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U.S. Securities and Exchange Commission

Roundtable Discussion on Financial Disclosure and Auditor Oversight

Thursday, April 4, 2002

Securities and Exchange Commission
Midwest Regional Office
175 W. Jackson Blvd., Suite 900
Chicago, Illinois 60604

Panel 1: Improving Financial Statement Disclosure

Moderator, John Rogers, Chairman and CEO, Ariel Capital Management
James Dimon, Chairman and CEO, Bank One
Robert Litan, Economic Studies Director, Brookings Institution
John Markese, President, American Association of Individual Investors
John Rekenthaler, Research Director, Morningstar
Maryann Waryjas, Katten Muchin Zavis & Rosenen
John Zielinski, Senior V.P., Equity division of Northern Trust Global

Panel 2: Assuring Adequate Oversight of Auditing Function

Moderator, J. Carter Beese Jr., President, Riggs Capital Partners
Ken Bertsch, Director, Corporate Governance, TIAA-CREF
David Costello, President and CEO, National Association of State Boards of Accountancy
Professor Dan Fischel, University of Chicago Law School
Barbara H. Franklin, President and CEO, Barbara Franklin Enterprises
Edward Nusbaum, CEO, Grant Thornton

Panel 1: Improving Financial Statement Disclosure

Chairman Pitt: Good morning, Commissioner Cindy Glassman and I are pleased to welcome all of you here. This is the third in a series of roundtables, that the Commission has been holding to consider public views on two critical issues. Financial disclosure, and regulation of the accounting profession.

We have been blessed with, as you can see in front of you, a panel of diverse and enormous expertise, all of which is being devoted to this effort pro bono, for which we are very grateful. And with that, I'd like to turn this over to the moderator, John Rogers, who's the Chairman and the CEO of Capital Management.

I just would say that Commissioner Glassman and I are here to learn. So, you will not hear us speak during the program, but it's not because we're shy or retiring, it's because we want to learn. John?

Mr. Rogers: Well, thank you very much. I'm really excited to be here today, at such an important time in this country's history to be able to talk about these types of issues. And we do have a really prestigious group here.

We've handed out everyone's biographies, and handouts, hopefully everyone has one. So, I won't read all of the biographies in detail. But, I want to just introduce our panel briefly. Mr. Jamie Dimon, who is the Chairman and CEO of Bank One Corporation, and prior to that Jamie served as President Chief Operating Officer, and Chief Financial Officer of Travelers, Inc. And subsequently is President of City Group.

Next to Jamie we have Bob Litan. Bob is the Vice President and Director of Economic Studies, a program in — Family Chair in economics in the Brookings Institution. He also is co-director of the family AEI Brookings Joint Center on regulatory studies, and co-chairman of the — Financial Regulatory Committee, and co-editor of the Brookings Wardens Paper on Finance.

Next to Bob is John Rekenthaler. John is the President of on-line advice, from Morningstar Associates. In this role, John overseas the development of, and marketing of Morningstar's Clear Future. An internet based service that provides investment research, education, and health for individual investors planning for retirement.

Then, we have John Markese, Dr. John Markese, who is President and Chief Executive Officer of the American Association of Individual Investors, a non-profit educational association founded in 1978. Dr. Markese presents investment seminars for the association, and write columns, and stock analysis.

And then finally, we have Maryann Waryjas. And Maryann is the partner and law firm of Katten, Munchin Zavis & Rosenen. She focuses her practice in the areas of sophisticated corporate securities, and venture capital transactions, and executive compensation.

And then, John Zielinski is a Senior Vice President, and Senior Port Folio Manager of the institution of Equity Division of the Northern Trust Global Investments. John is the lead manager of the northern growth balance, and diversified growth mutual funds, representing over $1 billion in equity assets.

Again, we have a very, very diverse group of panels here today.

As you know, recently the SEC, and under Chairman Pitt's guidance, has really been pushing hard for more disclosure, and more financial disclosure for american corporations. Jamie, what do you think of this new push for more financial disclosure?

Mr. Dimon: You know, I think, first of all, I've always been in favor of good adequate proper timely disclosure. So, I don't think it's that new, I think that Enron brought it to a forefront again. And, you know, I think somehow in the last ten years things got worse.

And they should have, you know, it's a shame, because it's hurt a lot, and we should fix it. And there should be some rules and requirements that fix it. And I think all management should make an effort to make sure they're making full, fair, and adequate disclosures.

Mr. Rogers: How does Regulation FD, how do you think that initial thrust that occurred a few years back, how do you think that that has helped to separate this thesis?

Mr. Dimon: I don't think, I mean, Regulation FD, in my opinion, mostly changed the timing, and not the quality of disclosures. And, you know, so there have been some pluses from Regulation FD, and some minuses, but I don't think it changed anything about how much you disclose.

Mr. Rogers: Bob, do you have some thoughts on that also?

Mr. Litan: Well, I agree with Jamie on FD. But, back on the first question on the issue of financial disclosure. We're all here because of Enron. Although, as the Commission's well aware, there were a series of accounting lapses highly publicized that led up to Enron.

I think Enron highlights three issues, which I hope that we will get into, in more detail, as we talk about it this morning. Number one is how to improve the standard setting process for financial statements. And specifically what to do, if anything, about FASB.

Number two, how to improve the enforcement process. And there, of course, we have the SEC's proposal to establish the public regulatory board, and I think we ought to have a conversation about that, and other devices to improve enforcement of the standards. And not just with respect to auditing, but the larger scheme that is established to enhance enforcement.

And the three, I hope we have time to get to what I call the cutting edge issues. The long run issue, which actually Chairman Pitt to his credit was trying to discuss before Enron blew up. And that is, how do we adapt disclosure to a world of the internet, to a world in which non-financial indicators are as important, if not more important, than financial indicators. And there is not better proof of that, and I'll conclude this opening statement with the front page of the Wall Street Journal, by total coincidence today, it's all about intangible assets. And I think at some point we need to have a discussion about that.

And I think it will be a shame, if in our rush to fix "Enron", that we miss dealing with some of these longer run cutting edge issues, which didn't have the hot button quality to it that all the post Enron fixes have. But, frankly in my mind, or as important, if not more important to the future of disclosure, than anything we're going to talk about with respect to Enron.

Mr. Rogers: John, do you want to —

Mr. Rekenthaler: Yes, in preparation for this gathering, I reviewed Chairman Pitt's words on this matter. And I would say that at Morningstar we're generally in agreement with what the principals that the Chairman is espousing.

First, he talks about the need for more quality, rather than more quantity in financial disclosure. One of our stock analysts noted that Nortel's 10-K Report had 220 pages. I don't think we need another ten or 20 pages added to that, in fact, we could probably shrink it fairly effectively.

However, there are certain items that we'll touch on later, in terms of quantity, that where we do things some specific disclosure is needed. But, in general, I think the answer for financial disclosure lies along the lines of better formatting, and in some case simplification, as opposed to additional rules. In general, there are a couple of exceptions.

The second point made by Chairman Pitt is the need for stronger SEC oversight. Stronger enforcement possibilities, I mean, just in general the SEC having more control over accounting principals. We're certainly in favor of something to give more teeth to the accounting board, more teeth than FASB currently has.

However, we do note that the SEC itself is, certainly has no choice but to listen to Congress, and listen quite hard at certain times. And we've seen corporate pressure exuded through Congress on the SEC, so we still have some concerns or thoughts that that central issue of congressional pressure might not be alleviated.

And third, Chairman Pitt calls for stronger corporate government governess, a stronger better role of the independent directors. We're all for that principal, although we have a little difficulty seeing how that will occur in practice.

At Morningstar, we've been quite involved on the mutual fund side, with mutual fund directors. And despite various efforts over the years, I wouldn't really say that the mutual fund independent directors have become more independent, and really driven more change now than they did 15 years ago. It's fairly tough, the incentive structures for directors to, in many cases, to get them to do what you and I might think of as truly independent decisions, or shareholder oriented decisions.

So, we're with the Chairman in spirit, but we have to spare a little bit in practice that that will occur. A little more input in comments.

Mr. Rogers: John?

Mr. Markese: Thank you, I'm an individual investor advocate, so my viewpoint is fairly narrow here. I think we're driving individual investors into the hands of analysts, which may be good or bad. I won't let individual investors off the hook, they need to have minimal education, they need to make an effort here.

But, if you've picked up a 10-K lately, it's not a question of undisclosed information, as much as over disclosure. There's so much information, and there's no points of relevancy, points of importance made. We have tremendous amounts of information, should we get it sooner? Of course. Should we get it in better formats? Of course.

But, we have to sit back and ask management of these corporations to summarize. We've done this in the mutual fund area, gone to the simplified prospectus. Plain English, we need a summary, we need management talking about value drivers, risk drivers, major accounting policies.

In other words, here's the 10-K with its enormous amount of information. We have to ask the management of these corporations to say what's important. In summary form, we have to ask them what major accounting policies, decisions, estimates, disclosures, what foot notes. We have to help individual investors, at least half way. And I think we don't have that. I think it's a legal, let's say a legal initiative to disclose everything. And there's no emphasis on the importance of the various issues disclosed.

So, I would encourage the SEC to encourage the corporate management of this nation to essentially talk about what's important, talk about forward looking things, talk about estimates, talk about trends. Talk about important accounting policies, not every accounting policy. We need to give individual investors summary financial information, and summary guidance on what this corporation is doing, what are the important elements.

So, that I think is —

Mr. Rogers: John, could you follow up on that? It seems that that's come up already a couple of times this morning, that there's possibly a danger of having too much information. And so could you maybe give a little more of your views of how you would determine what were the important issue that should be focused in on?

Mr. Markese: Well, you can ask, you can set it up. You can say at very detail, this is what management has to touch upon in an MD&A discussion. But, I think that changes by industry so much, and by firm, I think to ask them to say, okay, you're a manager, what do you need to communicate about these financial statements that are most important, that will most effect the future of this corporation? Whether it's individual issues to the firm, whether there are metrics involved, whether there are trend issues involved.

We talk about the foot notes, as I mentioned, two things happen. Number one, and when we collect the data, and we send it out through data vendors, those foot notes don't get attached along to that data. When we say, everybody's heard this, read the footnotes, read the footnotes. Well, there's 30 footnotes, which one of them are important? And they're all fairly intricate.

I think it behooves management to sit down and say, are these are the decisions we're making? These are the estimates we've made, here are the value drivers in these industries. Is that where we think we're going in a forward looking sense? And if we need more safe harbor rules to allow them to do that, than I think we should do that.

I don't think it's probably worthwhile for the SEC to sit down and enumerate for every firm a 20 point check list. But, I think, let the management decide, and let the markets decide if they've done a good job. Let's see how it works.

Mr. Rogers: It seems, you know, it seems to make so much sense. The question is, why doesn't that happen? And is there anything that, and I think John you're having some thoughts or Dave?

Mr. Rekenthaler: I just wanted to echo what John said. I think that, the way I look at that is the change in the mutual fund prospectuses. When I started at Morningstar in the late 1980's, my actually, my first job was to go through mutual fund prospectuses, to try to glean relevant information from them.

And fairly quickly I learned that that meant, you know, searching for a nugget on page three, then another nugget on page eight, and in between was five pages of the same boiler plate language that was in every prospectus. And what you had at the time for mutual fund prospectuses were 25 or 30 page documents that really contained about two pages, at most, of information that was different from one fund to another. And 28 pages of the same boiler plate, but not in the same places, in different prospectuses.

So, you might have the fees and expenses on page nine in one place, and page fourteen in another place. And it was just a, what was really a fairly narrow range of information became just a chore to pull this out. And that's what I hear our stock analysts saying about stock reports right now.

Now, the mutual fund side, it really made a great deal of improvement. There's now a summary section of mutual, in particular with the fees up front, that's formatted. There's a move towards plain English prospectuses. And there's a lot of good stuff up front, where frankly you don't really need to go back and look at the stuff at the back that's added. It's really, it summarized it, and got to where you can get to the key points in a mutual fund prospectus, at least the better designed ones, in two or three pages.

I'm not saying we can do it in two or three pages for stocks, for various reasons, they're a little more complicated. But, I think we can have the same process of prioritization and focus in formatting, up front, where the average investor can get meaningful information without being forced to wade through page after page of what turns out to be boiler plate. And this can be very difficult, unless you do this a whole lot, to be able to distinguish between the boiler plate, and the meaningful things.

So, let's pull that out, get it up front, say this is meaningful, and this part is more routine.

Mr. Rogers: Well, you're just saying adding, you're talking about in terms of written communications with prospectuses and the like, I've often noticed in the last year or so that corporate board meeting rooms, and committee meeting rooms are now getting into the point where people are filling up the time with all the, checking the boxes with all the information that needs to be discussed, and then not leaving time for there to be thorough discussion to prioritize what's really important, and to really get at what the driving issues are.

So, I think it's as equally important in the written communication, as well as in the way our board rooms are working these days. Is there another side of the argument that someone thinks that prioritizing and simplifying isn't a good idea?

Ms. Waryjas: Well, I'm not going to say I don't think it's a good idea. But, I guess as working stiff attorney who's out there in the trenches, what I would like to report back is that I have personally experienced, and my colleagues have experienced, a much heightened awareness of the overall scope of materiality. Which, John, I think does go contrary to the checking the box.

We still go through, and check the boxes as part of the due diligence that we do, because we want to make sure that we've covered the broad range of issues. But, in the dialogues that we are having with the companies auditors, with the companies management, with members of the boards of directors, there is a much heightened awareness. And people are paying attention, and are asking questions about what's material. Things that in the past might have just been presumed to be ordinary course, or how things are done, are now being questioned. And those meetings are lasting longer, and there are being other calls made to council from directors or other managers in the company, or from the general council's office.

I think that more disclosure is not necessarily better, in and of itself. I think we are all living in an age, right now, with information overload. I have the difficulty myself. But, I do believe that different individuals, different analysts, may ascribe different values to different types of information.

So, for example, while some folks might consider the pension, or the tax information, to be not particularly relevant, certainly in the mutual fund industry the tax implications of how fund earnings that are, you know, are channeled through, became very relevant. And more so, I would say in the last three to five years.

So, things that have previously been considered not as important can take on a new light. I think that the Commission working right now to address matters, to address financial products which have taken a driving force in our economy, which really didn't exist in any way the same shape or form ten years ago, is admirable. And the rules need to be more dynamic, the rules need to be reviewed more frequently, and updated so that the application has a broader base.

Mr. Rogers: John, do you want to?

Mr. Zielinski: Yes, I was just going to jump in for maybe a slightly different perspective. And I think most of the panel has hit a couple of very key points.

As an investor I listen to a lot of conference calls, as I'm sure others might. And you listen to the quarterly conference call, when a company talks about their earnings, and how the quarter went and so forth. And I think, you know, one of the earlier comments about Reg. FD, I think, while well intentioned, Reg. FD, in may respects, may have, kind of had an opposite effect.

And I think what it's done, like a lot of laws, it's caused a lot of the, kind of law abiding good citizen companies to really be very, very reluctant to want to talk to their investors, for fear that they may either disclose some information that might be viewed as forward looking, or promising results, and so forth.

And I think what's happened is that with many companies, the way I, when we talk to managements, when we invest in companies, we obviously want to have a high confidence, in terms of what they're doing, the products they're producing, what their next quarter's going to be like, what the future looks like. And what we find is that many companies, I think, are reluctant to be able to discuss things with investors, for fear of litigation, and so forth.

And I think what's happened is that while, as I say, while there are a lot of good intentions with Reg. FD, a lot of the information that you do get from companies now is that really, it's just that check list. It's just going over the numbers, it's not really talking about some of the things that Dr. Markese talked about. Talking about trends, talking about business outlook, which I think most investors would be probably more interested in, than just what were the earnings per share last quarter?

Additionally, to the extent there's some subjectivity in accounting, which I think there is, I think companies have to disclose to the extent they're using various accounting techniques, or various accounting tools in formulating their financial statements. At least prioritize, or disclose what the, you know, what types of interpretive data, if you will, is in the numbers.

And as I say, I think many companies would welcome the opportunity to do that, but may be reluctant to do so today, for fear of maybe a lack of a safe harbor provision, or adequate safe harbor provisions, and fear of maybe litigation on the part of some of their investors.

So, as I say, I think it really runs the gamut when you look at companies. The good law abiding companies out there, which I say the vast majority are, want to be more open, and want to have more disclosure to the extent that they can, and not jeopardize potentially their competitive position. Other companies that have things to hide, obviously, are reluctant to provide more disclosure.

So, again, I think there are plenty of laws, there are plenty of rules on the books already, I think we just need to enforce, and maybe that's the key, enforce the ones that we have for those that currently break the rules.

Mr. Rogers: Bob?

Mr. Litan: Yes, on this issue of summary information, let's just call them executive summaries of financial information. I'm going to express a little skepticism. I think it's very hard for the SEC to write rules about this, because it's hard to mandate, and define in advance, what's material and not material, that goes in the front part of the statement. And whatever the SEC decides to do, if it ends up writing a rule, is going to be taken by the Maryann's of the world, or the Chairman in his former life as a securities lawyer, you're going to reduce this to a formula. That's what's going to happen. Every company is going to want to just go by the checklist. And at the end of the day, are we really going to get that much more improvement?

I think, what I, what I would suggest is more productive, is to have the SEC out front exhorting companies, that they should have more meaningful executive summaries. And then let the markets punish and reward companies that do a good job, and that don't do a good job, on the issue of executive summaries.

Now, there are two broader issues though. And that is, I think what's even more important than the executive summaries, and a quarterly statement, or an annual statement, are much more frequent, and relevant intra-quarterly disclosures. And this is addressed by the Commission's 8-K filings, and the Commission has provided us with a list of a number of additional events, now, that it wants companies to publish within two days. Things like changes in management, changes in rating agencies, and so forth. This is the kind of thing that the markets want. They want more frequent, relevant information.

There's a lot of hand wringing about information overload. My experience is, is that there are always consumers out there for more information. Whether it's analysts, or underwriters, or rating agencies, or whatever, it may not be the individual investor, because they're at the end of the rope. But, there are all of these translators in there. More information is better than less.

And I'm actually an advocate of internet based disclosures. I think ultimately one day we ought to get to daily financial reports. I know that sounds totally far fetched, but banks such as Jamie's, balance their books every night. Securities firms do this. There is no reason why, there is no reason why in the world of the internet we can't at least have financial companies, and other companies, report much more frequently their financials on the internet.

And I will tell you what I think a side benefit of this is. Everyone wrings their hands about earnings management, and they don't know what to do about it, with companies trying to hit the quarterly targets. I think the best way to address earnings management, is to put more information out there more frequently, and people will forget about the quarterly numbers, when you've got numbers coming out weekly, or monthly, or even daily. The quarterly thing will disappear, and you can't manage weekly earnings. People will give up managing, and they will just report. And I think that will solve the problem of earnings management. I haven't heard any other good suggestions to address it.

Mr. Rogers: Jamie?

Mr. Dimon: Yes, I just want to talk about these issues. One is the executive summary. I agree there should be an executive summary. I think most companies try to write it up until it goes material. There is always a requirement that we disclose material stuff, that didn't change.

And, I, you know, so, but, I agree, I don't think it's going to solve this problem. I mean, people are looking for simple quick answers. You all have bought houses and cars? Do you want a three sentence summary on the house you're going to buy? You can do a title search, kick the tires, look at the roof, and look at the garage. So, there has to be fair, and full adequate disclosures.

The problem, in my opinion, and you know, is that, and in those days you could say it. You know, are we going to spank the people who don't do it? You know, you have to have some rules and requirements that can be followed, that actually make sense.

The disclosures aren't adequate, and fair, and full in a lot of environments. The accounting policies are not fully disclosed, they are not, they're too wide, okay? When, you know, these or whoever sets rules and requirements, it takes them four years to do something now. It's got to be done quickly, and then fully, and fairly disclosed.

So, anyone of us who, those of us who buy and sell companies, the first thing we do is we go and say, how did you account for this versus that? And what's this on your balance sheet for? And why did we do this? We make those adjustments to put it in an apples to apples basis. And it could be made a lot simpler.

