financial 
statements does not address internal control or purport to give any 
assurance about it, and auditors are not required to assess the overall 
effectiveness of internal control or search for control deficiencies. 
The important issues of the auditor’s responsibility for detecting and 
reporting fraud and for reporting on internal control overlap since 
effective internal control is the major line of defense in preventing 
and detecting fraud. Taken together, these issues raise the broader 
question of determining the proper scope of the auditor’s work in 
auditing financial statements of publicly owned companies. The auditor 
would be more successful in preventing and detecting fraud if auditors 
were required to accept more responsibility for reporting on the 
effectiveness of internal control. The Congress recognized the link 
between past failures of financial institutions and weak internal 
control when it enacted the Federal Deposit Insurance Corporation 
Improvement Act of 1991 that grew out of the savings and loan crisis. 
The act requires an independent public auditor to report on the 
effectiveness of internal control for large financial institutions. 

For all of the financial statements audits that we conduct, which 
include the consolidated financial statements of the federal 
government, and the financial statements of the Internal Revenue 
Service, the Bureau of Public Debt, the Federal Deposit Insurance 
Corporation, and numerous smaller entities’ operations and funds, we 
issue separate opinions on the effectiveness of internal control over 
financial reporting and compliance with applicable laws and 
regulations. We require extensive testing of controls and compliance in 
our audits. We have done this for years because of the importance of 
internal control to protecting the public interest. Our reports have 
engendered major improvements in internal control. As you might expect, 
as part of the annual audit of our own financial statements, we 
practice what we recommend to others and contract with a CPA firm for 
both an opinion on our financial statements and an opinion on the 
effectiveness of our internal control over financial reporting and 
compliance with applicable laws and regulations. We believe strongly 
that the AICPA should follow suit and work with the SEC to require 
expanded auditor involvement with internal control of public companies. 

The AICPA Chairman recently expressed the accounting profession’s 
support for auditor reporting on the effectiveness of internal 
control.[Footnote 10] Auditors can better serve their business clients 
and other financial statements users and protect the public interest by 
having a greater role in providing assurances of the effectiveness of 
internal control in deterring fraudulent financial reporting, 
protecting assets, and providing an early warning of internal control 
weaknesses that could lead to business failures. The SEC, the AICPA, 
and corporate boards of directors are major stakeholders in achieving 
realistic auditing standards for fraud and internal control. However, 
as we stated in our 1996 report on the accounting profession,[Footnote 
11] the SEC is the key player in providing the leadership and in 
bringing these parties together to enhance auditor reporting 
requirements on the effectiveness of internal control. We believe it 
would be difficult for the AICPA to unilaterally expand audit 
requirements without SEC support. 

Accounting and Financial Reporting Model: 

Business financial reporting is critical in promoting an effective 
allocation of capital among companies. Financial statements, which are 
at the center of present-day business reporting, must be relevant and 
reliable to be useful for decision-making. In our 1996 report on the 
accounting profession,[Footnote 12] we reported that the current 
financial reporting model does not fully meet users’ needs. We found 
that despite the continuing efforts of standard setters and the SEC to 
enhance financial reporting, changes in the business environment, such 
as the growth in information technology, new types of relationships 
between companies, and the increasing use of complex business 
transactions and financial instruments, constantly threaten the 
relevance of financial statements and pose a formidable challenge for 
standard setters. A basic limitation of the model is that financial 
statements present the business entity’s financial position and results 
of its operations largely on the basis of historical costs, which do 
not fully meet the broad range of user needs for financial 
information.[Footnote 13] 

In 1994, the AICPA’s Special Committee on Financial Reporting, after 
studying the concerns over the relevance and usefulness of financial 
reporting and the information needs of professional investors and 
creditors, concluded that the current model is useful as a reliable 
information basis for analysts, but concluded that a more comprehensive 
model is needed that includes both financial information and 
nonfinancial information. In addition to financial statements and 
related disclosures, the model recommended by the study would include: 

* high-level operating data and performance measures that management 
uses to manage the business; 

* management’s analysis of changes in financial and nonfinancial data; 

* forward-looking information about opportunities, risks, and 
management’s plans, including discussions about critical success 
factors, as well as information about management and shareholders; and; 

* background about the company, including a description of the 
business, its industry, and its objectives and strategies. 