I'll give you one example, just from my past that sticks in my mind. The proxy statements years ago had requirements to disclose contracts between executives and the company. And this was when — was first coming out. And so, all of you, if you wanted to figure out what those were, you could have gone and read the proxies. And they were fully disclosed, everything was in there, and how many years of bonus, and how many years of this, and how many years of pension.

But, if someone had said very simply, disclose how much it will cost your company if that parachute is triggered for, you know, individual "A". That's the one number you really wanted, and that's the one number you couldn't get, and would have taken you six to nine months to figure it out, and you would need actuary, but, in fact, the companies knew.

So, I think that someone, I mean, if I was in, you know, the Chairman's role here, I think that someone's going to have a faster, fuller, hold people's feet to the fire, what they disclose, and how they disclose it. And then let the people do their homework. And there is not totally simple answer for that at all times.

And the footnotes are important, some of them are worthless. You know, what they should do is change the ones that are worthless. I've never read a fair value footnote disclosure to a company. There's pages and pages of disclosures, I don't what they mean, you know? But, we spend a tremendous amount of time doing it. So, but there are other footnotes you absolutely read. I always read the tax footnote, always, every single time. It tells you a lot of information.

So, I think that this disclosure, the accounting policies are too wide. I can go to a lot of companies today, and they're reporting $100 of profit, they could report 130 or 70, by changing five accounting rules. I personally think that's wrong, okay? And that that should be buttoned up, and changed quickly, and disclosed. The Board should look at stuff like that, ask what's the quality of your earnings, and the quality of all the things like that.

And, so I don't think it's the summary that needs to be fixed, I think it's the quality of information that's already there has gotten a little bit lax, and should be changed over time.

Mr. Rogers: John and Maryann, you didn't have a chance to weigh in on the many broad themes that you wanted to get across.

Mr. Dimon: Just let me comment, I don't think, with all due respect, I don't think FD, any company who says they're not — we are required to make adequate, fair, full, and material disclosures. FD doesn't change that. So, if a company says, well we can't tell you that because, the only thing to get worried about at FD, the only thing is that we inadvertently tell you something that might be material.

Do you know what we've done? We go out and make a disclosure right away. And that's, we have a safe harbor for that, and that's, I think it works fine.

Mr. Rogers: Do you guys have any other themes?

Mr. Zielinski: The only kind of general theme I would maybe weigh in on is that I think the market, in many respects, is already fixing some of its problems. I mean, I think the accounting statements are very complex, they've gotten more complex, they're going to remain complex. There's probably things that can be done to simplify them, to make them more clear, and make them more timely.

But, I think the incentive on the part of most companies, will come through the normal market mechanism. I think we see that in the debt markets all the time. High quality bonds trade at lower interest rates than lower quality bonds. I think over time, those companies that might be viewed as lower quality, because either they have inadequate disclosure, or inappropriate disclosure, or their statements are too complex. Over time, I think what that does is their cost to capital rises relative to those companies who have understandable financial statements.

So, I mean, I think there's things that the Security and Exchange Commission needs to do from an enforcement standpoint. My hope is that over time, though, the normal market mechanisms work their magic, and companies will be, I hate use the term forced, but be incented to more adequately disclose, and have more transparent financial statement. Because over time that means a lower cost to capital, rather than a higher cost to capital. That, therefore, improves their competitive position relative to their fears.

So, I would just say as kind of an over arching theme, you know, that's my hope. So, while I think the laws that we have are, you know, need to be probably updated to the new internet age, or whatever, I think the market's already begun to kind of work its wonders, and differentiate those companies that I would just generally call high quality from low quality.

And I think whereas before, you know, the financial statement was just kind of a given, now the understandability, and the complexity of that is being differentiated in the market place, and there's a price to that. So, I think the, I would just say, I think that's all, that process has already begun.

Ms. Waryjas: I think it's important to note that the disclosures are not only in the financial statements, but in the MD&A. In one of the prior sessions, Warren Buffett spoke about having that MD&A communication read like a letter that the CEO is writing to a partner who has been out of the country for a period of time, and trying to bring that individual up to speed on the state of the business.

One of the other commentators at another one of the roundtables referred to the current state of MD&A as elevator music. And I chuckled when I heard that, because I found reading or participating in MD&A drafting sessions mind numbing. Revenues went up, cost of sales went down, this went here, you know. You know, and you do it once for this year to last year, then you do it again for the last year to the year before. By the time you're done, you find yourself thinking who cares.

Obviously people do, but to see that kind of information in tabular form, and to see what the Commission has called for about trending, and other information. To have a discussion about what the trends have been over the past three years, over the past five, six quarters, would probably be much more informative to both the investors, and the analysts. So that MD&A would read more, perhaps like the president's letter to the shareholder, than its current very static requirements.

That information should still be provided, but I think that there is a lot of current MD&A requirement that could be put in tables, which could be attached as exhibits or elsewhere, you know? But, maybe just before, or included there. But, the MD&A would be a discussion of the information that's presented in tabular form, rather than this mind numbing elevator music.

Mr. Rogers: Maryann, you mentioned Warren Buffett, and he had some very eloquent remarks at, I think, one of the prior sessions, about the kind of questions that should be asked by auditors, by audit committees. And I've been on a lot of audit committees, and it's been very rare that I've seen those kind of insightful questions asked. Can you comment on that?

Ms. Waryjas: Well, the one question that I find very intriguing, I think it's going to get a lot of information, but it's one that I think that the audit committee members should make sure that senior management knows, and the auditors know before they're asked, so that they're prepared.

His key question is, would you have prepared these financial statements any differently if you were doing them for your company? Okay? If this was you, if you're the auditors, would you have done anything differently here?

And Mr. Buffett wants the answer to that question recorded in the minutes of the audit committee meeting. One would hope that the answer there would be, no, everything here has been done the way we all agree it should be done.

On the other hand, I've been in practice long enough to have realized, Jamie has spoken about transactions, merging acquisition transactions. I don't think I have participated in any transaction where there has been a post closing purchase price adjustment where the parties have not negotiated, or argued vigorously, as to how the accounting was different. Okay? And over the years I joke that there has been, you know, a PriceWaterhouseCoopers GAAP, there was the Deloitte Touche GAAP, there's different GAAPS. Within a major accounting firm, within different offices you may have different interpretations.

So, GAAP, I think what's important to communicate to individual investors, I think that there is this sense out there that you pour all this information into a giant like concrete mixer, or computer program, and it spits out, and the numbers go into the appropriate boxes. And that's not how it works, there is not that level of scientific precision.

But, again, you know, understanding what's important, would the accountants had done things differently? Do the auditors really report to the audit committee? And I think that that change is occurring now, but I think in prior years, it was very clear to see that in many instances the relation was with the auditors and the CFO. And I'm not saying that was a bad relationship, I'm just saying that I believe that that's how it was.

Mr. Rogers: Bob, do you want to follow up on that? Because I think that's really, I think a crucial issue that I think hasn't been discussed as thoroughly as much as the consulting versus auditing issue is front page all the time. This issue has just recently started to bubble up a little more. You know, I think it's really more at the heart of it.

Mr. Litan: Yes, let's focus on the audit committee, because I think that's where the rubber hits the road. I testified before the Senate Banking Committee about three weeks ago, based on some work that I'm currently doing, thinking about, among other things, who should hire the auditors.

And the way it's done now, of course, is that management typically hires the auditors. And then we get all these kinds of proposals to try to objectify that process. Example, let's bar the auditors from doing non-audit work, let's rotate the auditors, those are the two most popular proposals. And I had expressed skepticism about whether either one of these will actually work. In the sense that you can bar, you know, from now until forever, accountants from doing non-audit work. But, the reality is if all they're doing is audit work for a CFO who is picking them, they will still have incentives when the times get tough, to bend the CFO's way, because they're going to lose all their business.

So, I find this, to be perfectly honestly with you, a sham issue. I know it's the issue, everybody talks about, that this is the root of all evil. But, I think if you stopped auditors from doing all audit work, you're not going to solve the problem.

Ditto with mandatory rotation. We've only got big, you know, if Anderson fails, we've got four firms left. And so we're going to basically rotate them on four firms. Do you really think this is going to help? And you're going to have beauty contests every four years with firms basically interviewing the auditors. I do not see how rotation's going to help as long as management is hiring the auditors.

And I survey all the other kinds of people that could hire the auditors instead. You could have the SEC do it, you could have the exchanges do it, you could have the new PRB do it. I saw an op ad in the New York Times a couple weeks ago, somebody suggested insurance companies ought to do it by offering financial statement insurance, and let the insurers do it. I don't think any of these other proposals, while they're attractive in principal, will actually work, once you go into the details. The only practical proposal for separating or insulating the auditor from being infected from management, is have the audit committee do it.

It is not perfect, because audit committee are still composed of board members, and board members are still influenced, if not chosen by management. On the other hand, it's better than all the other alternatives. At least it's insulated from the CEO telling them, telling the auditor what they ought to do.

So, I want to underscore the absolute imperative. I mean, maybe the SEC can do this by rule tomorrow. It ought to say that audit committees should have the decision to hire and fire auditors, period.

Mr. Rogers: Dr. Markese?

Mr. Markese: I want to make a comment on audit committees. But, first I have to say this. I still have the bruises from Reg. FD, from going around championing Reg. FD. I was beaten up in so many forms, and I just have to tell you the individual investor reaction to Reg. FD.

There were two reactions. One was dancing in the financial aisle, right? They've now been enfranchised. The second one was shock. Do you know what the shock was? That we didn't have Reg. FD all along, they thought we did. So, I'm delighted we do it, it's done great good for everybody, and the individual investor community, let's not change that. We can work on it, but let's not change it.

Now, I have what I would have said the privilege of being a Chairman of an audit committee, I don't know these days if that's a privilege anymore. But, just as a comment, we just redid our charter. And in that charter we have that the audit committee hires and fires the auditor. Very simple, and that the audit committee controls that decision. The auditors do not report to the management, they report to the audit committee as a function on the Board.

And if you have a good charter, you have good people, it will work. I don't think we have to look beyond that. So, I'm in sense saying yes, and no. I think any good board, with any good audit committee, and now, by the way, a good audit committee has to be financially literate, it has to be public, and independent, and they have to have the power, and they have to have the support of management. But, that's true of all our disclosures, all our ethics issues. Enron was an unusual configuration of a black moons lined up. I don't think the average board has that. I think we have the abilities to have great disclosure, and great control.

I think we all need to look at these audit charters, and the effective power. So, the audit committee I'm on, I feel we have the power, we have the mandate. And we hire those auditors, and those auditors better tell us what's going on. And we will fire them, if necessary.

So, I think I'm seconding it in a sense, but I think the system does work, and it can work.

Mr. Rogers: Is there a third out there? Or, is it worth this?

Ms. Waryjas: I guess I have a question for John. John, you said you're not sure it's a privilege anymore, and that is a comment I've heard from individual directors. There is concern about serving on the audit committee. The concerns relate both to personal liability, as well as to significant increases in the amount of time these individuals think that they need to spend now to appropriately fulfill their obligations. And I was, it would just be interesting to hear your reaction.

Mr. Markese: Well, I read an article on audit committees a while back, and that's where they stuck a lot of people that they couldn't figure out what else to do with. O.J. Simpson being one, being on an audit committee.

So, I think we're evolving here, and there is, I hope we're evolving. We have an enormous time commitment for all the committees, and I think there's liability on any board situation.

So, it behooves anybody, I think, to understand the management, and the trust in the management. I think that is ultimately your only safeguard against liability, is the quality of the management, that board you serve on, and the people that sit next to you. We've all served on boards, and that's ultimately the only — the SEC can't do anything about that. That's a quality of ethics. And we can have rules about it, but it's simply those people that are on that board, and are managing that firm.

Mr. Rogers: I'm just, back to this court issue, is there a new consensus opinion that audit committees really should hire and fire the auditors more directly? Or, is there another side to that argument?

Mr. Dimon: Well, obviously, first of all, it's almost always been that way for most companies already, that's not a massive change. And, you know, obviously they should be directly involved in interviewing and getting, you know, making sure it's done properly, and all that.

But, I, just again, as management, I would not, okay, rely, and I do not rely on our auditors for our proper numbers, we rely on us. They audit, but we are responsible for the accuracy, the timing this, and stuff like that. And, you know, I don't think that, you know, for example, Arthur Anderson is not to blame for Enron. Enron is to blame for Enron, okay? Arthur Anderson is also to blame for not being made the theme work better.

And so I go to committees, some do and some, it's hard. You know, it's very hard for a director, any director, to walk into a meeting, you know, and spend three or four hours once a month, or once every two months, and actually know what management's going to know, or what the accounting firm should know.

But, there are certain rules and requirements. It's absolutely — make it better, that they do hire and fire, that they meet privately with them, that they have a full disclosure about material accounting policies. And the best thing I heard, somewhere I was at a recommendation, was that an — this, I can, you know, sometimes putting these things in practice is much more complicated than just saying it here. But, that the audit firm would give a grade to management as to their, both their conservatism, and their proper financial disclosures and stuff. And that's A,B, or C, let's keep it simple. And that if it's going to be a "C" for a second year, it's got to be made public.

And boy you'd have audit committees spend a lot of time if there were C's, about making sure we don't ever go public. That we have, you know, our financial disciplines would get rated enough to see that we're not a "C" rated company. And, something like —

Mr. Markese: What about F, Jamie, you left out "F".

Mr. Dimon: Or "F", or "F" for that matter.

Mr. Rogers: John, do you want to?

Mr. Rekenthaler: Well, actually I have a question for the panel, because in many respects in relation to the other panelists, I'm a bit of an outsider here. I mean, I've not served on a public corporation Board of Directors. I've been in Morningstar's Board of Directors meeting, it's a privately held company.

So, I have a question. You know, what is the responsibility of directors in overseeing accounting practices? In this company like Xerox, that ends up restating earnings. What should, what is the role of the directors in that process? Is it absolutely unacceptable to be a director, associated with a company that has accounting practices that are later deemed to be bad? Is it understandable? I don't know, I'd like to know.

Mr. Rogers: That's a good question. Are you asking if that's, it follows up with sort of a, Jamie's discussion of saying that it's the Enron management that ultimately is responsible for the disaster that occurred there?

Mr. Rekenthaler: And I would assume that the, that internal management clearly bears responsibility, and there can be no shirking of it if the accounting is bad. But, the external directors?

Mr. Rogers: Right, and we've all heard this. Maybe just to put it, maybe expand it a little bit, too. Is that, you know, when you go around, like we all are, we go around town, and everyone, some people want to blame Arthur Anderson, some people want to blame Enron management, others want to blame the Board of Directors, some want to blame the regulators.

You know, where is that responsibility? And how much of it is the Board of Directors, as John brings out?

Ms. Waryjas: Directors have a duty of care under state law, to certainly oversee the company, and to ask appropriate questions based on what is brought to their attention. Audit committee members would have, I would think, if not a heightened duty of care, certainly the responsibility to take the initiatives on behalf of the entire board to drill down a little bit deeper into the financial statement, in the financial reporting area.

But, that duty is one where, again, I have participated unfortunately in some independent investigations of companies that have not complied with their financial reporting obligations. And you can't legislate honesty, you can't legislate integrity. People have been moved to do things for various financial rewards, and they've made some very bad, very poor judgements.

And I was involved in one situation where the outside directors were clearly uncomfortable, they weren't sure what was wrong. One individual in particular was uncomfortable, and that's why the audit committee sought separate counsel. Many companies would feel that on a regular basis, the audit committee does not need separate counsel, and I would concur with that.

But, certainly if there's a situation where the audit committee has particular concerns, and perhaps to assist the audit committee in connection with fulfilling the responsibilities, that that might be appropriate. Or other experts, so that they have fulfilled their duty of care.

John mentioned meetings, or Jamie mentioned meetings that are, you know, three to four hours, you know, every couple of months. That may work for a basic manufacturing company, that may work for some basic technology companies. But, once you have a company that is engaged in either multi national operations, or is using significant sophisticated financial products, I would think that that discussion could go a little bit longer.

Jamie, you said you've read footnotes, you know, and you don't know what they mean. I go through, and if I'm helping a company, I try to work very hard with the financial team, so that we understand. I'm not sure who else in the world may understand, but we need to understand what's there before it goes out.

So, I think that directors are aware of their duty of care. I would also, this is not a matter for the Commission, but as companies are going public, many of the newer public companies, despite the efforts of their accounting firms, and their outside counsel, and the underwriters, are not necessarily as aware. on a one and one basis, as to what their duties and obligations are going forward.

And if we are talking about having the CEO being personally responsible for negligence, and even if that doesn't occur, it might be a good idea for the listing agencies, for NYSE, NASDAQ, AMEX, to consider whether or not individuals who are going to be named executive officers, or directors, participate in some form of formal training.

Everyone has suggested training, companies are doing it for their audit committees, but it might be something to consider, that Professor Joe Grundfest out at Stanford, does an outstanding directors college every year. But, certainly to get the individuals somewhere where they I, yes, are exposed directly, and learn more about their duties and responsibilities. Because some of these individuals just haven't had that training.

Mr. Rogers: One thing, that maybe follow up a little bit, you talked about the three or four hour meetings. And I've noticed that there are some CEO's nowadays, who want to make the meetings longer, have more meetings, and it seems like maybe they feel like they're doing their fiduciary responsibility.

The interesting thing is there's academic research now that talks about that, you know, just like we all, a lot of us went to college or graduate school, and there's a certain time that your courses are, you know, how long they last. You know, typically a college course maybe is an hour and half. And that's because the academic research shows there's a certain amount of information that somebody can absorb effectively, and be able to, you know, really understand it, and respond to it.

Mr. Rekenthaler: Let's hope the boundary's two hours, not an hour and a half.

Mr. Rogers: But, do we run the risk as we move to four hour meetings, and sometimes six hour meetings, that we have filled directors with so much information that you would have to be some kind of Einstein to be able to absorb it all, and be effective as a manager? Just throw that —

Mr. Dimon: Yes, I, honestly I don't think making longer meetings, I mean, I agree with Warren Buffett, I should be able to describe to my Board, John happens to be on my Board by the way.

Mr. Rogers: Full disclosure.

Mr. Dimon: Full disclosure, what's going on, what's important, as best as I can. Not that we're perfect, not that we won't make a mistake in the three hours, okay? That does not mean you could be an expert in, you know, our tax returns, and things like that, that could come back and haunt us.

But, I want to give a legal, a non-legal answer to the question. The Board is absolutely to blame, the management is absolutely to blame, Arthur Anderson is absolutely to blame. They're all a hundred percent, in my opinion. Anyone of them could have stopped that fiasco, anyone of them.

So, it's, you know, now, we may look at the Board, because this is going to be an absolutely great book that gets written one day, and say, how much, maybe they weren't told enough to know. But, there was a, there is a, so maybe they're less contingent, you know, liable for all the things that happened. I'm not talking about legally, I'm just talking about what could've, should've happened in these kind of circumstances. And so —

Mr. Rogers: So, Jamie, if the Board is absolutely is absolutely to blame in Enron's case, is it absolutely to blame in more moderate accounting scandal? One that has restated earnings, but the company's still going?

Mr. Dimon: No, because I, no, I didn't read in detail, they haven't given the information, how Xerox is restating. But, lease accounting can get very technical, I don't know what happened there, and I don't think Board's going to get involved in technical lease accounting, okay?

And so the answer in that one would be no, not really. I wouldn't put that in the same category. Now, if it turns out that their accounting was virtually fraudulent, that there were memos that had gone on for years about some of the stuff, then the debates with partners about, you know, how we could move it offshore, so we don't have to book it the same way, well then, yes, then someone should be responsible for some of that stuff.

Mr. Rogers: It depends on the circumstances.

Mr. Dimon: Absolutely, it depends on the circumstances.

Mr. Zielinski: If I could jump in there. I think the, one of the questions, or the earlier question was, you know, what's the directors responsibility? I think in a broad sense at the end of the day, the directors are elected by the shareholders, and so theoretically they represent the shareholders interest.

If certain directors would want to micro manage the Accounting Department, or the audit committee, that's their choice. If other directors choose to delegate that function, and are comfortable with accepting the recommendations of the auditors, or the Finance Department, I mean, that's their choosing. I don't know that you can regulate, or mandate they need spend "X" number of hours managing the process, I mean, I think it's up to them.

But, again at the end of the day they represent the shareholders interest, to the extent they want to be detached, and may be not as interested, and to the extent then there are accounting problems. I mean, therein lies there, I guess the risk of not being as involved. But, I think it's up to them to either take at face value what the audit committee says, or what the outside auditors say, or what the Finance Department says. Or, micro manage if they so choose.

And I think most director's responsibility at the end of the day is not to micro manage. But, unfortunately the current environment probably dictates that they be more engaged than maybe they have been in the past. So, I think over time, though, that sorts itself out.

Mr. Dimon: Can I make a, can I give a specific example that there's a full disclosure, and what a board can, and can't do, okay? And this is a very personal one at Bank One, is that we lease cars. And, you know, when I first got there someone said, we're going to have a residual value adjustment, it's a $20 million loss, with all this technical stuff about operating leases, and accounting, and stuff like that.

I'm going to tell you what the real facts were, which I told our board the second I looked into it. We had $10 billion, these numbers may be off now, $10 billion of car leases. We had estimated the residual value of those to be worth six billion. Now, these are cars, remember people, you ever heard the saying people don't wash rented cars? Okay?

That means that six billion, in three years, or four years, they are going to hand back to us, stinky, dirty, rotten, smelly cars, which we've estimated to be worth $6 billion in three years. That's what that number is.

Now, I don't expect the Board to get into, now, we could be wrong on that six, it could be six two, it could be five eight. Does anyone know the answer to that question? I absolutely defy anyone to ever know the answer. We wrote up at $800 million, by the way, full disclosure is that it's six, that these are estimates. I don't expect them to know exactly how we did all those estimates. I do expect, my real question was, my opinion, you know, we should have never had that much. It was just too much, and we hadn't done it conservatively, okay? That conservatism is probably half of that $800 million write off.

And so there's full disclosure, but not the technical aspects of it. And by the way, it is in, I would talk about it in the Chairman's Letter every year, how much of that crap is left, okay? And it could be wrong again.

Mr. Rogers: Under the circumstances, I mean, that's even, it's also under — I mean John gives a good example. On John's point about how board members spend their time. You know, I remember Bill Bowen, who was the former President of Princeton, wrote a book about corporate government, and it was sort of the traditional view that board members were there to hire and fire the CEO, think about succession planning. Now, like if you'd naturally add hiring and firing, maybe the auditor.

Are we going to a world where those sort of traditional standards really are not acceptable anymore? And that you want a board that's micro managing? And if so, then what's the downside to that? And, you know, because I think we should confront that issue. Because I think a lot of board members are confused about whether they should be trying to get into every minute detail. And I think then there's a risk of, I guess I'm getting my opinion out here now, there's a risk of losing the forest from the trees, and the big core issues that really drive, that profitably the business could be lost if you're trying to do too much.

Mr. Zielinski: Yes, again, I guess my part would be, I certainly don't want my board members micro managing. You know, they're there to maybe kind of set the strategic course, assist in many of things that you mentioned, John. And to the extent they are micro managing, you're right. That's spending more time on probably things that they should not spend their time on.

I think that what we may be setting ourselves up for is kind of this, kind of an, you know, if you're, you know, kind of an asymmetric payoff. If you're thinking of being on the Board, you know, there's, you know, there's nowadays, maybe not, you know, not a lot of upsight necessarily, but if we tack on a lot more liability and problems, a lot of potential downside, either emotionally, financially, or otherwise.

So, again, in kind of viewing the role of the Board, unfortunately I think recent events have probably kind of forced them, in a sense, to get more involved in kind of a day to day, then what they're either comfortable doing, qualified to do potentially in some cases, or probably should be doing. Again, they're there to kind of set the strategic course, assist senior management in visioning the business. And that's what I think strong board members do, and don't micro manage.

Mr. Rogers: Let me just pursue one more moment, too. I just think about my own career, we're, you know, in the same field, and I'm in the money management, and mutual fund business. When we started our company 19 years ago, we used to have some clients who would approve every single trade, every stock we bought or sold was approved by the investment committee of our customer.

As the years have gone on, now, you're finding more and more of the big endowments and pension funds, they're delegating the endowments and pension funds to the staff, to really pick and choose the money managers who pick and choose the stocks. And it's gone, you know, totally away from the micro management of picking individual securities by those committees.

I think that's been a major improvement. And the performance, I'm on the investment committee at Princeton, and have an $8 billion dollar endowment. If they tried to pick and choose every stock in that endowment, it wouldn't be, they wouldn't run it effectively. I think the Boards made the right decision in delegating the management team to do that.

So, I get really concerned if we start to move toward where the board members feel this need to get in and run the show, and not have the confidence and faith in the management to make the core decisions that will be important. But, I guess, I'm sort of getting my opinion out as moderator, which maybe I shouldn't do.

We talked about how the board meetings themselves are run. One other thing that I guess I've noticed, and ask the question about is that, how much time should be spent in an executive session with the auditor? And who should be, and how much time should be spent with management in the room?

Because I think that's important to, in how information flows. When you asked me those great creative questions, and Warren Buffett, you know, brought up the other day, the answers will be different if you've got a room full of people versus a smaller group in an executive session. How do people view that?

Mr. Litan: Well, you can't give a hard and fast answer to that. Obviously you should do both. You want to see management in front of the auditor, just to see what they say. And then go into the executive session, and see what the auditor really thinks. And the facts and circumstances will dictate this.

But, let's get to the larger issue of how much time the audit committee is going to have to spend in this brand new world, assuming that they're going to have all these responsibilities, which I think they're going to end up getting. The fact is they are going to have to spend more time, and if they do, companies will have to pay them more in order to attract them.

I mean, there's nothing wrong, it seems to me, in saying that if you're going to serve on the audit committee of the Board, that the audit committee, because it requires all this extra time, these people get paid more. Because they've got to go to more meetings, both inside and outside of the company, and they have more responsibility, that's how the system works.

Mr. Markese: Bob, as a comment, I agree with you. I think audit committees should be paid more. But, I'm joking really. Because I think there's an issue of being bought here, and I think there are limits on compensation for all the committees.

I have to tell you, I mean, a structure of an audit committee is one where when you have meetings and you have management there, then you go into an executive session with the CFO for instance, management in a sense, you're external auditors, your internal auditors, you know, the general council, I mean that's a standard format. I can't believe a company would do that.

But, my point is, I guess is that if you look at this whole concept of trust, and audit committees, and payment in time, I think in the Enron's case there was substantial stock holdings, and option holdings by board members. There was, I hate to say it, the classic empty suit there, there was a celebrity, there was a political consultant, there was the people that actually had become corporate officers in a sense. They've been on this board so long, that we had such great familiarity, and we have the same concept with the audit firm being at Enron. We had alumni of that audit firm, again another issue, at Enron. And Arthur Anderson had substantial staff there.

And now we have audit committees, supposedly they're looking at those hires, who should be looking at those hires. I guess the whole issue comes down on, they're working harder, but we have to be careful about paying them more. I think we corrupted a lot of people at Enron, on the Board, and in the audit committee there.

So, while I think there's a compensation issue there, I think there's a dangerous issue also.

Mr. Rogers: Let me, I think the, how the meetings worked though, I think is something maybe people, I think, haven't explored it very much. But, there is actually a lot of, also, academic research on the number of people that should be in a committee meeting, to have an effective meeting where people can really communicate, and not give speeches to each other.

And I think what's happening more and more, is everyone feels the need to be in the room, because the pressure is so high right now. And so in effect, again, you could have ineffective, less effective meetings because of this pressure that's coming.

Mr. Dimon: I'll give you a great, great quote. Someone once said, the bigger the crowd, the better the news. And I kind of agree with that. You know, if you want to, you should, I mean, a lot of managements, you know, there are auditors who I want to make sure that they air everything, so that we overall, do much better. We're not going to be well served if they think they're doing us a favor by putting some problems under the rug. And so I think they should be lean, and full disclosure, you know.

Mr. Rogers: I think that would be something if the regulators would, you know, I think if we actually give them some guidance on who should be in the room, and how much time should be spent with the auditors in the executive session.

Because I think sometimes a lot of boards have rushed that at the end. They'll bring in the auditors for the last ten minutes, and people are rushing to the next committee, or to lunch, or dinner, and they've gone through all the, they've checked the boxes for an hour and 50 minutes, and then they've got ten minutes left for the auditor. And I think we've all been there in that situation, and I think that's something that needs to be thought about a little more.

Making change in gears, one thing we haven't talked about is the issue of the major investment banking firms, and their conflicts in terms of how the information flows to investors. How much responsibility, it's been recently that these sell side analysts are getting a lot of criticism for their inability to actually do their job effectively. Is that fair criticism? And what can we do to help resolve that?

Mr. Litan: Let me jump in on that. Yes, the criticism is fair. There's so much out there about sell side analysts, it's hard to know where to begin. I'll be totally candid. I think you've got to be pretty much crazy to trust a sell side analyst. That gets my views out.

Now, the real question is, from an academic point of view, is why aren't there more independent analysts out there? And the sort of standard answer you get from a lot of academics that I've talked to is, customers don't seem to want to pay for it. Right?

Mr. Rekenthaler: Right, we can tell you that.

Mr. Litan: Yep, they just don't value the information. And a second reason is, is that as more and more people go to index investing, I'm talking about individual investors, you don't need analysts to be an index investor, I mean, I'm an index investor. And most academic research tells you that that's what the little guy ought to do, they shouldn't be out there picking stocks.

So, there's a real conundrum here of how we're going to get to a world in which we have more independent analysts. I think in a world of more rapid, and more frequent internet disclosures, that it is conceivable that demand will grow up before an independent analyst industry. Especially as we go to, this is another sort of insider, or inside the beltway term, it's called XBRL. It's basically a business language that will, that is currently being developed by the accounting profession in a number of firms, to enable people to manipulate data much more easily than they're able to do now.

But, as we get more and more information out, there will be a greater need, I think, or a greater evidence of a need, for independent people to interpret this information, as more and more of it comes out. And so it's conceivable that the independent analyst industry will grow up, and the investment banking owned analyst industry will wither. Because I can certainly tell you now that the investment banks have suffered a severe setback in terms of their credibility.

Mr. Rekenthaler: Bob, if I can follow up on your point, because I've been thinking about your earlier comments on the dissemination of information, and this moving to a monthly, weekly, daily, and I've been wondering where that leaves the individual investor?

As you've touched on that, if the individual, presumably most individual investors are not going to be tracking many stocks on a daily, or weekly basis, and it's going to be difficult to compete with professionals. As you increase the time limits, you increase the demand. I mean, the professionals, that's what they do, they get paid to sit there and look at the terminals, and look at the information, as opposed to somebody, individual investors may have another job. And in addition, if they can't rely on the sell side analysts, it doesn't seem that there's much of a world for individual investors picking stocks, which is what you alluded to when you talked about indexing. And I just wanted to kind of confirm that that seems to be where your viewpoint leads. Without the development of this independent analyst industry, there's not a lot of good reason for an individual investor to be selecting stocks. In which case, you know, I mean, that has implications on this whole issue of disclosure, as it is how much are we trying to satisfy the individual investor?

Mr. Rogers: Jamie?

Mr. Dimon: Well, here, I'll split it between the way I think is fair, and unfair criticism. Fair criticism, if research people report to investment bankers, that's not, that's fair criticism. And if they're paid directly for deals or recommendations, etcetera, that's fair criticism. Here's the, I probably would put the unfair category. They're all different, some are very, very good, they do great work, okay? And some aren't that good, and they are independent. Sanford Bernstein's independent, mutual fund people are independent. If I want to know about this company, and John's done research, I could talk to his analyst, and learn a lot about it. So, there is a lot of independent stuff.

I think that if you were, that and most people, again, they want the quick little answer. And then now, they're going to, because after the grateful market, they're going to come down and blame someone. They didn't buy it because those people made recommendations, okay? I defy most money managers, if you got all the money managers all lined up, and you said, did you buy that because of the analyst's recommendation? It's almost never true. They like reading the research for the quality information, and again, it's quite good. And again, some aren't that good. And that's, that's the free world, there's nothing you can do to change some of that.

So, you know, I don't think you're going to totally change it. I think that maybe eventually, like more like utilities that, where people do some great research on companies. And, you know, I always go, when we look at companies, I always read the research reports that other people did. Particularly the ones who I think are really smart. And I don't look at what it says, whether they say buy or sell. I would agree, and if somebody says, you know what, maybe just get rid of that in total. Just wipe it out, and stop doing it, and just read it for the quality of the work that's been done, and their analysis that they've added extra value to the understanding of a company, or an industry.

Mr. Rogers: That's the same way that I read reports, Jamie.

Mr. Zielinski: Yes, I'd, I guess as a reader of many of those sell side research reports of maybe kind of chime in here. And I'd agree with Mr. Dimon, I mean, it runs the gamut. I think, certainly post Enron, most, if not all sell side analysts have kind of become the whipping boy, or the poster child for, you know, the fact that over time, you know, and you see the statistics, you know, 95 percent of the recommendations out of Wall Street are, you know, buy or strong buy. And, you know, very rarely will you see a sell recommendation.

But, you know, there's been independent analysis for years. In fact, I'd say right now the booming industry, and if I were, if I had a little pocket change, I think that the great, a great industry, which has thrived and really thriving even more, kind of an independent forensic accounting research boutique. I mean, believe me, there are going to be money managers that will pay for that kind of independent research, for firms that can go through and analyze company's financial statements.

But, there's been a lot of independent research, and I think, now, what probably happens over time is that it's not cheap. I mean, you know, we buy independent research, I'm sure John Rogers buys independent research, and it doesn't come cheap. And so what that does though is, it certainly makes, I guess, the larger investment houses, the larger mutual fund complexes who have access to that, who can obviously absorb that high fixed cost, and buy that research at a somewhat competitive advantage to those maybe smaller, or individual investors that don't have access to that independent research. Which, again, is somewhat costly.

But, I guess, that fact that, you know, there's been a lot written in the press lately that, oh gee, all the sell side analysts only issue buy recommendations. I guess that's something that we've kind of known all along. And you do have to take some research with a grain of salt, but again it runs the gamut. There are a lot of very, very bright people on Wall Street working for investment banking houses that happen to write research reports, that I use in my day investment activities.

But, again, I think what does happen, though, I think you'll see, and we've seen signs already, that those maybe sell side firms that had maybe more of a traditional structure where maybe research was kind of joined at the hip, if not formally, only somewhat informally to the investment banking side, certainly try to, you know, separate those two functions a little more formally to at least create the aura, and probably make them more independent going forward.

So, I would say there's a great need right now, and people are willing to pay for that independence. And I think a lot of these research boutiques that are out there are really having a field day, now, in terms of signing up new clients, to be honest with you.

Mr. Litan: I just want to amend for the record, since I made the outrageous remark about sell side analysts. I was referring specifically to the recommendation, at the end. And I certainly agree with Jamie that, I mean, I read a number of these reports too, and they have incredible amounts of very useful information in them.

The economic question though is, is who's going to pay for this stuff going forward? If they're really delinked from the investment side, who's going to pay for it? Now, in the work of institutional buyers, there is a demand. And it seems to me that one thing we could see evolving naturally, is some of these really smart people that Jamie's talking about, and I know some of them. They may leave the investment banks, and form their own firms. And we'd end up getting the independent analyst industry developed that way, because once you've divorced them from the investment banking side of the business, why should they hang around a Morgan Stanley, or a Goldman Sach's, when that supposed advantage, two or three years ago, now may turn into a liability?

And if people are really paying for brains, why don't they go off and do it themselves? And without issuing recommendations, all they're doing is selling their smarts. And if they do that, that may be the industry structure in the future.

Mr. Markese: Bob, the independent analyst for the individual investor turns out to be newsletter writers.

Mr. Litan: Right.

Mr. Markese: All the newsletter writers that are out there, they're not the formal on Wall Street analysts. But, we have thousands upon thousands of investment newsletters, I wouldn't venture to guess how many are good. But, those are your independent analysts who are simply putting out advice.

So, and by the way, the individual investor's always going to be buying stocks, and probably, hopefully indexing. They're not mutually exclusive, so we need to arm them better in all of this. And we need not to force them into the hands of an analyst, if they choose to make an effort, and choose to educate themselves, at least minimally.

But, I think what we've talked about today is a good start, I think we're moving that way.

Mr. Rogers: Is there any downside to the hardening of the Chinese Wall, with truly investment operations, and the analyst positions? And how about Jamie's suggestion of getting rid of the buy and sell. Is there another side to that argument?

Mr. Rekenthaler: Well, I think there's certainly a market demand for buy and sell. So, unless you want to regulate, you're not allowed to say buy or sell. I think you probably could see it, despite the articles, and the suspicion that's been given here about sell side analysts. There are a whole lot of people out there that believe sell side analyst's viewpoints, and that buys and sells are valuable. And, you know, these folks are on CNBC for a reason. People pay attention to it, and, you know, I don't see that changing.

So, you know, if I ran a firm with sell side analysts, I'd keep buys and sells, or mostly buys in this case, going.

Mr. Rogers: John, you work with Morningstar, which is a wonderful, the successful mutual fund ranking company that's sprout out into lots of other areas. But, could you talk some about the disclosures issues that are front and center in the mutual fund industry right now? I know, you've been fighting some battles, and we'll get some of those out.

Mr. Rekenthaler: Yes, well, one of the issues in the mutual fund area that's similar is the, relates to what I was talking about earlier, one of the downsides, I think, of the argument, that you have summary information. I like the idea of having summary information up front, and the detailed information, or more marginal information back there. And force management to prioritize, which is important, and work with that.

But, what we've had in the mutual fund industry is something called a statement of additional information, and which used to be, I think, in the old days part of the traditional prospectus. At any rate, it's not mailed with a, it's considered to be marginal information that somebody can get upon request. The trick is, it's really hard to get it, even when you request it. We found that the statement of additional information, which is the part "B" of the mutual fund prospectuses, that's available upon request, in reality there's still many mutual funds we don't have them for, because we just can't get them. People are so unused to sending them out, that that's a — so, it's withered away, and become too marginal in our view.

So, that would be, I noticed there's some ideas about having some kind of summary annual report. And then you might be able to ask for additional parts of the annual report upon request. And based on my experience, you might not get it.

Now, possibly this could be addressed to be of the internet age, that this is up and freely available to anybody with an internet address. So, that's, it's possible the technology will solve that.

Mr. Rogers: I know Morningstar's also talked about how disclosing more quickly to the stock holdings that the portfolio managers pick. I'm curious, we have another portfolio manager here, John, and what your view of that is? And then other's might have opinions on that?

Mr. Zielinski: I've got to be very careful, because one of my chief compliance officer's is in the audience here, so I've got to — as a, you know, surely we follow the SEC mandates in terms of our annual reports, and our semi annual filings. Additionally, if I'm not mistaken, we do furnish other periodic reports, monthly and quarterly. At minimum, I believe, disclosing our top ten holdings. I happen to run in equity funds, so if the things I'm describing are unique, or particular to an equity fund, a fixed income fund, we would probably need to disclose different types of information.

But, things like our sector diversification, our capitalization, distribution, et cetera, our average PE ratio. In some respects I have no problem with having that information disclosed. I mean, I think in the normal course of business, again, it kind of gets — I see a parallel track in here in terms of what companies need to do. To the extent, we want to attract more investors to our funds, I'd like, like companies may want to attract more investors to their stocks, more disclosure is better than less disclosure.

I think investors, whether they're investing in an individual stock, or into a fund, will put their dollar into those funds that they have the highest confidence in. And if that means disclosing things like our fund holdings on a monthly basis or something, you know, that's perfectly acceptable, to a degree. I mean, I think having a disclosure fund holdings everyday may be a bit onerous.

I mean, I'm competing with other funds in my category, in some respects, I, while I welcome the opportunity to tell my investors what we're investing in, and why we're investing in it, I guess in some respects I'm a little reluctant to tell my competitors what I'm doing, for fear that that may lessen my advantage I have over them in this competitive environment that we're in.

So, I mean, I think, again, more disclosure is better than less disclosure. I think over time, those funds that may disclose more information find that that attracts more investor dollars to their funds. And so being profit minded, I would expect that we'd favor more disclosure.