The Committee acknowledged that many business entities do report 
nonfinancial information, but it stressed the need to develop a 
comprehensive reporting package that would promote consistent reporting 
and the need to have auditors involved in providing some level of 
assurance for each of the model’s elements. Opposing views generally 
cite liability concerns as a risk to reporting forward-looking and 
other related nonfinancial information, concerns over cost of preparing 
the information, and concerns whether more specific disclosures would 
put business entities at a competitive disadvantage. Although standard 
setters have addressed certain issues to improve the financial 
reporting model, a project to develop a more comprehensive reporting 
model has not been undertaken. 

Enron’s failure and the inquiries that have followed have raised many 
of the same issues about the adequacy of the financial reporting model, 
such the need for transparency, clarity, and risk-oriented financial 
reporting, addressed by the AICPA’s Special Committee on Financial 
Reporting. The limitations of the historical cost-based model were made 
more severe in the case of the Enron failure by accounting rules and 
reports designed for a pipeline operator that transitioned into a 
company using numerous offshore, off balance sheet, quasi-affiliated, 
tax shelter entities to operate, invest in, trade or make a market for 
contracts involving water, electricity, natural gas, and broadband 
capacity. However, criticism of the financial reporting model should 
also consider the criticisms of the corporate governance system, the 
auditing profession, and the regulatory and self-regulatory oversight 
models which may impact the quality of financial reporting. Also, human 
failure to effectively perform responsibilities in any one or all four 
of these areas has been raised by the many inquiries following Enron’s 
sudden failure. Also, Enron’s November 8, 2001, reporting to the SEC 
(Form 8-K filing), which restated its financial statements for the 
years ended December 31, 1997 through 2002, and the quarters ended 
March 31 and June 30, 2001, acknowledges that the financial reports did 
not follow generally accepted accounting principles and, therefore, 
should not be relied upon. 

Among other actions to address the Enron-specific accounting issues, 
the SEC has requested that the FASB address the specific accounting 
rules related to Enron’s special purpose entities and related party 
disclosures. The SEC is expecting the FASB to revise and finalize the 
special purpose accounting rules by the end of this year. The FASB has 
stated its is committed to proceed expeditiously to address any 
financial accounting and reporting issues that may arise as a result of 
Enron’s bankruptcy. In that respect, the FASB at a recent board meeting 
set a goal of publishing an exposure draft by the end of April 2002 and 
a final statement by the end of August 2002 that would revise the 
accounting rules for special purpose entities. The SEC has also 
announced specific areas for improving disclosures, including: 

* more current disclosure, including “real-time” disclosure of 
unquestionable material information; 

* disclosure of significant trend data and more “evaluative” data; 

* financial statements that are clearer and more informative for 

* disclosure of the accounting principles that are most critical to the 
company’s financial status and that involve complex or subjective 
decisions by management; and; 

* private-sector standards setting that is more responsive to the 
current and immediate needs of investors. 

In addition, the SEC has announced plans to propose new corporate 
disclosure rules that will: 

* provide accelerated reporting by companies of transactions by company 
insiders in company securities, including transactions with the 

* accelerate filing by companies of their quarterly and annual reports; 

* expand the list of significant events requiring current disclosure on 
existing Form 8-K filings (such events could include changes in rating 
agency decisions, obligations that are not currently disclosed, and 
lock-out periods affecting certain employee plans with employer stock); 

* add a requirement that public companies post their Exchange Act 
reports on their Web sites at the same time they are filed with the 
SEC; and; 

* require disclosure of critical accounting policies in Management’s 
Discussion and Analysis of Financial Condition and Results of 
Operations contained in annual reports. 

The SEC Chief Accountant has also raised concerns that the current 
standard-setting process is too cumbersome and slow and that much of 
the FASB’s guidance is rule-based and too complex. He believes that (1) 
principle-based standards will yield a less complex financial reporting 
paradigm that is more responsive to emerging issues, (2) the FASB needs 
to be more responsive to accounting standards problems identified by 
the SEC, and (3) the SEC needs to give the FASB freedom to address the 
problems, but the SEC needs to monitor projects and, if they are 
languishing, determine why. 