Mr. Rekenthaler: Just a couple comments. One, for clarification. Yes, what Morningstar, and some others, have been requesting in terms of mutual fund disclosure is, I think, fairly parallel to what Chairman Pitt has been talking about. You know, a modest increase, and cut down in disclosure time, as opposed to anything like daily.

Right now, the rules are that mutual funds need to disclose their holdings twice a year, and there can be a 60 days lag time from the point of the measured, say June 30, and when you actually need to release that report. And we've been asking for quarterly with a monthly lag.

So, a fairly modest increase. Although that's not one that has necessarily been embraced by all the mutual fund companies, and by the investment company institute, which is the fund trade group.

The second point to make is, John, your notion of the market addressing this. You know, I don't know. I mean, I'm in favor of market solutions. On the other hand, one could argue, you know, we don't need any regulations regarding corporate disclosures. And the market will solve, and reward the companies that make good disclosures, and not buy the stocks of the bad disclosures, and we're probably back to the 1920's, or something like that. And I will note that Fidelity is a notable opponent of disclosing more frequently. And they seem, the market seems to be treating them pretty well.

So, I wouldn't say that the evidence has been strong, that the market has rewarded companies that have disclosed information more often. Which one can say, then maybe it's not that valuable, get that information more often. At least that's the market place score card.

Mr. Markese: You know, what seems obvious to me, and I may be inventing something that already exists. But, anytime there's a filing by a firm, an 8-K, a 10-K, whatever, why aren't we requiring firms put that up on the internet immediately at the same time they file? I don't see any great cost burden on firms to have an underside base. And maybe that's something the SEC is considering.

But, that would be a mandate the SEC could make, and it seems to me it would improve disclosure, improve the timeliness, get it a broad distribution to shareholders. And, in fact, the shareholders could request, push E-mail on that. So, whenever an announcement is made like that, it could be pushed to everybody who submits their E-mail, all shareholders, and in fact, anyone interested.

A simple solution, we have the technology. Again, a disclosure, not related mutual funds.

Mr. Dimon: I think it's already pretty much done.

Mr. Markese: But, it's not mandated, I don't believe.

Mr. Dimon: No, but it is, once you're, I think once you file with the SEC, you know, within hours it's on their public sites.

Mr. Markese: Yes, but that's different.

Ms. Waryjas: So, within less than hours.

Mr. Markese: Yes, but you're, that's different from sending it out to your shareholders.

Ms. Waryjas: Shareholders. The Commission has proposed that there be posting within one business day after the filing of any of the mandated reports. So, I think that is a positive. But, I do think many companies are already doing that.

Mr. Markese: Probably the larger companies, a lot of the smaller ones do not.

Ms. Waryjas: The 8-K incremental list of items to be filed, and including the posting on the website, I do think there's a change, which will provide additional disclosure to investors. In the past, companies have been able to file an 8-K without having to do a press release, or post the information in the 8-K. It was not really a secretive filing, but was sort of a, there would times the company would decide that they did not want to go forward with a press release regarding a particular item, but they would, or matter, but they would prefer to do the filing on the 8-K, which would fill the disclosure requirements.

That decision was not necessarily made because the company had something that it wanted to hide. For many companies, they have so many press releases going out, that it would get buried, or they felt that the nature of the disclosure was such that it didn't rise. It was a mandated disclosure, but they didn't think it was appropriate to include in a press release.

However, now having that information, the 8-K information available on the website, I think will provide a lot more information to investors, and analysts.

Mr. Markese: Yes, I agree. But, the 8-K comes out episodically. And if we had pushed technology to send it out as soon as it, in other words, an individual investor would have to know what was coming, and they couldn't know that.

So, I think it's something that could be done. There's no cost to it involved. You simply get everybody's E-mail, and you send it out as a notice.

Mr. Rogers: And then, on this issue of disclosure, how about the, how do we think about evolving the way that we disclose insider trading transactions? Should that be something that we move up the time frame on?

Ms. Waryjas: Well, again, the Commission has proposed that the disclosures in that area be accelerated substantially. And we do have the technology today. Again, we're dealing with a situation where the rules were written many years ago, and we now have the technological advances. I'm not as technologically proficient as John is, I'm still real lucky if I can get a conference call going with three people in my office.

But, the insider trading information, if there is, I guess, information that an individual investor is interested in, it's information as to are the key executive officers at the company buying or selling? And I think that that is important.

And I have certainly recommended to clients, that if their executives have 10b-5(1) plans, where they have a plan of selling on a periodic basis, and they've put that into place, that it's a good idea, though not required, to issue a press release, which describes the fact that that plan is in effect. In effect, it's a proactive step, so that investors are not surprised to see the CEO selling shares. But, it's part of a plan that the CEO has put in place, and this will happen over a course of time.

The new disclosures as proposed, I believe, are within two business days after the sale.

Mr. Dimon: I think it's one of those things where it's a kind of no brainer improvement to just — forget the technological side for a second, you know, that it'll be easier for people to make mistakes. But, there's no reason that you shouldn't do it. And it should incorporate all things that look like equities, derivatives, swaps, trades, asset transfers, 401-K's. So, there's no noise in that. Just, what did you do in your own position, if you're a 16-B insider? And I don't, I think that's rather easy to do.

And, also, if you're going to have a periodic close, just disclose it.

Mr. Rogers: Very well. This has been a great discussion, and we've kept, I think, right on time now to have time for some questions from the audience. We've been trying to keep this very informal today, for discussion and dialogue, and so we'll promise if you ask precise questions, we'll do our best to give you precise answers.

So, if you will, I'd like to open it up for questions and answers. (Questions from floor)

Ms. Waryjas: The question was comments regarding the Federal Reserve and Chairman Greenspan's recent comments. Which I apologize, I had not followed, regarding caution, regarding accounting changes.

I think accounting will be dealt with this afternoon. I would certainly recommend that the Commission proceed a pace. But, again, the issues here are fairly complex, as we've noted. There are calls for additional types of oversight, there are calls for new accounting rules.

We have seen, in recent years, a development of financial products that, on a basis that I don't think we had experienced historically, with repeatedly. The creativity of the investment banking firms are the consulting firms out, and developing the products. So, adjusting the rules. There has been quite a bit of discussion between, or rather about the time delay between rules being discussed, and when they're actually implemented.

I think that these are issues for a new oversight board to look at very carefully. But, I would concur that we don't want to shoot from the hip here. We, the rules that come down, again, need to be thought through. And they need to allow for interpretation as we go forward.

Mr. Markese: Alan always calls for caution on everything, so it's hard to sort that out. I do think there's an issue. I think there's some outstanding issues we have to address, that's options. I think part of the Enron problem we had, were there were a lot of options floating out there, highly leveraged. And there was incentive to pump and dump the stock. Pump it up, keep the price up no matter what, and have the executives dump. Because the game was so enormous with those options.

So, we have to start looking on how to account for options, I think that's something we have to do. Whether we can account for it, whether we need to disclose more, whether it should be considered as expenses or not, the enormous leverage, the impact on earnings in the sense of dilution, it's out there, and we've sort of said we can't do it, therefore we won't do it. But, we have to something there.

So, I think, I think there are other things we have to move forward. I would also suggest we need a public oversight board, and I'll go along with Bob Glauber, who heads the NASD, that we need a board, something like the NASD. An industry board completely independent to supervise the accountants.

But, I think that's coming, and I think it's all in the works, but, and I don't think we should be cautious on that, I think we should go ahead and do it.

Mr. Rekenthaler: A further thought on options, and I think Warren Buffett has said this, he pretty much has said anything I can think of. But, the issue with options, and the compensation for management, and directors to be so heavily incented towards options programs, is options prices are rewarded by volatility. And that, you know, there's an enormous incentive when you have the fact that the prices are positively affected by volatility, and the fact that there's no loss, only potential of gain, to take on risks.

I mean, that's the idea behind options. There is, you give, you want to encourage management to take risks, and not play it too safe. But, that also means accounting risks can be a rewarding strategy for, and it's different if compensation is in stock, and there's a chance for meaningful losses. You know, there's an opportunity loss with options, but there's an actual loss, particularly if the CEO or management has invested their own money, not just been given the stock.

So, the trend towards stock options, and expenses, and should this be showing up in expenses? And will this change the incentive programs that are done? I think this has, definitely it ties back to the full issue of accounting, and disclosure, and practices. Because as long as you have economic rewards that, or an economic system that rewards aggressive accounting tactics, you know, we can talk about different disclosure rules all day. And there will be another, maybe not something quite as dramatic as Enron, but other situations like Enron.

Mr. Rogers: What's interesting is the issue seems to be getting hotter and hotter. Just in today's Wall Street Journal, there's a wonderful editorial by Burt Malkiel, who wrote the classic, A Random Walk Down Wall Street. In making the case that maybe Warren Buffett is wrong for the first time. And, so it's a, you know, it's, so it's an interesting, that you're really getting this high profile of folks fighting it out in the press.

I'm just curious if any others have any insights? Because I think it is important, an important issue these days.

Mr. Litan: Yes, I want to make a general point, just generally about the setting of accounting standards. It's important to distinguish between the Public Regulatory Board, which has been proposed by the SEC, and may even be legislated by Congress, that's going to deal only auditing standards. It's not going to deal with accounting standards, which are set by the Financial Accounting Standards Board.

And one of the issues we have not talked about, which I feel very strongly about, is how to insulate better the FASB from the political process. Now, some people say that because accounting standards are inherently political, like any other standards, you can't take the politics out of them, and you ought to just give up. I don't take that view. I think what we have now is an imbalance in political forces. So, that when FASB considers a rule, like stock options, they get heavily lobbied from one sector of the economy, namely high tech, and they don't get effectively counter balanced, or counter lobbied from the other side. Which is the retail investor, and institutional investors.

And with all due respect, there just isn't enough clout on the other side. And the reason is, is that investors don't have enough financial incentive to do the homework, and do all the lobbying that is required to have a fair game at FASB. Because if they don't like a particular stock, they sell it. There's no reason to exercise what Albert Hershman calls voice, when you can exit.

So, one solution to this problem is to try to encourage the institutional investors of the world to have more organized participation in FASB proceedings. I pray for that, I don't know if it'll ever happen. And the other solution, frankly, is to go to a world in which, this is something I called in my Senate testimony several weeks ago, a world of constrained competition between U.S. GAAP standards, and International accounting standards.

If we had a world in which we had a true competition in standards, and we did not have the reconciliation requirement, which is now required between GAAP and IAS, we would have a lot more companies picking and choosing which standard that they wanted a report on. And we could constrain some of that competition by, I think, urging the two of them, FASB and the International Accounting Standards Board, to get together to resolve some of their differences on some of the key issues, without harmonizing the standards completely.

In a world of constrained competition, if you really believe the markets will reward the better standard, that will give the powerful incentive for standards to have honest reporting. And we have a real live example of that in Germany, in their noire market, where basically the companies there report 50/50, whether it's GAAP, or International Accounting Standards.

And so I would encourage the SEC to think seriously about a world in which we get to a competition in standards. And that would dilute some of the political influence now that is exercised by very narrow interest in the United States on FASB.

Mr. Rogers: You mean, on the option issues specifically, we need to give a brief answer?

Mr. Litan: Yes.

Mr. Rogers: There was an article recently, also, that talked about the fact that, if the information is disclosed in the footnotes or elsewhere, that market's are being so efficient, and analysts being so thorough, that it really doesn't matter. This whole issue is kind of an issue that really shouldn't be such a big deal, because disclosure is there, and markets are going to reflect all the information.

Mr. Litan: Yes, and no. I didn't buy Burt Malkiel's article today, in the Wall Street Journal. He made the argument that "A", you can't value options by a Black- Scholes formula, because they're long term. And "B", if you use a sort of a second best method, it's not perfect, so let's don't do it.

Well, let's not let the perfect be the enemy of the good. The fact is, is that stock option is giving somebody something valuable. And right now, at least in the income statements, it's recorded at zero, and that can't be the right answer.

Mr. Rekenthaler: I can tell you, our stock analysts don't feel that they have all the information that they would like to have, regarding stock options, and the potential effect on stock prices. Maybe our analysts aren't good enough, I don't know. But, they welcome some additional disclosure, or expensing of these items. So, that's one of the requests that they gave to me to pass along.

Mr. Rogers: There's a question in the back? (Question from audience member.)

Chairman Pitt: I'm going to exercise the unique prerogative of remaining silent on that. We, I would say, are benefiting enormously from these panels. And we also think there's a need to move quickly, so we're going to have to balance that. (Question from audience member.)

Mr. Rogers: Can you at least stand up, and let us, everyone hear you? (Question from audience member.)

Mr. Litan: Let me, let me try to address that. I think Enron exposed that we have both problems. On the standard side, we woke up to the fact that special purpose entities were not treated right under FASB. And while we can celebrate GAAP being the greatest standard in the world, we were horribly embarrassed Internationally.

I'm working on a book right now on Global Accounting Standards, and I've got two co-authors from Europe. And the E-mails they sent me, making fun of the U.S. GAAP, you know, were no joy to read. So, Enron exposed that we did have a problem. FASB, in record time, attempted to fix it, by changing the three percent rule to a ten percent rule. I mean, this is something that was unheard of, I've never seen FASB act so fast in my life. And that, by the way, is proof of the fact that if there were competition in standards, you'd see a lot more rapid standard setting, or standard changing.

Now, on the auditing side, or on the enforcement side, Enron also exposed problems there in spades. And all the other previous accounting scandals that we've had before Enron, were examples not of the standards, but of the failure of the enforcement.

And so that's why we need something like the PRB, or I've argued frankly that, in my personal opinion, and it's not going to happen likely, but I think the SEC ought to do the enforcement itself. It can give the PRB the auditing standards. But, I, my own personal view is that enforcement is inherently a government function, the SEC ought to do it.

But, putting that aside, enforcement is, in my view, just as big a problem as the standard side.

Mr. Dimon: Can I, because it's a little bit, a very big perspective. The United States has the best capital markets in the world. And people forget that, you know, everyday on the phone, millions of people buy, sell, do things, sell securities, raise capital, start new ventures. And it's unbelievable, it's by word of — these agreements are verbal, they're deep, they're adequate. But, they always can be improved. And the attitude should be, can you always make it a little bit better than it was?

I think Greenspan was talking about the unintended consequences of laws, rules and regulations. And they're enormous. And, you know, very often, you know, you're taking up the nuclear weapon to kill the mosquito. And so in most of these things, the unintended consequences dwarf the intended ones, and so I think people have somewhat the same intent.

And I, you know, I look at the, and I think it was right to separate audit from accounting standards, this did bring up some disclosures in GAPP. Now, this three percent, ten percent, in my opinion is a joke, okay? If that's the solution, I mean, what they did was fraudulent, okay? Let's not kid ourselves at all about accounting rules, and stuff like that. They, there's no way that any one valid company would have done what they did in that kind of accounting. I don't care what the accountant said, or what rule said, or something like that.

And there are some gaps in GAPP. And the fact is, the world is moving so quickly now. You know, maybe if FASB was moving along at, you know, 20 miles an hour, and now is — and it hasn't kept up in my opinion, okay? Because most of us who buy and sell these things, well, we spend an awful lot of time making these adjustments.

Now, the other thing I want to put a little perspective in is, as a management of a company, let's see, I've been down at the SEC 30 or 40 times in my life. And when we file things, we get questions, calls, and so forth. We're terrified of enforcement. And they do a pretty good job, you know? And they have over the years, about full disclosure, and 8-K's, and 10-K's. It doesn't mean you can't look at how to make it look better, or a little bit more readable, or clearer.

I mean, like even, you know, we spend. And I know that, you know, a lot of the people who, you know, who I work with, and other companies, other CEO's, we spend ten, 20, 30, 40, 50 hours going through these things, making sure they're proper. When we do a press release, when we say the reasons for increase, you know, MD&A is mostly requirement, I agree it's not that great, but when we say that earnings went up for the find reasons, A,B & C, we try to make sure that A's the biggest and most important, B's the second biggest and second most.

Now, we can't always be perfect, and stuff like that. But, this, I think these things did roll, and I think Enron showed that there need to be changes in GAPP, okay? That there needs to be quicker, more fixing of rules. There's too much flexibility in certain areas, certain businesses, and it should be changed.

Disclosure, by the way, is 90 percent of it, fair disclosure. If you get that right, then at least the investor, and other people can decide. Fair disclosure, you know, we all learn the whole truth, and nothing but the truth, and it was the whole truth part. The part truth part doesn't work, that's the equivalent of lying, even though you didn't technically lie.

And so, you know, we, that's when, people do try to do that, and so I would worry like Greenspan said, too. And like, you know, the 401-K's, and the executive. I mean, there are some things that are very reasonable, that can be done right now to fix some of the problems that were created. Others will take a little bit more time.

Like, you know, this thing about people owning company stock. Well, you know, when we got into Bank One, we put our 401-K matching company stock. And I think our people should a lot of money if our company doesn't do well, it's our company, it's our team. This is part of one of the greatest things that happened in America, is that these things did get spread wide.

And that, now we're going to take it away, and mandate what people can do with their money? And so, maybe we should mandate a little bit, but not just totally using the blunt instrument to eliminate, from one problem, eliminate, you know, the 99 good things that happened from it. And I think Greenspan's right, we should use care and caution on some of these things, others we could do very quickly.

Ms. Waryjas: I'd just like to emphasize what Jamie has said about materiality. Again, the overall thrust is that the disclosure be full, that it be fair, that it be complete. That it not just be complying with a number of individual line items, in either Regulation SK, or SX. Those are where you start, but you have to look at the overall disclosure.

I don't believe that the accounting system is horribly broken. I think we had some areas where things did break down. I don't believe that our public company system is horribly broken. As you recall what happened with Enron, and we're focused on that today, please remember that five business days after 9/11, the U.S. markets reopened. Trades were executed, and within 30 some days, the market went back to where it was, to the pre 9/11 levels. That took not only the work of Chairman Pitt, the SEC staff, the New York Stock Exchange, NASDAQ, AMEX, the other exchanges, the investment banking firms, but it also took real reliance on the disclosures that were made by the individual companies that are trading on all of those exchanges in the industries.

There are many, many people out there who are trying to do the right job, who are trying to comply. And I think that, again, referring to Jamie's comment, we don't want to take a nuclear weapon, and wipe them out. We don't want to scare people serving on audit committees, because they are so concerned about personal liability, that the good people decide that it's not worth it.

And maybe we need to consider some, you know, some way of looking at how they are indemnified, how they are protected. But, we need to keep encouraging the positive, while punishing the negative.

Mr. Rekenthaler: And Enron aside, we would be, in general, more concerned about the disclosure in accounting standards than the audit issues. Although admittedly the audit issues, when they strike you, are, tend to be a gigantic bomb. But, we feel like we're nicked to death in a variety of ways by, in hundreds of cases where the disclosure could be improved. And we're having a little trouble getting to the bottom of what a company's business is like.

Also, I would like to note for the record, we do not share Jamie's viewpoint on 401-K in company stock, which is a different issue, but we don't all agree.

Mr. Rogers: I just want to follow up on one thing about Maryann's point, and it came up earlier, too. This issue of how we can make these jobs on audit committees more interesting for people, for people who want to serve. And I think part of it is trying to make the meetings themselves, as we touched on earlier, where there's more of an opportunity to have a dialogue, to make the meetings more meaningful.

But, I think that people who are successful executives, if they keep getting spoken to in slide show presentations, and check the box kind of structure, the mind numbingness of it, I think, will discourage, you know, thoughtful people, successful people, from wanting to serve on these committees.

So, it needs an added reason to try to make sure that we think more about how board meetings actually work, and how committee meetings actually work. And on Jamie's board, he does an excellent job with creating a small group climate where there's quality discussion. And I know we actually had lunch once with the former CEO of —

Mr. Dimon: Citibank.

Mr. Rogers: — of Citibank, who talked about the way that they created a board room where people were talking with each other, and there was discussion, versus people being talked at. And I think more information actually gets disclosed when people have a chance to discuss things, and have a dialogue. And we'll define more of these problems if we can create that kind of environment, that kind of a climate. Are there any other last questions as we're winding down?