We support the SEC’s stated plans to specifically address the 
accounting issues raised by the Enron failure and the broader-based 
planned initiatives that begin to address some of the overarching 
issues with the current financial reporting model. It will be important 
that these initiatives be aimed at the end result of having a financial 
reporting model that is more comprehensive while, at the same time, 
more understandable and timely in providing current value financial 
information and nonfinancial information that will provide users with 
data on the reporting entity’s business risks, uncertainties, and 
outlook, including significant assumptions underlying the nonfinancial 
information. We also support a more direct partnering between the SEC 
and the FASB to facilitate a mutual understanding of priorities for 
standard-setting and realistic goals for achieving expectations. 

On balance, standard setting is inherently difficult and subject to 
pressures by those parties most affected by proposed changes. Today’s 
business environment that includes increased globalization, rapid 
technological advances, real-time communication, and extremely 
sophisticated financial engineering is a difficult challenge for 
accounting standard-setters as our commercial world moves from an 
industrial base to an information base. Further more, creative use of 
financial reports, such as the recent phenomenon of using “pro forma” 
financial statements to present a “rosier picture” than GAAP may 
otherwise allow, adds another challenge for standard-setters and 
regulators. On December 4, 2001, the SEC issued FRR No. 59, Cautionary 
Advice Regarding the Use of “Pro Forma” Financial Information in 
Earnings Releases. One of the key points in the cautionary advice 
release was that the antifraud provisions of the federal securities 
laws apply to a company issuing “pro forma” financial information. 

With that said, we believe that the underlying principles of accounting 
and financial reporting are still valid, namely, that financial 
reporting must reflect the economic substance of transactions, be 
consistently applied, and provide fair representation in accordance 
with generally accepted accounting principles. In applying these 
underlying principles, it is important to recognize the variety of 
users of financial information and their financial acumen. One size 
will not likely fit all, and targeted audiences for reported financial 
information may need to be identified, such as sophisticated investors, 
analysts, and creditors versus the general public. We also believe that 
the auditors need to be active players in developing a more 
comprehensive model with the objective of adding value to the 
information through independent assurances. Finally, effective 
corporate governance, independent auditors, and regulatory oversight 
must accompany accounting standards and financial reporting. For 
meaningful and reliable financial reporting, it is not enough to say 
the rules were followed, which is the minimum expectation. Those with 
responsibilities for financial reporting and their auditor must ensure 
that the economic substance of business transactions is, in fact, 
fairly reported. 

I would now like to turn to the results of the work that you requested 
in asking us to look at the resource issues at the SEC. 

The SEC’s Ability to Fulfill Its Mission: 

Over the last decade, securities markets have experienced unprecedented 
growth and change. Moreover, technology has fundamentally changed the 
way markets operate and how investors access markets. These changes 
have made the markets more complex. In addition, the markets have 
become more international, and legislative changes have resulted in a 
regulatory framework that requires increased coordination among 
financial regulators and requires that the SEC regulate a greater range 
of products. Moreover, as I discussed earlier, the recent, sudden 
collapse of Enron and other corporate failures have stimulated an 
intense debate on the need for broad-based reform in such areas as 
financial reporting and accounting standards, oversight of the 
accounting profession, and corporate governance, all of which could 
have significant repercussions on the SEC’s role and oversight 
challenges. At the same time, the SEC has been faced with an ever-
increasing workload and ongoing human capital challenges, most notably 
high staff turnover and numerous vacancies. 

In our work requested by this Committee, for which our report is being 
released at this hearing, we found that the SEC’s ability to fulfill 
its mission has become increasingly strained due in part to imbalances 
between the SEC’s workload (such as filings, complaints, inquiries, 
investigations, examinations, and inspections) and staff 
resources.[Footnote 14] Although industry officials complimented the 
SEC’s regulation of the industry given its staff size and budget, both 
the SEC and industry officials identified several challenges that the 
SEC faces. First, resource constraints have contributed to substantial 
delays in the turnaround time for many SEC regulatory and oversight 
activities, such as approvals for rule filings and exemptive 
applications.[Footnote 15] Second, resource constraints have 
contributed to bottlenecks in the examination and inspection area as 
the SEC’s workload has grown. Third, limited resources have forced the 
SEC to be selective in its enforcement activities and have lengthened 
the time required to complete certain enforcement investigations. 
[Footnote 16] Fourth, certain filings were subject to less frequent and 
less complete reviews as workloads increased. Fifth, today’s technology-
driven markets have created ongoing budgetary and staff challenges. 
Finally, the SEC and industry officials said that the SEC has been 
increasingly challenged in addressing emerging issues, such as the 
ongoing internationalization of securities markets and technology-
driven innovations like Alternative Trading Systems[Footnote 17] 
(ATSs), and exchange-traded funds. 