Okay, maybe we could just, I'd like to thank Chairman Pitt for allowing us to be here today. This has been an exciting morning, and a meaningful morning. And let me, I'd like to thank all of the panelists for being here, and volunteering their time today, to be here for this discussion. And would you give them all a hand?

Chairman Pitt: Thank you all very much for this. There is a session this afternoon, which will start at 1:30. Which will deal with assuring the adequate oversight of auditing and the accounting profession.

Thank you all for attending.

Panel 2: Assuring Adequate Oversight of Auditing Function

Chairman Pitt: Good Afternoon. This afternoon we have a continuation of our Roundtable with a new panel to discuss the assurance of adequate oversight of auditing. We are very fortunate to have, as our moderator of this session, former SEC Commissioner, and now a member of Briggs Capital Partners and a friend, Carter Beese. So, Carter, thank you and it's all yours.

Mr. Beese: Thank you, Mr. Chairman. We are all here today because there is a credibility crisis in the accounting industry. Mr. Chairman has pointed out in his speeches and testimony, there have been failures.

We do have markets in the U.S. that are the best in the world. We have a disclosure system that has been regarded as the best in the world. Our markets and our disclosure and the oversight of those markets is not perfect. We've never said it is. We've said it is the highest standards in the world. And we've also said these standards should constantly evolve. That is what the SEC does on a day to day basis.

Often the change is incremental. It's evolutionary. Today, we are here because the change that is confronting the accounting industry is that one of wholesale change and is one of potentially revolutionary change. Revolutionary possibly on the same scale that led to the founding of the SEC back in the early '30s.

I'm confident of the outcome of this wholesale change. It is that the U.S. will still be the model for the world. And that's because of the process. The process of which we are part of today. The process of the comment letters. The process that is taking place in Congress. And certainly these Round Tables are a significant part of that.

We will be the model for the world unless it emproaches on balance. Unless we, if we don't resist the temptation, which happens at times, of heavy-handed regulation or so-called shutting the barn door after the horse has escaped regulation, we will be the model for the world if we resist that temptation.

It's a temptation that particularly, in my view, has to be resisted on Capitol Hill. And we also will be the model for the world unless we create significant disincentives. Disincentives to join the accounting profession. And disincentives for the right people to serve on Audit Committees.

I just want to add a personal note that I have a particular concern that the events that we are now living with regard to these issues, could put us in a position, could put many people in a position, where we're going to take the A Team off the field when it comes to having the right people on Audit Committees, if it becomes onerous to serve on that. That is something we're here today, certainly, to start to talk about. The Chairman's proposals for an SRO and the other proposals that in the other issues surrounding a new SRO for the accounting firms. But we're also here to talk about auditing standards and we're here to talk about the whole process of auditing and the role of Audit Committees.

We're here to talk about whether the SRO's should be a private or government body. And who should appoint the directors and what should the background of those directors or governors be.

We're here to talk about who funds this new SRO. We're here to talk about who plays the, who has the enforcement role, with regard to both discipline of the profession and enforcement of other infractions that are related to these issues.

We're here to talk about what the proper SEC role is with regard to oversight of this entire issue. And we're here to talk about many other related issues.

We're going to begin today by introducing the panelists. And I'm going to introduce them one by one. And as I introduce them, I'm going to ask them to give some brief opening remarks about the issues that they would like to see covered today and issues that they would like to have on the table. The only ground rules for this afternoon's session is that it's not enough to name issues. You have to name solutions during the course of the program.

So to start, we're going to start with the honorable Barbara Franklin, our former Secretary of Commerce, the highest ranking woman in the 41st President Bush Administration and very apropos for today's discussion, have served on more Audit Committees than anybody I think I've known, Barbara.

Ms. Franklin: Really? I don't know if that's a distinction or not as somebody said this morning. Yes, my role here, I believe, is, although I have to say too, I'm a former regulator, a Commissioner of a Regulatory Agency, not the SEC, 25 years ago, Consumer Products Safety Commission when it was new. So, I have a public interest that appears in my background.

But I'm here today as a Director. Been a Director of more than a dozen public company's. Served on at least that many Audit Committees, I feel. Chaired six and am currently chairing two. And if I could, Carter, do you want me to take a few minutes and just —

Mr. Beese: Please.

Ms. Franklin: — okay. I wasn't sure how many minutes you wanted me to take.

If I focus, then, on the relationship of the audit committee with the auditor, what I would expect from the outside auditor is the following, independence. And we got into a thing this morning about reporting directly to the Audit Committee. I concur with that. I believe it. And in most Audit Committees that I'm involved with, that do have the power to hire and fire the auditor, the nub comes about who negotiates the fees. I'm going to leave that for a different part of this discussion.

So, independence, competence in all areas, highest ethical standards, guts, courage, and then candor with the Committee and there's a communication skill that I think goes with that.

So, how do we get this, in terms of the best quality performance from the auditing firm? Well, one thing that I do think will help is what has been proposed by Chairman Pitt, the PAB or whatever we're calling it, every legislative proposal has a different set of letters, but I think that this will be a good step forward. It should be private. It should be overseen in the right way by the SEC. And it should deal with quality and ethics, not accounting standards or auditing standards. But quality and ethics and I would like that, if there were standards somewhere that the firms are being peer reviewed against independent members, independent staff and I think that's enough to be said.

What I really want to go into for a minute, is what I think the Audit Committee has to do to ensure this level of performance that we'd like from the outside auditors.

Fundamental to this is the Audit Committee's got to be proactive. Got to be proactive across the board, but particularly in the relationship with the auditors.

We mentioned the reporting relationship. I do think that is the way it should be. Audit Committee is where the auditor reports. But there's more that has to be done. Because, let's face it. The auditors are around management people more than they are around the Audit Committee. So you need to make sure that the reporting relationship is intact. So you have to always keep the balance as much as you can toward the Audit Committee.

One thing that was mentioned this morning is closed executive sessions without fail at every meeting with the outside auditor. Not perfunctory, but really two-way communication. I always, in setting up an agenda, use 30 minutes, allocate in a two, two and a half hour meeting, 30 minutes for executive sessions. Outside auditor, internal auditor, financial management and the Committee itself. And not perfunctory. And do it every time no matter what, whether the sky is falling or whatever.

Secondly, in between meetings, I think the Chair, who, and here the Chair has got to set the tone of candor anyway. And there are ways to do that. Small rooms. Crowd people together. I mean, there are a lot of little things you can do, but in between meetings, I think the Chair needs to be interacting with the engagement partner. And not necessarily just to ask inquiring questions, but just to chat about, you know, what's going on, what do you think? It's got to be real two-way communication so that you're building your relationship. That's the bottom line here. You want a relationship with the guy on the other end here.

And then, if you're the Chair, you've got to be able to hear the nuances in what people are saying or what they're not saying. And then be able to know what to do about that, if you hear something that's slightly changed.

This happened to me last week. And I did do something and I e-mailed the Committee about what I had done. Which is another thing. I like to engage the Committee if something like that happens, they get an e-mail from me. So everybody's kind of up to speed the next time we walk into the meeting room.

I also sometimes talk to the client service partner and the CEO of the firm, just to make sure everybody understands who reports to whom here.

It's also important to use the checks and balances that are already in place in a very vigorous manner. In other words, really questioning the outside auditor in the open session of the meeting about management's accounting policies, quality, about the estimates that management has come up with. And do it even kind of offhandedly. And people now know I do it so that it's not a big deal. Say, "Well, what do you think about that, Jack?"

And then I would ask it again, probably, in the closed session. And then to the, the Audit Committee needs to stick up for the outside auditor if it's necessary against management. And we've probably all had to do that one time or another. But that's important to, again, keeping the relationship the way it ought to be and keeping the reporting relationship coming to the Committee and not overly influenced by management.

And I think I should stop right there. But proactivity is the bottom line here.

Mr. Beese: Proactivity, and as you said, setting the right climate, setting that type of climate so that the auditors do feel comfortable talking to the Audit Committee when they have a disagreement with management. Letting them know that not only is the door open for that, but the Audit Committee insists upon that.

But, Barbara, as we take a look at how the Audit Committee interacts with a PAB or body like that, what can be done at the SRO level to encourage the type of climate that you've described in an Audit Committee and also encourage the people that you want to be on the Audit Committee to agree to serve on the Audit Committee? How can that be influenced by —

Ms. Franklin: The SRO?

Mr. Beese: — the SRO?

Ms. Franklin: I'm not sure the SRO can really deal with the second one.

I think it helps, though, if the SRO, if we know that there are standards for the various things we care about and that there is a peer review. And I think the suggestion is, on an annual basis.

I always ask anyway, if, every year, when the audit firm is being renewed, there's due diligence that, if the audit firm is being renewed I should say, there's due diligence that the Committee always need to do. Has to do with the performance of the auditor, but it also has to do with peer review. I always ask about peer review results.

Now, you know, it's kind of not very interesting. Every three years, and nobody's ever had anything other than a clean opinion with one comment or something. I mean, it's been, it's kind of a sham. I would feel an awful lot better if I knew there was a peer review being independently done and I could really look at and grapple with the results. I think Committees would just feel a whole lot better about that part of it.

And I think it reinforces, also, the independence of the auditor and helps the Committee to reinforce that.

Mr. Beese: Yes. And I think that's helpful and I think maybe we should just move right down the table to Edward Nusbaum, the CEO of Grant Thornton. We're delighted to have Edward here today to represent the view of the accounting firms.

And I would just add, to Barbara's remarks, when I was at the SEC Speaks several weeks ago, I heard a proposal that for interpretive relief, before interpretive relief will be issued from the Commission on accounting issues, there is a proposal that each member of the Audit Committee individually give their opinion before the SEC. I'm not sure if I'm paraphrasing correcty, Chairman Pitt.

But it was a proposal along those lines and what worried me about this from the public policy issue, is you start to disintermediate the audit members from the accounting firm. And I'm a strong believer that audit members have to rely on the accounting firm. They are the full-time people on the job. Audit Committee members are Boards. And that is a dangerous road to go down. I think there was some discussion on this broader public policy issue during the Blue Ribbon Commission Reports.

In fact, Barbara, would you just comment on Number 9 and why this issue came up?

Ms. Franklin: Yes. If anybody remembers that report, and I just remember Recommendation 9 because it got everybody's attention, where they were trying to, initially, it got changed, set things up so that the Audit Committee was in effect attesting to everybody else's comments, including the auditors. And I don't believe Audit Committees are equipped to do that. Nor do I think they should be doing that.

We are in an oversight capacity. I would call it proactive oversight, but it's oversight. It's not attestation.

So this did get changed and we are now not in this situation, happily. And, Carter, what you've just said came up at that meeting. I think it's a bad idea. It's going in the same direction and it's a bad idea. And I really do believe if Audit Committees are put into that kind of a situation, they're going to disappear. I mean, people are really not going to want to serve.

I have not seen people baling out, maybe others have, of Audit Committees right now. But there's certainly a lot more nervousness and I think we're going to have trouble getting people to serve.

Mr. Beese: The proxy season is upon us. We will watch and observe.

Ms. Franklin: Yes. We'll watch.

Mr. Beese: Good. Ed, can we have some opening observations from you?

Mr. Nusbaum: Sure. Thank you, Carter. First of all, I want to talk about the new proposed Oversight Board. As the CEO of Grant Thornton, Grant Thornton's a global accounting firm, we strongly support this proposed Oversight Board for, as Barbara said, for the quality and ethics provisions related to the accounting profession.

The members of the Board should represent various organizations and various groups of individuals.

I believe that the members of the Board should represent users of financial statements and there are different user groups that could be represented, preparers of financial statements, the accounting profession, and by the accounting profession, not just the Big Five, but a wide variety of the accounting profession, as well as some academic representation.

The Board, in our view, should be a private organization, although it must work closely with the SEC to accomplish its goals. And certainly the SEC should have a presence with the Board, but should not be running the Board, or should any government authority be running the Board.

One of the questions that has come up on this Board is, should the Board establish accounting standards? I believe that it would be a mistake to have the Board establish accounting standards. We have a financial accounting Standards Board. It seems to, in 99 percent of the cases, or at least 95 percent of the cases, do an outstanding job and we should improve how the FASB works. The FASB is receptive to change and we should insist upon some changes to improve that process, but should not replace the Board for the establishment of accounting standards.

Similarly, the establishment of auditing standards should be done by the AICPA and the accounting profession. It's hard to imagine that nonaccountants would try to establish auditing standards.

However, we strongly recommend that the accounting firms review the best practices of the auditing process that all of the firms use. That the AICPA coordinate that effort and that we review those methodologies, audit methodologies, to make them better going forward.

There are other steps that we believe need to be taken. And Grant Thornton issued a five-point plan about, oh, probably about six weeks ago, and it's, in a way, disappointing that no action has really been taken. But we're very pleased to see the progress of the SEC and the leadership role of the SEC to take action, which is where the actions should take place with the private organizations as well as the SEC and, in our opinion, not by Congress.

We think that the, in that five-point plan, we talked about the policies and practices of accounting firms, of promoting professional excellence and demonstrating an absolute commitment to professional excellence, which we think is critical and important. We also talked about improving disclosures, in particular, the breakdown of the nonaudit fees and improved disclosures over what those fees include. We also believe that disclosures can be improved in the accounting policies area. And I know that the SEC is looking at that right now.

Grant Thornton believes that principles-based standards are critical to the profession and to the accounting world. Those standards should address accounting standards, auditing standards and independent standards. All of those standards should be principles based.

And then, finally, the hot topic lately is the role of the Audit Committee. We believe the Audit Committee should play an increased role. The Audit Committee must be truly independent. It must work more closely with the auditing firms, Grant Thornton and all other firms. The Audit Committee should be very closely involved in the hiring and firing of audit firms as well as the establishment of fees. The Audit Committees, in our opinion, need to play an increased role in understanding the business and accounting that the companies are following. And that can be accomplished through improved coordination with the auditors.

Just to circle back to the Oversight Board for just a second, that Board should be an SRO, should be involved in the enforcement and discipline of accounting firms. And the funding, I'm not sure I have any answers for that, although I suspect we'll have to pay our fair share at some point.

Couple of other comments about some of the other things that are going on, I think that the profession and everybody involved needs to take action quickly. But we have to be very careful that we don't take inappropriate action, and that action should be taken by the regulators, not legislation.

I'm also concerned about how registrants and public companies are going to comply with some of the new standards. There are many more registrants than are included in the Fortune 500 and while we can shorten the filing time for some of the largest registrants, I'm concerned about the smaller companies being able to meet a shorter filing time and the possibly negative impact that may have on the audit process and the ability to agree to audit decisions.

I just want to close with a last statement commending the, and congratulating the SEC for putting this together and for taking action.

Mr. Beese: Ed, I can't let you close without getting you to comment on how you would change the peer review process, one. And two, you mentioned that some changes should be made at the FASB, and you think they would be welcomed, but if you could be, give some specifics on those changes.

Mr. Nusbaum: Well, on the peer review process, I think the proposal to have the Oversight Board have a full- time staff conducting those reviews is a good proposal. I think it's workable. I think there are obviously issues that need to be addressed. But that's a proposal that we can make work and I think the profession, certainly at Grant Thornton, we welcome that.

I'm not sure that we like the idea of having somebody in there every year, certainly the concept of having somebody in every third year is a lot easier to deal with. But we'll deal with whatever it is.

That process, if it does go to every year, will increase the cost for accounting firms and ultimately the cost of doing an audit and the cost the companies will have to pay. And so there's some trade offs there. And that's, you know, it's not something I'm probably best to comment on. But there is an increased cost involved.

But we think that the peer review process, the proposal to have that done by a full-time staff is a workable solution and can improve the process. We know that the staff of the old Public Oversight Board was a quality staff, and we believe a quality staff could be put together to perform this process.

And you had another question?

Mr. Beese: You mentioned that some improvements could be made at FASB.

Mr. Nusbaum: Oh, the FASB. Yes. The changes at the FASB. I think the FASB, the FASB, needs to take steps to get standards up quickly. I know standards sometimes take over ten years to develop and get out and that's part of the normal process. But they clearly need to improve the timeliness of the development of standards.

In addition, we believe at Grant Thornton, that the FASB needs to move more towards principle-based standards. And that's a very difficult process. That doesn't mean you eliminate all the rules, but you set the objectives or the rules and you establish principles-based standards that we're trying to accomplish and then use examples and other means to show how those standards get accomplished. Rather than having cookbook rules that we then find all of the preparers of financial statements and some cases, even the auditors, trying to find ways around the rules rather than adhering to the substance of the transaction.

I think that the FASB is taking some steps to move in that direction. At least, I'm hoping they are. And I think those actions will improve their process.

Mr. Beese: Thank you. I think, and thank you, that's a good lead-in for Professor Fischel, a well-known commentator on these subjects. Dan, do you want to start with some of the accounting issues that Ed just spoke to and give your other observations?

Mr. Fischel: Well, I would if I knew anything about them. Okay? But I don't. So I'll have to speak about maybe something that I know a little about.

I think, unlike my very distinguished copanelists, I have no background in accounting, no background in being on an Audit Committee. Certainly no background as a regulator. So, my perspective maybe, is slightly different and, in some sense, much less informed than a number of other people here, not just on the panel, but in the audience.

I guess my reaction to reading the materials and let me come back to Carter, the way you started the program. I think there perhaps is an overstatement of the problem. Meaning, I'm not sure there really is a credibility crisis in the accounting industry, to use that phrase. That, you know, may be true in terms of the view of certain columnists and social critics, but in the marketplace, I'm not sure it's true.

And I also think that if it is true, it's very unlikely that any of the reforms being discussed are going to do much about it. So, in a sense, I think there's also perhaps overly high expectations about what can be done to change the existing rules to deal with it. In other words, I think, if there is a crisis of confidence, I assume what's being referred to as, if that exists, it's because of various public reports of alleged frauds in connection with Enron, particularly in maybe some of the other widely publicized incidents.

You know, we've had a long history of very highly publicized frauds. I'm not sure this is one of them. I think that remains to be proven and may well be, but it may not be. But, from a historical perspective, thinking back, we had a crisis of confidence with Wall Street, insider trading. We had a crisis of confidence with Drexel Burnham. We had a crisis of confidence with savings and loans. There have been lots of crisis of confidence that, if you look at it, I think, objectively, the situations are dealt with by prosecutorial authority, sometimes, in my view, overzealously. But the world goes on.

I think the suggestion of a fundamental problem and the way markets operate as a result of current events is likely, with the benefit of hindsight a couple of years ago, likely to be as overstated as all of the previous incidents that I've just referred to.

That said, assume that there is a massive fraud at Enron and that accountants at, in connection with other companies, are also facilitating, either passively or actively, active frauds in connection with public companies. Again, I'm not suggesting that that's the case, in fact, I'm doubtful that that's case, because of the inherent disincentives to engage in that behavior. But let's assume it is the case.

If that's true, I'm very skeptical that any proposed self-regulatory organization, no matter who it's staffed by, no matter who it's funded by, is going to make any difference whatsoever.

I think all professions have gone through this kind of a debate about the optimal mix of self-regulation and governmental regulation of one kind or another, certainly among lawyers. That's a very common debate and the general consensus is that all of the regulation of the legal profession and the medical profession and the accounting profession and the architecture profession and any other profession, you have the same kinds of trade offs between expertise within the profession, but obviously a self interest in perpetuating a monopoly position, or as close to a monopoly position as possible, versus the value of independence, but without the same information as people within the profession.

And that trade off has worked out in different ways and different context, but I don't think there's a lot of evidence that even if one system is better than another, that there's going to be a lot of payoff in terms of preventing people who really want to engage in fraud from engaging in fraud.

I think the other things that the Commission and other regulatory and prosecutorial bodies are pursuing of actively going after wrong doers and having people face loss of professional status, loss of income, in certain cases, loss of freedom. That's a pretty powerful deterrent. And I think it's very unlikely that anything that's proposed, the Chairman's proposal or any other proposal, is going to make that much difference.

I, myself, am a supporter of the Chairman's proposal, but only because it's less intrusive than other worse proposals. And therefore, likely to possibly do some good, but probably not do a lot of harm. Although you could imagine a circumstance where if you had so-called independent members, you could put members on with very different agendas than having investors be fully protected with various kinds of social agendas or various kinds of consumerist agendas, that might not dovetail with what investors would want. So, it could do harm.

I assume as long as we're talking within the parameters of what's been proposed so far, it's likely not to do that much harm. But it's infinitely better than the various proposals that the Chairman and others have rejected. At the extreme, the federal government taking over the role of accounting public companies. Or the exchanges taking over the role of accounting public companies. All of which, at least in my view, would very much have the quality of throwing out the baby with the bath water, having a cure much worse than the underlying problem.

So, if we accept that in the current climate, something has to be done, I think the Chairman's proposal, at least from the various proposals that I've seen, is the less, least likely to make things worse. May slightly make things better, although I'm not sure of that and, therefore, I think it's a worthwhile objective.

Mr. Beese: Thank you, Dan. I think Dan has a pretty good familiarity with the issues. And let me ask specifically, one proposal that seems to be making the rounds is whether or not the accounting firms, themselves, should have independent directors, which obviously Paul Volker has at this time instituted at Arthur Anderson. Do you have view as towards that?

Mr. Fischel: You know, this actually is a broader question. I'm in favor of all different types of experimentation in the marketplace. I'm skeptical of mandatory proposals, which includes all different types of mandatory proposals about the structure of accounting firms, whether they should have independent directors, whether they should be prohibited from combining accounting and consulting.

I think there's room for a lot of different experimentation in the marketplace.

The question of whether of accounting firms should have independent directors is a variant of the time-honored question of who monitors the monitors? In other words, if accountants are supposed to make sure that there's a reputational intermediary between firms and investors. If they're not doing a, if they're not adequately independent, would their having independent directors make them more independent? And it's not a question which I think there's an obvious answer. I think it should be left to experimentation.

I do think there is something of a fundamental contradiction between the rhetoric that we apply to accountants as well as the legal standards and economic reality. In other words, no matter how many times we say that accountants should be public watchdogs, it's very hard to be a public watchdog when you're being paid by somebody else.

Economic reality, being what it is, whether you're an expert witness, which is what I frequently am, or an accountant or any other kind of service provider, within the context of ethical standards and worrying about your own reputation, you're going to try and shade things in the direction of the person who's paying you. And I think that's just an economic reality that is frequently ignored in the context of the public discussion of accountants. But I think it's a reality.

Having independent directors I don't think is going to change that. You have the same problems that you always have with independent directors of how are they going to get information, how are they going to know enough.

One of the things in Enron, of course, is you had a Chairman of an Audit Committee, who is one of the most distinguished accounting experts in the United States, an accounting professor at Stanford.

So I think we have to be careful of equating having a certain kind of personnel structure and just assuming that that's going to be a relatively reliable safeguard. Because people also have to have the ability to have the right incentives to be able to have access to information.

People who are independent work full time generally doing something else. Given a corporate structure as complicated as Enron's was, I'm not sure what an independent director at the accounting level, I'm not sure what difference that would make.

So again, might be good. I'm in favor of experimentation, but I think to have too high of a level of confidence that that would change things in a fundamental way, I think is very unlikely.

Mr. Beese: Thank you.

Ms. Franklin: Wouldn't it be hard to do, excuse me —

Mr. Beese: Sure. Please.

Ms. Franklin: If the firm is a partnership, wouldn't that be a little awkward to add independent directors to a Partnership Board?

Mr. Beese: I guess that question would be best directed to Paul Volker.

Ms. Franklin: And he's not here.

Mr. Beese: Certainly, I mean, there's room to do it.

Ms. Franklin: There's room to do it, but whether it — another conversation for another time.

Mr. Beese: We'll get to it. We'll get to it.

Ms. Franklin: Okay.

Mr. Beese: But let me move on to David Costello who, here, represents the constituency of CPAs. David is the President and CEO of NASBA, the National Association of State Board of Accountants, which is a organization of, a voluntary organization, across the U.S. that are responsible, these Boards are responsible for the licensing of CPAs nationwide as well as for monitoring their continuing competence, continuing licensing requirements, as well as their continuing education and their practice review programs. And David also has a background as a member of Ernst & Ernst and can speak to this from several perspectives.

Mr. Costello: How long that's been. Thank you very much and good afternoon. I am David Costello and I'm proud to be a CPA. And I say that very proudly.

My constituents are state boards of accountancy and they are comprised both of CPAs and public members. We have state boards in every state in the United States, plus the four jurisdictions of Puerto Rico, Guam, Virgin Islands and Washington D.C.

We are the bedrock of defense as far as regulation and as far as the public interest is concerned. We live it. We breathe it. We work with it every day. And I want to say as much as I can about state boards because I believe state boards have something to offer as we go forward in making some of the changes that we're talking about.

For over a hundred years, that's a hundred years, folks, for over a hundred years, we've been at this job. For over a hundred years, state boards have been licensing CPAs, accountants. They've also been revoking licenses. And they have done it to the extent that now we have about 550,000 CPAs in the United States. Now you hear a number, many times of 340,000. That's how many belong to the AICPA. It's not a requirement to belong to the AICPA. It is a requirement to be licensed by a state board of accountancy. Five hundred and fifty thousand of them out there.

And these, all these CPAs have done something in a very similar way. They've all met education requirements and they're very lofty education requirements. They have met experience requirements. And they have all passed a very rigid, very challenging examination.

And once licensed, these CPAs must meet continuing profession education requirements. They cannot rest on their laurels. They've got to continue to keep up their educations.

Violations of professional conduct, malpractice, incompetency are met with strong, effective disciplinary actions, including, when appropriate, the death penalty of revocation.

I'm telling you, state boards are the only ones out there that can do this. And one reason why, as I go through the rest of the afternoon, I'll make a strong plea for the SEC and other federal agencies to work with state boards because we can really hit people, the malefactors, where it hurts. And that is taking away the license, putting them out of business anywhere there's a threat to the public.

State boards' members are accountants and they're public members. There are about 450 currently serving on boards throughout this country.

I want to talk to you just briefly about some areas of concern that we have with respect to the changes being talked about. Not that we're against them. I, too, applaud the SEC and others who are working on these projects. It's a very challenging time for us.

Unlike my friend to the left, I am not a doomsayer. I don't believe we're getting ready to go down the tank here. I believe we are actually in a very good period as far as, I hate what brought us here, but I think we're in a good period of reassessment. And I think we'll come out very well.

But I want to mention some things that I think are very important. And I think, and the commonality of these issues will be that look to the people who have been doing this for 100 years at state boards. We've done some things right and we're very effective.

The state licensing system should continue, should continue to be used as the basis for recognition of professional competence. I've read a bill or two that would dare suggest that there should be some other type of federal certification. I think that's nonsense. I think we've got a system that's worked for 100 years in certifying CPAs, licensing CPAs. We ought to continue to work to make that the best system in the world. So, state licensing system should be used.

Number two, there must be cooperative enforcement with a newly established national regulatory board. I don't care what you call it. But whatever it is, it should be cooperating with the state boards of accountancy.

We have pled for years, "Please, work with us federal agencies. Get us the information. Don't sit on it for three, five, six years, but get it to us quickly. And we'll go to work on it. And we'll be a good deterrent with you. We can work together to protect the public."

A new board should notify state boards of accountancy quickly when enforcement actions begin on a CPA firm or a CPA. Quick report. Investigative documents should be shared. I don't know all the legal ramifications to get that done, but I know we have a lot of bright people at the SEC and in the legislature and Congress, and we can get it done.

Number four, the new board should be given the authority that the SEC has in conducting due process hearings that will enable the state boards to discipline, on the basis of the new boards findings, where we don't have to wait for years to open and reopen another case. But that we can work off of the new boards' findings. Findings against the CPA already afforded a hearing hastens the state board action and the process of enforcement. And it also is very efficient as far as taxpayer dollars is concerned.

Number 5, State Boards need to be notified immediately on new boards' disciplinary findings.

Number 6, and I think this one is very important. There has been a lot of talk about the composition of this new board. No one has mentioned the one thing that's key. And that is the people who have been at it for 100 years and know how to regulate should be on this board. They should be represented in this new board.

State Boards of Accountancy should have a seat on the new board. We don't care again whether it's a public accountability board, a professional regulatory association, whatever it is, state boards need to be represented. We have a lot to give.

Number 7, state boards should receive copies of quality review reports. Let's make them transparent. Let's open them up, folks. Let's stop shielding them. We're going to get into a new quality review process, let's be open about it. Give it to the state boards where we can see what's going on with those people who are practicing in our states.

You know, these 550,000 CPAs, they don't practice in Washington D.C. alone. They practice in every state and jurisdiction that we work with.

I think, I want to say a couple of things on nonaudit services and I will reserve some of my comments until later, but independence is a huge area. And everyone is an expert on independence. But I do think that it's time that we convene the major interest groups on independence. And that would certainly include the SEC. That would include the AICPA. That would include the GAO. It certainly would include State Boards of Accountancy. Any others that have a vested interest in this, have something to offer.

Let's get together and instead of having two, three, four, five sets of independent standards and four, five different versions of what nonaudit services that an auditor can perform. Let's get together and harmonize this and stop confusing the public any further about this issue. It's time, we've got time now to do it right. I don't want, you know, I don't want to take forever getting this done. But I don't want to rush around and come out with a half- baked solution that's not going to address this area.

Nonaudit services is too important with respect to whether or not a firm ought to be doing these, an audit firm ought to be doing this. It's too important to rush through quickly. Let's get the right people together and let's agree on what nonaudit services can be provided and also what independence means.

You can ask five people what principles-based standards mean and you're going to get five different answers. So, it's not that simple.

I want to comment about Audit Committees. I feel strongly that the Audit Committee is an outstanding control that a company has. I think it's an outstanding control for investors. I think there are two or three things that we can yet do that will improve Audit Committees.

I believe there should be periodic meetings of the Audit Committee with the outside auditors. Not just that once or twice a year meeting, that end-of-the-year meeting, to sort of assess where they've been, what they've done, any significant adjustments and that kind of thing. That's good. But I think there ought to be some checkpoints along the way during the year. Maybe we ought to have three or four of these meetings with the outside auditor. Let's get a continual assessment going on.

Also, I feel very strongly that the investing public out there needs someone who has no ties to the Board of Directors, is not paid and is a public member, if you will. I believe we should have that on the Audit Committee. I think it would give the investing public additional confidence.

Also, I support, certainly, that we have to have knowledgeable people on the Audit Committee. It can't just be anybody. These are very difficult issues. I've served on an Audit Committee, myself. I am fortunate that I've been trained in knowing how to ask questions. Believe me, it's very important just to know how to ask the right questions. And, I believe for that reason, we need knowledgeable, aware people, people who know auditing, people who know how to ask questions.

I do appreciate being here. I think we are at the beginning of some tremendous change, very positive change. And whatever happens, I know it's going to be good for the profession, but moreover, it's going to be better for the public interest.

Mr. Beese: Thank you, David. It's a certainly interesting proposal to have both paid and nonpaid members of a Board of Directors and an Audit Committee. And it's actually a good lead in to Ken with his background. But, you have told me that you have experienced this in practice and you think that there is a constituency out there that would be willing to perform this unpaid service.

Mr. Costello: There's no doubt about it. Four hundred and fifty volunteer State Board of Accountancy people are doing it everyday for nothing. They get paid a little amount of travel money. And they get a small amount, but it's not, it's nothing compared to what they could be billing per hour.

So, yes. We've got a lot of people out there that would be willing to serve as public members of Audit Committees and they would do a great job.

Mr. Beese: Thank you. Ken? Ken Bertsch is Director of Corporate Governors at TIAA CREF and we'd like your observations on the public, the PAB, that the proposals that are on the table as well as some of these corporate governor's issues, Ken, that have been put on the table.

Mr. Bertsch: Okay. Thank you, Carter.

I work for a large institutional investor and probably should just give a couple words of background in what I do because it's a little different, like Professor Fischel, I'm not an accountant and I don't serve on any Audit Committees. So we're, I'll have to identify with his remarks in that regard.

We have a very active corporate governance program at TIAA-CREF. Talking to portfolio companies, where we perceive governance concerns, where we're concerned about the Board of Directors, maybe insufficiently independent or may be insufficiently vigorous from what we can judge.

We take on other issues including issues related to the market for corporate control, issues related to executive compensation, a variety of things. But the issues of financial transparency and the functioning of the Board and its Audit Committee on financial reporting issues is absolutely crucial.

I should mention, by way of full disclosure, that my boss, John Biggs, the CEO of TIAA-CREF, served on the Public Oversight Board and also continues to serve on the International Accounting, International Accounting Foundation. I, in no way, speak for him in those capacities, but I just want to put that out there as part of the picture.

I also should mention, since we're in Chicago, one of my colleagues is Ken West, who is the former CEO of Harris Bank, has been a very valued member of our corporate governance team for the last seven years and is a terrific asset to TIAA-CREF.

The, in discussions with Boards, I think I want to report first before I get to the main subject, that I think Audit Committees, Enron notwithstanding, already have improved in the last several years. Or at least people are talking the talk.

A few years ago, people were quite willing to say that the Audit Committee was a great place to put new directors so they could learn how to be directors, learn about the company, which has some logic to it. But, somewhere along the line in the last few years, people realize they shouldn't probably say that, that the Audit Committee is not just a leftover committee. It's actually the most important committee of the Board. At least, we perceive it that way. And people, in talking to us, when we go out to companies, emphasize the importance of the Audit Committee.

And I think because of the Blue Ribbon Commission that was set up a few years ago, and now certainly because of developments at Enron, you have a lot of Audit Committees who are really trying to figure out as best they can how to do the job.

So I think there have been some improvements regardless of any regulatory changes that may or may not take place.

In terms of an independent oversight body, we support the view that a body should be established by statute to give it as much authority as possible. That there should be automatic funding for this body, not what my boss has called tin-cup financing, where people, including he, go around trying to get money for this and for the International Accounting Standards Board.

An automatic funding mechanism for not only this new entity, whatever set of initials we're going to use, but also for FASB and also for the American contribution to ISB, I think, would be very useful.

One of the notorious little e-mails that has come out of Enron, and we get stuff every week or so, but one of the ones that passed by a couple of months ago was a particularly crass, as perhaps is typical of management terror, but a comment on whether they should contribute $100,000 for the International Accounting Standards Board. What would they get for it? What kind of leverage would they have?

I don't think most people think in those terms quite so explicitly, but there is the background suspicion, certainly of people outside, that there is influence that can be bought through this use of, through the funding.

So automatic funding. And I hear people talking in terms of SRO, which I think is good. I think that's the model that we want. An SRO with strong investigatory power and strong disciplinary power.

I don't have any particular view on whether it makes sense to pull all the different bodies together as the Public Oversight Board as recommended, but I think it's worthwhile, and there's been a lot of heated exchanges related to the Public Oversight Board. But I think it's worthwhile to look at their proposal to create a perhaps more rational structure, at least a structure more understandable on the outside.

So that's sort of the overview. If I've got a minute, I'll just mention some of the other —

Mr. Beese: Okay.

Mr. Bertsch: — the other governance concerns.

First, I think it's very important that the auditors report to the Audit Committee only. And that's really one of the reasons why the issue of nonaudit work comes up. We have a policy internally that we don't give nonaudit work, nonaudit-related work to our outside auditor. And the reason is you blur the reporting relationship. The audit should be controlled by the Committee and to the extent management is involved in hiring the auditor in other engagements, that blurs that relationship.

Secondly, we are encouraging companies and having discussions with a number of them about rotating their auditors on a regular basis, which is also something we do and have done for awhile. And, we think, with considerable success.

We minimally want companies to do a regular reevaluation of their engagement of the audit partner. Real evaluation that this thing of keeping the same auditor for 100 years, which you see on a number of proxy statements and sounds great in certain regard, that's not necessarily the best model. That this should be a relationship that may change over time.

We also support the notion of a cooling off period for employment between the audit firm and on the audit team in a company.

We, and this one haven't heard mentioned today so I want to sort of throw it in. I think it's very important to have an independent Nominating Committee. There has, at least up until very recently, not been a lot of progress. A lot of the bigger companies have Nominating Committees. Many of them are fully independent. But many companies, the majority of larger U.S. companies, still do not have fully independent Nominating Committees. Many have no such committee at all. And I think that's something that needs to be looked at.

The Nominating Committee not only should be responsible for new directors, but also for doing committee assignments. So that it's very clear where the responsibility lies and that it does not lie with management.

We think it's very important that there be adequate funding for the SEC and pay parity for SEC staff. I say this to play to the crowd here. No, but we mean it. I think these issues are very important for the functioning of the Commission, which is absolutely a core issue.

And, I've got several other things to say, which may come up later. But, I'll put them off for the moment in favor of maybe asking Barbara Franklin, if I may?

Mr. Beese: Please do.

Mr. Bertsch: Do you perceive that the Audit Committee at most larger companies really does control the auditor engagement? And you had mentioned the issue of how to negotiate fees. How can you do that?

Ms. Franklin: That's the hard part. In all of the companies that I'm a Director of currently, the Audit Committee would indeed have the power to hire and fire the auditor.

The fee negotiations, this is what I consider to be the hard part because the Audit Committee does due diligence. Smart Audit Committees of the sort that I mentioned performance and independence and so on before hiring. But the fees, generally, have already been negotiated with management. So there's going to have be quite a different structure, I think, or a different collegiality, shall we say, between the committee and management in terms of negotiating the fees. And I don't think that's really being done very well right now.

Mr. Bertsch: Okay.

Ms. Franklin: And so that's the nub. I think Audit Committees now are looking at fees to see whether they are reasonable vis-a-vis the scope. Not whether they're too high or too low, but reasonable.

The other thing that gets negotiated more with management is the scope. Although, I must say, Audit Committees get their fingers in that. But I think that's the area that really needs some now creative work and thinking.

Mr. Beese: Let me ask you a question, if I might start with my own view, and that is I believe that the events of last Fall, with regard to corporate America, really were a watershed event that we, it was, if you will, an emperor with no clothes event.

Up until the issue Enron, and the issues surrounding Enron came to light, I believe there was a general acceptance of audit and financial statements as statements that had a Good Housekeeping seal of approval. And I think this came in the context of 20 years of increasing, increased financial engineering of balance sheets.

A point today where I know very few people that will make the claim, including some of the most sophisticated Wall Street professionals, that they can pull apart the balance sheets of most of the larger corporations in the U.S. because of this financial engineering. And I believe the Enron was the trigger event for the emperor having no clothes with regard to these complicated balance sheets. And we do have to restore some confidence to audited financial statements.

And I will note that the Chairman, in some remarks in January, said that the Commission cannot, as I quote him, and in any event, will not tolerate this pattern of growing restatements, audit failures, corporate failures and investor losses.

Somehow we must put a stop to this vicious cycle that has been in evidence for too many years. We cannot afford a system like the present one that facilitates failure rather than success.

Do you have view with regard to how complicated balance sheets are today and the role of financial engineering that exists today in corporate America?

Mr. Bertsch: Yes. I absolutely agree with you that —

Mr. Beese: Let me ask the whole panel this question.

Mr. Bertsch: I absolutely agree with you that these questions are much more difficult that they used to be and that the investing community does not adequately understand, for one reason or another, the basic balance sheets and financials of some of the companies out there.

Now, I think it gets complicated and there's a lot of blame to go around. In the case of Enron, I have to say, and this is something we don't talk about a lot but it's a good story to tell so I think I'm allowed to tell this. At this point who could ask some other questions about some other case. But our analysts in our active component had, did figure out Enron pretty early on, or pretty early on. He was under some pressure to pick it up when the stock price had gone down a year ago or so. And he did analysis saying it doesn't add up. The numbers do not add up. And so I'm not sure that there wasn't more information there than is being acknowledged.

I also think, just as a footnote, there was a comment made about the Audit Committee at Enron, which was very distinguished but it clearly fell down on this and not because of obscurities. It fell down, I think, because of some pretty obvious issues. It granted relief from the company's own conflict of interest policies and then didn't follow up on that. And I don't think that was, I don't think that's an obscure question of financial derivative products or this or that.

Nevertheless, I think that things are more complicated than they used to be and the investing community needs to do, and is, I think, trying to organize itself. Because there's a lot of pressure these days on everybody to do a better job of understanding the fundamentals.