The SEC routinely prioritizes and allocates resources to meet workload 
demands, but faces increasing pressure in managing its mounting 
workload and staffing imbalances that resulted from its workload 
growing much faster than its staff. Critical regulatory activities, 
such as reviewing rule filings and exemptive applications and issuing 
guidance, have suffered from delays due to limited staffing. According 
to industry officials, these delays have resulted in forgone revenue 
and have hampered market innovation. Oversight and supervisory 
functions have also been affected. For example, staffing limitations 
and increased workload have resulted in the SEC reviewing a smaller 
percentage of corporate filings, an important investor protection 
function. In 2001, the SEC reviewed about 16 percent of the annual 
corporate filings, or about half of its annual goal of 30 to 35 
percent. Although the SEC is revamping its review process to make it 
more risk-based, recent financial disclosure and accounting scandals 
illustrate how important it is that the SEC rise to the challenge of 
providing effective market oversight to help maintain investor 
confidence in securities markets. 

SEC Staff Turnover: 

In addition to the staff and workload imbalances, other factors also 
contribute to the challenges the SEC currently faces. SEC officials 
said that although additional resources could help the SEC do more, 
additional resources alone would not help the SEC address its high 
staff turnover, which continues to be a problem. Furthermore, in recent 
years the staff turnover and large differentials in pay between the SEC 
and other financial regulators and industry employers resulted in many 
staff positions remaining vacant as staff left at a faster rate than 
the SEC could hire new staff. Although the SEC now has the authority to 
provide pay parity, its success will depend upon the SEC designing an 
effective implementation approach and the agency receiving sufficient 
budgetary resources. We also found that the SEC’s budget and strategic 
planning processes could be improved to better enable the SEC to 
determine the resources needed to fulfill its mission. For example, 
unlike recognized high performing organizations, the SEC has not 
systematically utilized its strategic planning process to ensure that 
(1) resources are best used to accomplish its basic statutorily 
mandated duties and (2) workforce development addresses the resource 
needs that are necessary to fulfill the full scope of its mission, 
including activities to address emerging issues.[Footnote 18] 

As we noted in our 2001 report on the SEC’s human capital practices, 
about one-third of the SEC’s staff left the agency from 1998 to 2000. 
[Footnote 19] The SEC’s turnover rate for attorneys, accountants, and 
examiners averaged 15 percent in 2000, more than twice the rate for 
comparable positions government-wide. Although the rate had decreased 
to 9 percent in 2001, turnover at the SEC was still almost twice as 
high as the rate governmentwide. Further, as a result of this turnover 
and inability to hire qualified staff quickly enough, about 250 
positions remained unfilled in September 2001, which represents about 
8.5 percent of the SEC’s authorized positions. SEC officials said that 
they could do more if they had more staff, but all cited the SEC’s high 
turnover rate as a major challenge in managing its workload. Likewise 
industry officials agreed that many of the challenges that the SEC 
faces today are exacerbated by its high turnover rate, which results in 
more inexperienced staff and slower, often less efficient, regulatory 

Although the SEC and industry officials said that the SEC would always 
have a certain amount of turnover because staff can significantly 
increase their salaries in the private sector and some staff only plan 
to stay at the SEC for a period of time, many said pay parity with 
other financial regulators could enable the SEC to attract and retain 
staff for a few additional years. The SEC estimated that a new employee 
generally takes about 2 years to become fully productive and that pay 
parity could help them keep staff a year or two beyond the initial 2 
years. Although industry officials said they were generally impressed 
by the caliber of staff that the SEC hires and the amount of work they 
do, they said that staff inexperience often requires senior SEC 
officials to become more involved in basic activities. Industry 
officials also said that certain divisions, such as Market Regulation, 
could benefit from staff with a fundamental understanding of how 
markets work and market experience. They said that such experience 
could help speed rulemaking and review processes. However, SEC 
officials said that they have a difficult time attracting staff with 
market experience, given the government’s pay structure. 

Some officials said that the SEC’s turnover rate should decrease after 
pay parity is implemented. Presently, the SEC professional staff are 
paid according to federal general pay rates. On January 16, 2002, the 
President signed legislation that exempted the SEC from federal pay 
restrictions and provided it with the authority necessary to bring 
salaries in line with those of other federal financial regulators. That 
legislation also mandated that we conduct a study to look at the 
feasibility of the SEC becoming a fully self-funded agency. Although 
the SEC now has the authority to implement pay parity, as of March 1, 
2002, the SEC has not received an additional appropriation to fund its 
implementation. In addition, the SEC has to take a number of steps to 
effectively implement this new authority. 

Although the SEC’s workload and staffing imbalances have challenged the 
SEC’s ability to protect investors and maintain the integrity of 
securities markets, the SEC has generally managed the gap between 
workload and staff by determining what basic statutorily mandated 
duties it could accomplish with existing resource levels. This 
approach, while practical, under the circumstances, has forced the 
SEC’s activities to be largely reactive rather than proactive. For 
instance, the SEC has not put mechanisms in place to identify what it 
must do to address emerging and evolving issues. Although the SEC has a 
strategic plan and has periodically adjusted staffing or program 
priorities to fulfill basic obligations, the SEC has not engaged in a 
much needed, systematic reevaluation of its programs and activities in 
light of current and emerging challenges. Given the regulatory 
pressures facing the SEC and its ongoing human capital challenges, it 
is clear that the SEC could benefit from an infusion of funding and 
possibly additional resources. However, a comprehensive, agency wide 
planning effort, including planning for use of technology to leverage 
available resources, could help the SEC better determine the optimum 
human capital and funding needed to fulfill its mission. 

Closing Comments: 

A number of witnesses who have recently appeared before this Committee 
and other congressional committees to discuss Enron’s failure have 
stated that our nation’s system of capital markets is recognized around 
the world as the best. I share that view. Our capital markets enjoy a 
reputation of integrity that promotes investor confidence that is 
critical to our economy and the economies of other nations given the 
globalization of commerce. This reputation is now being challenged. The 
effectiveness of our systems of corporate governance, independent 
audits, regulatory oversight, and accounting and financial reporting, 
which are the underpinnings of our capital markets, to protect the 
public interest has been called into question by the failure of Enron. 
Many of the issues that are being raised have previously surfaced from 
other business failures and/or restatements of financial statements 
that significantly reduced previously reported earnings or equity. 
Although the human element factor, and the basic failure to always do 
what is right, are factors that can override systems of controls, it is 
clear that there are a range of actions that are critical to the 
effective functioning of the system underlying our capital markets that 
need attention. In addition, a strong enforcement function with 
appropriate civil and criminal sanctions is also needed to deal with 

The results of the forum that we held last week on governance, 
transparency, and accountability identified major issues in each of the 
areas, which I have addressed in my remarks today, that endanger their 
effective functioning to protect the public interest. As is usually the 
case in issues of this magnitude and importance, there is no single 
silver bullet to quickly make the repairs needed to the systems 
supporting our capital markets. The fundamental principles of having 
the right incentives, adequate transparency, and full accountability 
provide a good sounding board to evaluate proposals that are advanced. 
A holistic approach is also important as the systems are interrelated 
and weak links can severely strain their effective functioning. I have 
framed a number of the key issues today for congressional 
consideration. As always, we look forward to working with you to 
further refine the issues, and develop and analyze options and take 
other steps designed to repair the system weaknesses that today pose a 
threat to investor confidence in our capital markets. 

In summary, Enron’s recent decline and fall coupled with other recent 
business failures pose a range of serious systemic issues that must be 
addressed. Effectively addressing these issues should be a shared 
responsibility involving a number of parties including top management, 
boards of directors, various board committees, stock exchanges, the 
accounting profession, standard setters, regulatory/oversight agencies, 
analysts, investors, and the Congress. In the end, no matter what 
system exists, bad actors will do bad things with bad results. We must 
strive to take steps to minimize the number of such situations and to 
hold any violators of the system fully accountable for their actions. 

Mr. Chairman, this concludes my statement. I would be please to answer 
any questions you or other members of the committee may have at this 

Contacts and Acknowledgments: 

For further information regarding this testimony, please contact Robert 
W. Gramling, Financial Management and Assurance, at (202) 512-6535. 
Individuals making key contributions to this testimony include Cheryl 
E. Clark, Michael C. Hrapsky, Thomas J. McCool, Jeffrey C. Steinhoff, 
and Orice M. Williams. 