And also, there certainly was an element of momentum investing that caught up, not only individuals, but, I think, also the bigger investors. There was such a prolonged period and such huge increases in stock value that people were getting criticized for being left behind even though they couldn't really justify the values. So —

Mr. Beese: Thank you. And again, I do think it is right not to focus on Enron. Enron certainly highlights a lot of these issues but there's, I mean, I think it's a fair statement to say that there were other issues besides the ones that we're here to focus on today that were taking place at Enron.

But I would like other comments from the panel about the growing restatements and the growing audit failures that have been mentioned. And it is the reason we're here today. It is the reason why the new structures are being proposed. David?

Mr. Costello: Yes. I'd just like to comment on the financial statement presentation. I don't think there's been a time, at least in my history in the profession, that it was ever very easy for the general public to understand financial statements. But that's why we have CPAs. That's why we have Audit Committees. That's why we have Boards of Directors at companies. To help the investing public get through that. Hopefully that's why we have analysts.

There aren't very many people who can look at a balance sheet, no matter how simple it's presented and tell you what's on it much less understand the footnotes. I mean, certainly we should try to get those notes in as plain of English and as understandable as we can, but that doesn't solve the problem that we're facing today. The problem we're facing today is one of loss of credibility in the that attest function, that assurance function. And we've got to restore that.

Yes. Work on the financial statement presentation and, but if we can align the standards, get those standards right, and then get the auditors right and get the other control processes right, then I think that goes a long way to giving the public more comfort in the financial statements.

Then I could go rush out and buy a balance sheet made simple kind of book. I don't know that they exist. But they can have confidence in the regulatory scheme and in the auditors.

Mr. Beese: Thank you. Does anybody else like to comment on the threshold issue that the reason that we are here today discussing a Public Accountability Board is because there are fundamental issues that have to be addressed within the accounting industry?

Mr. Nusbaum: I was just going to comment on the previous item on the complexity of balance sheets. I think the financial markets and the activities of companies have become much more complicated over the last ten years with increasing use of derivatives, special purpose entities and other types of transactions that are extremely complicated. And we need to have accounting rules that develop quickly and focus on the substance of the transaction and, of course, principles-based standards will do that, and that goes a long way to solving the problem.

I don't think that financial statements is, other panelists pointed out, will ever be able to be completely understood by the general public, but it's important that analysts and the sophisticated user groups be able to understand the financial statements. And so their involvement in the development of standards is critical to make sure that we develop standards that meet their needs and allow them to analyze companies properly.

Mr. Beese: Thank you.

Ms. Franklin: Carter? Yes, I think the complexity of things is profoundly different today than when I first joined a public company board 20 years ago. And we now have a much faster pace of everything that's going on and we have far more global activity, which is another layer of complications, and then these new financial instruments that seem to get dreamed up every day.

It's really hard if you're on an Audit Committee as an outsider to keep up with all of this stuff in several different companies that may have different businesses.

Helping disclosure, as we talked about this morning, a better quality, plain English, more timely disclosure focusing on the really important things, I think, is crucial here. And we're behind the curve on that. I think everybody recognizes this. The challenge will now be to fix it. And we've put that in the hands of our competent SEC Chairman and others to figure this one out, maybe with a little help.

From the Audit Committee perspective, I believe that if the Audit Committee, which is the only Board committee that monitors what management does all the time, work of other Board committees goes up and down depending what's going on. Audit Committee vigilance all the time. I think if the Audit Committee can get the process right, it has a much better chance of getting the substance right.

Now, process to me means proactivity across the board. It means using the system of checks and balances to question everybody. Question the outside auditor, as one of my colleagues one day said, is there something squirrelly here? Which I thought was a great question of about some transaction we thought we couldn't understand.

I think the Committee has to set its own agenda with management input but not controlled by management. And I have a, use a process to do that but it's based on risk. I think you've got to figure out if you're the Audit Committee, along with input from various people.

I do it through a planning process once a year before the year starts with the outside auditor, the internal auditor, financial management, the General Counsel and whoever wants to sit there. Everybody comes in with their list of risks. What are the risks facing this enterprise short, medium term? And broadly define, don't limit yourself to accounting niggling stuff. And everybody does that. They get written down. We say, "Okay, now which ones of these are in the Audit Committee charter, bailiwick to oversee?"

Figure that out. And if there are white spaces, risks we don't think anybody's looking at, or the Board should, we would tell somebody. I would tell the CEO. And then the next question is, "Well, okay, if we're having four or five meetings this year, how are we going to make sure we oversee these risk areas?"

And then it will be up to management to prepare the right stuff so that we can oversee. And then, of course, that goes to the full Committee for amendment or change. Usually we buy off on that. Of course, you have to leave flexibility, too, for other things that come up during the year, but, and then I would go talk to the CEO and say, "Hey, this is the process. This is what we came up with in terms of risk areas. What do you think?"

And, generally, CEOs like this because sometimes it eliminates some things for them.

I have the sense that something like that wasn't done at Enron. An obvious risk area would have been all of these things out here. These SPEs, how many of them there were around the world? Three thousand or something? I mean, that's a clear risk area and how you get hold of that as an Audit Committee is a challenge. But hey, somebody should have been thinking about how you get hold of it. And apparently, nobody did.

So setting the agenda and sticking to it is crucial. And then the, this communication apparatus and the closed executive sessions to just keep the communication going and to try to eliminate whatever else is coming up. And then, of course, you've got to report to the Board if there's a trouble. And the Board gets behind the Committee to get management to fix it.

If you can get that right, I think you have a better shot at the substance. Nothing's perfect. If management's dishonest like they were in the Enron case, well, lots of luck. But I think you have a much better shot at it if you can get the process right. And I think that's the best defense for those of us who can't possible know everything.

Mr. Bertsch: Carter, can I just take another shot at your threshold question?

To me, one of the threshold issue, issues that has gotten everybody together on these questions is whether the accounting oversight system has worked. The accountant oversight system. And I think there's broad consensus that it didn't work. I suspect some people still disagree with that. But just for the record, we really don't have confidence in the peer review process and the Public Oversight Board process that had taken place in the past.

So that's really important to fix. My perception is that people aren't really very far apart by and large on a solution. But I'm not an insider on this so maybe I'm missing — there seems to be a lot of heated words but a lot of distance between people on the main elements of a proposal like Chairman Pitt's proposal.

Ms. Franklin: Can I inter —

Mr. Beese: Please, interrupt him, please.

Ms. Franklin: Some of the stuff coming out of the Hill, though, would have this entity in effect require through, one mechanism or another, the mandatory rotation of auditing firms. And I would disagree respectfully with you on that. I don't think that's a good idea. And I can't, I think we're now, I hate to say this, but I think we're down to four — shh, I never said that. But for a large, public, global, complex company, I would use Dow Chemical as an example of a company like that that I'm on the Board of.

I think to have to change auditors every four years just because somebody had a mandatory rule, I think is a real hardship. And it doesn't make any sense. I mean there's always a learning curve and there's not a whole lot of others to choose from. And some firms, audit firms, have different strengths than others. And so I think that the choice of when to change an audit firm should be in the hands of the Audit Committee and it should not be a mandatory rule.

Mr. Bertsch: Our policy is to change between five and ten years. The intention is to change about every seven years with some flexibility. So it's a little bit looser than that.

Ms. Franklin: I still wouldn't make it mandatory. It's semi-mandatory.

Mr. Beese: How about the halfway step club, mandatory turnover of the lead audit partner.

Ms. Franklin: Yes. Yes.

Mr. Bertsch: Well, that takes place now.

Ms. Franklin: And it does and it should. I'm for that kind of mandatory rotation of the engagement partner. Yes. And for cooling off.

Mr. Costello: I want to go back to the Audit Committee one more time because I've learned something today that I wasn't aware of. I thought all public companies' Audit Committees set the fees but the auditors were involved in the scope of audit. Management doing that, to me, is just, I can't imagine that being done. I think if that is going on, that's one thing that ought to be fixed quickly.

Audit Committees, they are the last best control for those investors out there. And I think, you know, not, and one way to get at the fee, that was mentioned awhile ago, is to how do you do that? Well, one way we do it is that we have an RFP process every so many years. And we just don't let one auditor be it. We go through, it's not a mandatory rotation, we've had the same auditor for maybe 12, 15 years. But that firm has to go through an RFP process. We want to know what's out there, what another firm can do. Maybe there's something else they can bring to the table.

But today, I think any public company, well, I think any company, their Audit Committee ought to negotiate those fees because how can they not do it especially when they are today required to react to nonaudit kinds of services. They have to disclose those. I don't know how you determine independence with respect to those if you're not involved in some significant way with setting those audit fees.

Ms. Franklin: But nonaudit fees are totally different.

Mr. Costello: Yes, but they have an impact in the overall assessment of independence.

Ms. Franklin: Well, yes.

Mr. Costello: I think we should put the two together.

Ms. Franklin: No. The committees that I'm a part of really do look at independence and really do look at other fees paid to the auditor. One of the concerns we have had relates to, on this point, relates to the proxy disclosure that is now in force that's got the three buckets in which you categorize your fees. Audit, financial systems development or whatever those words are, and other. Now the problem is that the other category is too big. It's too broad. And so some of the really audit-related fees get stuck down there when they really are audit related. Some of the tax work. Some of the work that auditors might be doing having to do with registration statements. And there are a few other categories like that.

Well, I think somehow that those buckets aren't quite right. So it's a little bit confusing if you just look at the buckets and say, "Well, there's too much in all other." And this is not an independence problem when it really may not be an independence problem. So maybe this is something that over time could be fixed.

Mr. Bertsch: And we have concerns on that from the other side. We're not quite sure what to make of these figures. And I do think that issuers can do something about it in that they can explain a little bit in the text which very few companies are doing. I think lawyers always want as little disclosure as you can get away with. But don't listen to the lawyers. Try to explain this to investors.

Ms. Franklin: Well, that's what we're doing because the, otherwise it can look very strange.

Mr. Bertsch: Right.

Ms. Franklin: So I think you have to separate the audit-related fees from the really strictly consulting fees in some other category. And the Committees that I'm well aware of have policies about that. We're now preapproving those sorts of fees. And whereas, in a big company we might have had the threshold level $500,000. And it would, the job would be brought to the committee for preapproval. It's going down to zero. That's the kind of thing that is now happening.

Again, to protect the independence of the auditor. I think we have to do it.

Mr. Beese: Dan?

Mr. Fischel: Well, actually, let me ask just kind of a follow up question of something you just said about you don't see a lot of company explanation because one of the things that, at least I would expect, if it were the case that was very hard for market participants, not everyday market participants, but sophisticated market participants such as yourself, to understand balance sheets, to understand financial statements.

I would worry or I would expect that companies would worry about being penalized in the marketplace for that. People would say I can't understand. I'm not going to invest. Or I'm going to wretch down the price that I'm willing to pay. And at least by the relatively uninformed accounts that I've heard, maybe that's not the right way to put it, but just by word of mouth, I've heard that a number of companies, for example companies that have off balance sheet vehicles and relatively complicated interest in derivative securities are providing a lot more disclosure. Because they were battered in the marketplace for not doing so, which is a reason why I think it's always good to have a period to allow some market adaptation and experimentation. I'm just wondering if you observed that as well?

Mr. Bertsch: Oh, there's definitely, I'm not on the investment side, so I'm not doing the investments. I don't want to put myself out as doing that. But there's no question that disclosures at quite a number of companies have been substantially enhanced, particularly because of the recent market punishment of companies where things are not transparent.

This is a narrower issue on the little audit fee thing, but there I would just suggest as a public relations matter, companies could help themselves out a little bit.

But on the broader disclosure issues, they're in the current environment. There's no doubt that there's greater reward for transparency.

Mr. Fischel: Which, at least I would interpret in contrast with what Carter said or maybe a somewhat different perspective, that if there really is a concern among investors in the marketplace, there are powerful private incentives to firms to overcome it just in order in their self interest to maximize the value of their equity.

Mr. Beese: No. I would agree with that. And you saw a number of firms, we don't have to use the names here, but a number of household names went to post Enron guilty and had to prove their innocence with regard to their balance sheets. And that did take place in the marketplace. And some have been correctly been able to do that and some are still laboring under the burden of doing that. But that can take place in the marketplace.

And at the other end of the spectrum of the marketplace, we also have litigation that plays a policing role.

But let me go back to Ed and talk about the role of litigation in the accounting industry. Obviously one of the reasons that we're here talking about the Public Accounting Board today is that we want to be proactive in putting in a structure and the type of processes that Barbara described at the Audit Committee level, the same type of structure processes need to take place at the oversight level so that we mitigate litigation as a way of policing the industry.

Would you give us some observations on that?

Mr. Nusbaum: Well, certainly. Obviously, improved oversight, from an accounting firm standpoint is a lot better than increased litigation. Litigation is a real problem for the profession, and we see the impact on at least one of the big firms. And while there are many other firms besides the four, I might point out, couldn't let that go.

Nevertheless, it's not good to see any accounting firm go out of business. And certainly not a larger one. And that is not a good thing for the market system. And anything that the regulators can do to work with the profession to improve that process and set up an oversight process that will mitigate litigation and sets some limits on litigation is probably in everyone's best interest, going forward.

You know, I think that things like increasing transparency and a lot of little steps can help reduce litigation. But the real key is to have a system that relies on the oversight and the regulators to help oversight rather than litigation that can destroy an accounting firm, maybe appropriately, maybe inappropriately.

One of the questions that we've talked about is restatements. Why are there so many restatements? And I think that there's a lot of reasons for so many restatements.

One is increasing use of cookbook approaches to accounting standards and having those cookbooks inappropriately applied. I think also the SEC has done a better job and the SEC's accounting staff has done a good job of finding things that need to be restated. And companies maybe have been pushing hard to paint the best picture.

But, no matter what we do as an accounting profession, companies will always push hard to paint the best picture for those companies. And it's up to the accounting firms to act as the watchdog, to police that effort. And I believe, and I sincerely believe this, that the accounting firms are committed to accomplish that, to act as the watchdog.

And we need to have a culture and a change in what we're doing, not only by the accounting firms, but by the preparers, the accounting firms and the regulators to develop an approach that gets us to the right accounting principles and the right disclosures of those principles and the right application of those principles.

And I really do believe that that would require a change in culture in the way, not that's just the accounting firms, but the entire accounting profession, which includes the preparers, the firms, the auditors and the regulators. So that we're trying to accomplish the right thing. And then the regulators work with the preparers and the auditors to not beat up the accounting firm and the preparers if the intent was right, but only beat them up if there was an intent to mislead and defraud the public.

Mr. Beese: Thanks. If I may just ask you to comment on the question that Barbara Franklin was speaking to earlier about the possibility of outside directors for accounting firms. Obviously, there are issues with that, but the reason why it has been floated and now effective at one firm, is because there needs to be the confidence to the, instilled in the public that there is integrity to the process, that there is a quality control to the process. Is that a viable option, and if not, well, what other options are out there to try. And you said the cultures need to be changed. But how can the public and the confidence be enhanced that there is internal quality controls at the firms?

Mr. Nusbaum: Well, I think that the Oversight Board that we're talking about will look at internal quality controls of the firms. And so the establishment of that Board, the assistance of the SEC and the regulation by the SEC, can help, I think, go a long way to restore the confidence. Because the internal control processes are going to be reviewed and carefully studied and improved if necessary.

Putting independent directors on a public accounting firm may make some sense. We, at our firm, we've talked about this for many years. How would it work? What would it work? And we've considered things like an Independent Advisory Board. But accounting firms, like any other organization, is a business. And, you know, it's a question as to what is the role of the independent director?

A typical member of a board of a corporation, their role is to improve the business and increase the stock. I think what we're really talking about here is improving the audit process and improving the public's confidence in that audit process. And some independent advisors to help in that process might the right solution. I think studying the process more and having the accounting firms work with, maybe with the help of some outsiders, to improve that process could also help restore public confidence.

Ms. Franklin: Carter? My experience is that, well, I don't think this is terribly workable. I guess I should start with that. To put, to advocate putting one or two or something independent members on the board of a public accounting firm.

In order for people like that to have any clout, there has to be a critical mass of them. And otherwise, it's a token thing. And they can always get overridden by the mass of people who are there. And so you have, if you're in that situation, I've been in this so, this is why I'm speaking this way. You either have to go along or you have to quit. So I don't think that's the way to go. Maybe your independent advisory apparatus is a more viable thing to advocate for an accounting firm.

Mr. Costello: I agree. I think putting another layer into accounting firms lessens their credibility. It doesn't raise it in my mind. You know, it's just only until recently CPAs were right up there with the priests, rabbis and ministers as being the most trusted people with integrity. And, you know, there was a reason for that.

I think we have to get back to that and it's going to take a lot of hard work. But I think a PAB, a Public Accountability Board, with the right mechanisms, which includes a seat for state boards, I think would help. I think all the other kinds of things we're talking about, Audit Committees and getting serious about beefing up Audit Committees with the right people and giving them the right processes, I think that's the way you go about it. But putting another layer into an accounting firm doesn't do anything for my credibility.

Mr. Beese: Okay. David, while we're on the topic, let me ask you about the observation on some that there should be a cooling off period before, some suggest two years, that an auditor would not be allowed to join the firm that he's auditing.

Mr. Nusbaum: Well, can I comment on that while you're thinking? I'll give you a chance to get your thoughts together.

There's a couple different layers, obviously, within an accounting firm. And if the debate whether partners should have some kind of cooling off period or not, but I would certainly be vehemently opposed to any cooling off period for staff or anything below partner. It would be hard to entice people to come into public accounting if we told them they could never work for a client that they audited, that's where a lot of them end up working and it's a natural job progression.

I think the people that currently are coming out of college and going into the accounting profession are some of the brightest students in the universities. And we attract a very high caliber of person into public accounting. Many of them, unfortunately from our perspective, but I understand the reasons that they do this. Many of them want to come work in public accounting, get some good experience, see a lot of different companies and then go work for a company. And it'd make it very, very difficult to do that if we put all kinds of restrictions on that process.

I'd prefer to not see it even at the partner level, but that's certainly something that may be workable.

Mr. Costello: I think I'd agree with that. I'm, although I'm a regulator and I represent regulators, I'm, I really don't like just regulation for regulation's sake. And I'm very careful about those things. Whether two years is the right period, I don't know. Yes, there should be some period for the audit partner that was involved in that climb, yes, I think so. I think that makes some sense.

Ms. Franklin: Carter, can I jump back to your restatement?

Mr. Beese: Can you do it coming on this particular —

Mr. Bertsch: Well, yes, I just, I just, I'm not sure really of the, I'm not sure that whether this should apply to staff or not. But it's not immediately apparent to me why it should really restrict their opportunities that much in that most of the companies out there are using other auditors so, you're just sort of shifting things around. You've still got the same pool of people who are likely to be leading candidates to be hired a company in finance departments, I think. It's just, well, the, pick any of the firms who will go to Grant Thornton and hire your staff or where you weren't auditing. I was going to say Arthur Anderson, but I don't, where we're counting them.

Mr. Fischel: I think the proposal's really stupid.

Ms. Franklin: Stupid?

Mr. Fischel: Stupid myself, because I assume what's motivating it is some sense that if somebody could work for a client, they are going to be to willing to do what the client wants in exchange for getting a job.

But on the other hand, they can't work for a client not only is there a problem that was already alluded to in terms of making the career choice less attractive, but they also have less of an incentive to really immerse themselves in understanding what the client's business is. In any, and they will do a better audit if they really understand the client's business.

In a situation where you don't know what you're going to do in the future, where there's a possibility of making partner in the accounting firm is a possibility, or if you're already a partner, rising in the hierarchy or going to work for a company or doing something else to foreclose one option just makes you much less willing to invest in that option.

And the downside, it seems to me, is potentially far greater than the upside. And again, I'll keep coming back to the theme that I've articulated several times. If it were really confidence enhancing, if investors really thought that an auditor who couldn't work for the company, that that would really build investor confidence, give investors more confidence in the integrity of the firms' financial statements. Then just as you have seen, the voluntary adaptation in disclosure policy, you would see firms adopting rules that they would disseminate to investors that when they hire an independent accountant, they will adopt a rule that no person who works on that audit will be eligible to work for the company. There are very strong, private incentives to do things like that if they're really confidence enhancing. So I think it's probably a mistake.