[End of section] 

Attachment I: Overview of Regulatory and Private Sector Structure: 

{Refer to PDF for image] 

This attachment contains a rather complex diagram of regulatory and 
private sector structure. Included in the diagram are lines of 
responsibility between various agencies indicating their 

[End of figure] 

[End of section] 


[1] Highlights of GAO’s Forum on Corporate Governance, Transparency, 
and Accountability [hyperlink,
494SP], March 5, 2002. 

[2] SEC Operations: Increased Workload Creates Challenges, (GAO-02-302, 
March 5, 2002). 

[3] FASB, as part of the Financial Accounting Foundation (FAF), is a 
not-for-profit organization supported by contributions from accounting 
firms, corporations, and other entities that are interested in 
accounting issues. FASB consists of seven full-time members who are 
selected and approved by the FAF. 

[4] Government Auditing Standards, Amendment No. 3, Independence 
[hyperlink,], January 

[5] Government Auditing Standards were first published in 1972 and are 
commonly referred to as the “Yellow Book,” and cover federal entities 
and those organizations receiving federal funds. Various laws require 
compliance with the standards in connection with audits of federal 
entities and funds. Furthermore, many states and local governments and 
other entities, both domestically and internationally, have voluntarily 
adopted these standards. 

[6] The Advisory Council includes 20 experts in financial and 
performance auditing and reporting drawn from all levels of government, 
academia, private enterprise, and public accounting, who advise the 
Comptroller General on Government Auditing Standards. 

[7] Testimony of AICPA Chairman before the House Energy and Commerce 
Committee (Subcommittee on Communications, Trade and Consumer 
Protection), February 14, 2002. 

[8] Federal, state, and local government auditors generally have their 
responsibilities defined by law or regulation. Therefore, rotation of 
government auditors raises different considerations than in the private 
sector. However, the rationale behind rotation of auditors (enhancing 
auditor independence) is addressed in Government Auditing Standards. 
The standards add organizational criteria that consider factors in the 
appointment, removal, and reporting responsibilities of the head of the 
audit organization to ensure independence. The organizational criteria 
for determining auditor independence are in addition to personal and 
external requirements that are considered in judging the independence 
of government auditors. 

[9] The Panel on Audit Effectiveness Report and Recommendations (August 
31, 2000). The Panel was formed by the Public Oversight Board at the 
request of the SEC to study the effectiveness of the audit model and 
other issues affecting the accounting profession. 

[10] See footnote 7. 

[11] The Accounting Profession Major Issues: Progress and Concerns 
September 24, 1996. 

[12] See footnote 11. 

[13] The accounting and reporting model under generally accepted 
accounting principles is actually a mixed-attribute model. Although 
most transactions and balances are measured on the basis of historical 
cost, which is the amount of cash or its equivalent originally paid to 
acquire an asset, certain assets and liabilities are reported at 
current values either in the financial statements or related notes. For 
example, certain investments in debt and equity securities are 
currently reported at fair value, receivables are reported at net 
realizable value, and inventories are reported at the lower of cost or 
market value. Further, certain industries such as brokerage houses and 
mutual funds prepare financial statements on a fair value basis. 

[14] Staff resources are measured in this report in terms of full-time 
equivalent staff years. 

[15] A company files an exemptive application when it seeks an SEC 
decision to exempt a new activity from existing rules and laws. 

[16] The SEC Chairman has recently announced an initiative called real-
time enforcement, which is intended to protect investors by (1) 
obtaining emergency relief in federal court to stop illegal conduct 
expeditiously, (2) filing enforcement actions more quickly, thereby 
compelling disclosure of questionable conduct so that the public can 
make informed investment decisions, and (3) deterring future misconduct 
through imposing swift and stiff sanctions on those who commit 
egregious frauds, repeatedly abuse investor trust, or attempt to impede 
the SEC’s investigatory processes. According to the SEC, insufficient 
resources may inhibit the effectiveness of this initiative, which 
depends upon prompt action by enforcement staff. 

[17] An ATS is an entity that performs functions commonly performed by 
a stock exchange. 

[18] High performing organizations are organizations that have been 
recognized in the current literature or by GAO as being innovative or 
effective in strategically managing their human capital. 

[19] Securities and Exchange Commission: Human Capital Challenges 
Require Management Oversight [hyperlink,
bin/getrpt?GAO-01-947], September 17, 2001. 

[End of section] 

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