Mr. Beese: Dan, I knew if we could mill, we'd agree on something.

Mr. Fischel: Right.

Mr. Costello: Well, actually, I'm going the other way. Now, I'm feeling that it ought to be at least two years based on his remarks because —

Mr. Fischel: Ten years.

Mr. Costello: — the issue is just not investor confidence. Many investors, you're right, don't care one way or the other. Many of them don't know. But there is a propensity for temptation here. It's particularly if an audit partner has his eye on a very key CFO position or VP of Finance position. But there is that propensity to be tempted. And it can lead to things. No one would have thought about this except for failures. And that's the only time you start scratching your head and say, "Well, I wonder if those 25 people that used to be at Anderson, did they have an influence?"

Maybe they never had an influence, but perception is very real in our society. So, why not have some cooling off period to remove that?

Ms. Franklin: I am not for any mandatory regulated regulatory cooling off period. I am for a cooling off policy, but I think each company or, yes, each company ought to set its own policy for a cooling off period, two years or three years or what have you. But I really don't think things like this should be mandated. I think they're counterproductive.

There's something I'm really itching to say about restatements.

Mr. Beese: Please.

Ms. Franklin: The, and the rash of them, one of the poster child's is SAB 101 Revenue Recognition. Now, part of the problem for that, that caused that, it seemed to me was regulatory process. And I hasten to add, it was not the Harvey Pitt SEC. It was earlier.

Here was rule-making really by staff bulletin that had no due process associated with it. I am a really strong believer in regulatory process and due process. It comes out of my regulatory background. There was no due process here that I could find. And it seemed that the requirements kept changing and then became retroactive. That is not the way regulation should be promulgated. And I was really upset by it. I'm sure it's not going to happen in the future. I'll be upset by it again.

But I think that was one, that's not the only reason we had the restatements, but that was, that was in the mix of this one. And I just had to say that, Carter.

Mr. Beese: No. I think it's a very appropriate point to make. And does anybody else like to comment on that?

Mr. Bertsch: I have a comment going back one. I'm sorry.

Mr. Beese: Okay.

Mr. Bertsch: Sort of a middle way on a policy that may be a good idea such as a cooling off period. There are other corporate governance policies, but maybe you don't want to mandate.

Stock exchange is, in some other markets, particularly the London stock exchange and Toronto stock exchange, have come up with guidelines for best practice. And then asked companies to talk about that best practice and talk about why they don't follow them if there's some areas where they deviate. And companies do deviate and they explain. And I think it really does contribute to some transparency, some understanding. And also comparability. You can look at different companies and understand something in one place, but that's not mandated. So it's a middle way.

Mr. Costello: One more comment on that.

Mr. Beese: Okay.

Mr. Costello: You know, I made a comment earlier in my opening remarks that we've got an opportunity to do things right here. And part of that doing things right, and I'll just say it, is trying to keep a congressional solution away from this.

You know, we can't trip on something as simple as a cooling period. If it takes that, it's not that big a deal. But, I know there are people in Congress who are thinking about cooling off periods much more extreme that what we're talking about. I would just say, let's not dismiss outright, because we may get something much more egregious than we're dreaming about. And I don't want to see that happen.

Mr. Beese: Let me take the opportunity now to just ask Chairman Pitt and Commissioner Glassman. I know you've said you're here to listen, but if you would like to make any observations at this time or correct anything you heard that you think should be corrected, please let me ask. Commissioner?

Commissioner Glassman: I just — is this on? I just, as Harvey said this morning, we are here to listen. We're not here to provide our views. We're here to learn from you. So I just want to reiterate how helpful this is to us to get all of these different perspectives on all of these issues. Because we do, we're the ones that ultimately have to write some of these rules and it is very challenging. So, and then we appreciate all the input.

Mr. Beese: Thank you.

Commissioner Pitt: Well, I appreciate both the help and also the opportunity, which I will decline. But I would like to say that the fact that I decline the opportunity doesn't necessarily mean that I've agreed with everything that's been said. But I have found all of it very interesting.

Mr. Beese: Thank you. I've got a couple more questions for the panel, but let me ask at this time if there are any questions from the audience, that they would like to address to any of the panelists? Yes, please.

(Question from audience.)

Ms. Franklin: That's good. I used to ask for them before, so thank you. That's good. Thank you.

Mr. Beese: Helpful.

Mr. Costello: And does that include 100 percent of the reports or is that just adverse reports?

Audience Member: One hundred percent of, every member every 1,200 members of the SEC Practice Session that's on this —

Mr. Costello: Right. Yes. And there are a few that aren't so —

Audience Member: They're all there. All the reports are there —

Mr. Costello: No, this is the first I've heard of it.

Audience Member: I don't think it has outside of the people —

Mr. Beese: Thank you. If anyone has any other questions during the balance of our process, please just raise their hand and we'll make this interactive. Yes, please?

Audience Member: Ken, you mentioned that you didn't think tin cup funding was —

Mr. Bertsch: Well, I think that there should be perhaps a transaction fee, some sort of fees. I think actually the SEC probably has within its authority now, but certainly could be given the authority to provide automatic funding from what essentially are very small fees on, ultimately on investors, who really should be paying for this. It should not be paid for by the audit industry, by the accounting industry.

Ms. Franklin: By investors. I'm sorry. You had the floor. I was going to pursue that. I wondered what he meant by investors.

Audience Member: Through the —

Mr. Bertsch: Transaction fees. Yes.

Mr. Beese: Transaction fees.

Mr. Bertsch: Right. Right. Right. That's what I mean. Small transaction fees. One of the disappointments, in the investing community, there's always a free rider problem. And among the people who have been very poor about supporting these institutions are the investors, frankly. In a direct voluntary contribution way. I think this needs to be made involuntary.

Mr. Beese: Let me try to get some more comments about the structure of a Public Accountability Board. And let me ask in a shorthand way, one of the structures proposed for that would be one that would be similar to NASDAQ and the NASD. Can I get comments from the panel as to how appropriate they think that is. Ken?

Mr. Bertsch: I think that's a good, the NASD model has been very effective.

Mr. Beese: So you think we can get, have all the organizations within that the equivalent of what had been the POB and the AICPA?

Mr. Bertsch: I think that should be looked at. I'm not prepared to endorse that. I think as the accounting oversight body, that sort of model would be very effective. I'd like to look at it for the broader group but I don't want to endorse it here today.

Mr. Beese: Okay. Other panelists? And let me also ask, you know, a related question which is who should appoint the directors of an entity such as this? Dan?

Mr. Fischel: I don't know. I'm agreeing with you. That's a very hard question if you're going to take the step that the Chairman has proposed, obviously the identity of the participants and who gets to choose and how insulated they are from influence and political pressure, while at the same time being sufficiently informed to know what they're doing. It's a critical question.

Mr. Bertsch: One of the proposals I think is to have the Chairman of the SEC, the Treasury Secretary and the Chair of the Federal Reserve make some kind of appointment, long-term appointments, that — but I don't know exactly how that's spelled out.

Ms. Franklin: And somebody has got the GAO in there, too, I think. One of the congressional proposals.

Mr. Beese: End of the observations?

Mr. Nusbaum: Well, I think that the oversight or the leadership by some of the regulators in the groups you mentioned is okay, but I think that the actual members themselves should be from various organizations and groups and picked by those organizations and groups, starting with some of the user groups, including maybe even some of the groups on this panel. But also including the preparer group, whether it's the FEI or another group.

The accounting profession and certainly coordinated by the AICPA, again with a broad spectrum of accounting firms from the largest of firms to medium-sized firms and maybe some smaller firms. And then, at least some representation from academia. And I think by having a broader perspective on that. But clearly some user groups should be represented as well as just the profession and the preparers.

Mr. Fischel: I have a question for my copanelists. Is there any logic to making this organization international as opposed to national?

Mr. Nusbaum: Well, I think that there is some logic to that. I mean, there is a program currently going called the Forum of Firms. Our firm and I think six other global firms are on that forum of firms. And I think there is some advantage to doing that because they were going down a process of peer review. And they were trying to follow the U.S. model and think there's maybe a little bit of confusion as to what they should do going forward. I think what we do might set the stage for what is done on a global basis.

We probably ought to start with the U.S. first and try to figure out what the best process is. But if we could do it on a global basis to start with, if we could figure out how to accomplish that, that would be even better from our perspective.

Mr. Beese: I mean I would just make the observation. The time I spent as a financial regulator that there are times when regulation can get rather nationalistic over certain issues. I think it works very well to have a very good working relationships with your international counterparts and particularly with regard to standard setting and discussion. But there are times when you've got to respect the borders and certainly some countries do that a little more bristally than others at times and there are problems with some of these agencies that would supersede borders if you will, that have a jurisdiction that supersedes a border would be my observation. Anyone else?

I have one last question and then I'd like to ask each of the panelists if they have any closing remarks to make and invite, again, any questions from the floor. But there is a question that came up in this morning's panel that is, I think, a very important question and I will direct it first to Barbara Franklin. Again, given her tremendous experience on Audit Committee , but serving on Audit Committee always has been, I believe in many cases, a disproportionate burden for a Director. And clearly today that has been enhanced.

The amount of time that is put in by Audit Committee members is usually dramatically more than that of most other directors unless there's another special committee that arises that takes the, you know, a particular amount of time. And now the burden that is placed on Audit Committees. I think in a sense we have created or the climate has created, if you will, a super class of directors. Maybe, if you will, you've had the concept in the past of a lead director at some companies. And now I think the Audit Committee members themselves have become, in a sense, a group of lead directors. And in essence we've created two classes of directors. And not only is the workload dramatically more, but now the liability is dramatically more.

And you can debate the liability issue from several factors saying, "Well, if they're doing their job, they shouldn't have liability." Or, "If they don't have time to do the job, they shouldn't do the job." But if nothing else, what's become clear is the liability with regard to reputational risk of being on an Audit Committee has become dramatically more.

And so I wish, the question came this morning, should Audit Committee members be paid more. I mean, they usually are paid something more for being on the Audit Committee, but it's a small percent addition in many cases to what every other director receives. That's something that I think is a question that's going to be debated across corporate America. Secretary Franklin, do you have any observations on that?

Ms. Franklin: Well, you're correct about the workload, responsibility, liability having gone up. And that started with the outcome of the Blue Ribbon Committee and the implementation of those recommendations. And it's, the expectations are higher now. Where that's going to stop? I don't know. I don't like the talk, quite frankly, about two classes of directors. And again, maybe it's more a liability concern that if they start singling out Audit Committees in lawsuits, I think we have a whole other set of problems. And people will start to get off Audit Committees.

I think one thing we're all watching is what is going to happen with this Enron situation. There's some case law going back, this is that I looked at prior to the Blue Ribbon Committee recommendations, because I had the liability concern then. And people were saying, "Oh, forget it." You know, "You're overstating it." Well, I don't think so. There was some case law then. There wasn't a lot of it. But enough of it in different states, it's all state stuff, that did single out the Audit Committee as a super committee or something that did have more liability concerns.

I don't like that as a trend for obvious reasons. Some of it may be self-preservation. But I do think Audit Committees are going to have a lot of trouble, will have a lot of trouble on Boards getting people to serve.

The compensation issue, I've been through this in a couple of places. Now, not just lately. So maybe there's a sea change going here, we'll see. But it was a very — well first of all I should say, I always was a little uncomfortable bringing up the fact that there was more work and more responsibility, et cetera, because I was, it was too self-serving I thought. But it's a very hard sell, more compensation for Audit Committee members. And I don't think they're getting more now.

I think there's a lot of equilibrium across Board committee work. And Boards are viewing themselves like that. They don't want to, if you're in the board room, they don't want to elevate one committee in any way. And so I don't know where this goes. Something has to happen. And right now I haven't got the answer.

One thing that has, I think, worked effectively one place where I am. Actually more than one, but one place where I Chair the committee, where the company is still paying meeting fees retainer and meeting fees. Now some companies have gotten rid of meeting fees so if you're on a committee, you're getting the just whatever the retainer is for that committee work. And that's where the rub is. People haven't wanted, on Boards, to elevate the retainer for the Audit Committee.

However, if there are meeting fees still being paid, that helps a little bit. What has happened after the Blue Ribbon Committee recommendations went into force, of course, is those quarterly reviews of earnings reviews and 10-K that involve the Audit Committee Well, if those are telephonic, which often they are because the meetings aren't the right time to do all of that in a meeting, so then the members would get paid for the phone call. So that's a meeting fee. But if you have no meeting fee, then the workload has gone up and the retainer has just stayed the same.

There's something wrong with this, but I have to tell you right now, I don't know what the answer is because I don't see, so far, the sentiment in Boards to pay Audit Committee more.

Does anybody out there have an answer? Or up here?

Audience Member: I've got a question about equity compensation for — and then CFO's, that would be an option.

Ms. Franklin: Well, I've gotten a couple of press calls over the last two weeks because somebody has put forth a proposal that says Audit Committee should not be paid in stock instruments. The rational being that somehow we have access to inside information that is going to give us the opportunity to do something, sell something or exercise options or what have you.

I think this is baloney, quite frankly. I don't think we have, as Audit Committee members, access to any real inside information that other members of the Board really haven't got. Plus, it doesn't take into account the fact that there are restrictions on when you can buy and sell and there are blackout periods and all of that.

My answer to one of these guys was that if you're going to do that, then you've got to do it across the board for the whole Board. However, that flies in the face of what shareholder activists want, which is to have a shareholder, the director's interest in the shareholders' interest be in consonance, and so therefore, they need equity stakes.

Audience Member: CFOs?

Ms. Franklin: CFOs?

Mr. Nusbaum: Well, I'm going to chime in on that one because I think CFOs are just part of the management team. And I think if you do it for CFOs, you really need to do it for CEOs. Because they're really the ones setting the tone of the organization and where the company's going. And that, you know, becomes sort of a crazy answer. But that's really where the tone and the way a company is going and how a company operates, that tone established by the CEO really dictates what happens.

I think that this concept of stock options somehow being bad or profits, you know, the needs to increase profits is what caused the problem at Enron, is sort of an absurd answer. I think, you know, our system of capitalism is based on having profits. And having stock options are not necessarily a bad thing. I don't think the problems at Enron were cause, although I don't know all the issues, but I suspect they were not caused by the fact that somebody owned stock options.

You know, there's thousands of employees of corporations that own stock options. And I think that on most days, they do the right thing. Not only from an accounting standpoint, but, you know, maybe you shouldn't allow scientists to own stock options because they'll promote drugs that are bad through their company because that will increase the value of their stock. I mean, you could take this to a pretty absurd level.

Now you can debate the accounting for stock options and that would require a lot more time than we have here on this panel.

Ms. Franklin: The internal auditors, too, were included in this questions. Internal auditors shouldn't get options.

Mr. Beese: If you've got that concern with the CFO, I think you've got the wrong CFO. I mean, the question is having confidence in the CFO and it's a bigger issue, I think, whether he's sufficiently independent from the CEO as opposed to whether he might be motivated by equity incentives that he may have.

Mr. Bertsch: For outside directors, just to put in a view, I would rather see paid in stock than stock options. I think stock options are a great tool for the executives, but for directors I think that there's an argument that direct grants of stock and purchases of stock, having ownership guidelines, will align their interest more closely with shareholders.

Mr. Beese: Thanks. Let's take a couple questions as we wrap up. Yes, please?

(Question from audience.)

Mr. Beese: Ken, you want to handle that?

Mr. Bertsch: Well —

Mr. Fischel: I agree with you.

Mr. Bertsch: I think there needs to be a system of accounting oversight that doesn't just result in either, I guess, a market based solution, which may work out in the very long term or no penalties or the death penalty. I think right now we're seeing the death penalty used and it's partly because of the absence of effective disciplinary means that were accepted by the firms and actually meant something in the past. So, you know, that's a piece of the argument. I think there are other areas you can aim at. But that's, I think we need an effective system of auditor oversight.

Mr. Beese: Yes, sir. Sorry, go ahead.

Mr. Costello: His analyst works for a multibillion dollar company and it's his job to look at financial statements and he's trained to do that. And many investors aren't that trained at all and they are relying on that auditor. And so there has to be something for that kind of industry also.

Mr. Fischel: I think it's, I think it's important to not make the answer too easy. In other words, nobody's in favor of an ineffective system of oversight. All right. So to say we need an, obviously we all agree we need an effective system of oversight, but there's an optimal amount of oversight. We don't want to have so much oversight that innovation in the economy is discouraged. And I think that's the problem.

Mr. Beese: Thank you. Please?

(Question from audience.)

Ms. Franklin: Stock gets to result together. Any time stock gets —

(Question from audience.)

Mr. Beese: I would answer. The question was, if all the committee members are paid with equity instruments, what does that do to their independence? I would go back to what I said with regard to the CFO. If that is going to affect a person's judgement, then they don't belong on the Audit Committee in the first place. The same with the CFO and for those that do go astray of that, that there is enforcement, which is, I think, the better answer when you do have abuses, when someone is motivated in that way. And I do think you're going to see some enforcement in that way. And I do think you're going to see some enforcement in recent cases we've already met. As opposed to have just a prophylactic approach of not allowing them to have any alignment with the shareholders.

(Question from audience.)

Mr. Fischel: I think it's an excellent question. I was thinking about it when the issue was raised before. I think if you, I mean myself, it wouldn't bother me to allow people on the Audit Committee to get compensated in stock, in stock options. But if you start from the opposite premise that the Audit Committee is the ultimate watchdog, even more so than the independent accounting firm, it's hard to understand how you could allow the company insiders, who are the, not the insiders, excuse me, the company ultimate watchdogs to get paid in stock, but the auditors not to get paid in stock.

Mr. Beese: Well, there's a distinction here. The Audit Committee member, the members of the Board in general, are under restrictions, blackout restrictions, inside trading restrictions. Now, auditors, in a sense, you know, have continuous inside information. Maybe you could come with a structure where they had blackout periods and, you know, blackout periods apply to certain time periods, but also there's also the restriction that any time that you deem yourself having inside information, not being able to trade.

(Question from audience.)

Ms. Franklin: It depends how you view this. I can tell you that whether I'm paid in cash or in stock is going to have no bearing on my independence. I think we have view the payment in stock as part of compensation. Directors have to be compensated. The question is how. And I just —

Mr. Fischel: But Barbara, the question is if that's true for you, why isn't it also true for the auditor?

Ms. Franklin: Yes. But the auditor, as Carter is pointing out, is —

Mr. Fischel: Are you —

Ms. Franklin: Hold it. What did he say? I missed it.

Mr. Beese: No. I made the point that the auditors do not have blackout restrictions the same way the Audit Committee does. That's a big distinction to start with.

Ms. Franklin: Yes.

(Comment from audience.)

Ms. Franklin: I think — I don't know what you're assuming about Audit Committee people, but the ones I serve with are really quite upstanding people with great integrity who want to do the right thing. And I don't think that they think about, I certainly do not, what's going to happen to my stock? If we do X, Y and Z, I really think you're overstating that point totally.

(Comment from audience.)

Ms. Franklin: Pardon me?

(Comment from audience.)

Ms. Franklin: I agree with that. But this is a different situation, I think, with the audit firm.

Mr. Bertsch: If I can just throw in a footnote.

Ms. Franklin: All right. I don't know.

Mr. Bertsch: The institutional investors in the U.K. take this view. The mainstream institutional investor view in the U.S. has been you need independent boards but you also need to align the interest of directors to make them interested in a sense. And you need stock ownership to do.

Mr. Beese: We've rode over our allotted time now, so let me just ask if anybody has any brief closing statement.

Ms. Franklin: I have one thing to say. And that is somebody down here earlier said he was proud to be a CPA. And that we needed to bring the trust in the profession and the pride in the profession back.

I really agree with that and I worry about this period we're in because I fear that it will discourage some bright young people from going into this profession. It will encourage other people who are in it to get out of it. And the caliber of auditors and auditing will go down regardless of what kind of regulatory apparatus we have. That's not good for Audit Committees. I love auditors. Auditors are our friends. And I want the caliber and the pride to come back.

Mr. Beese: We will close on that applause. Thank you all for your time and attention.

Mr. Pitt: I'd like to thank all of the panelists and Carter for moderating this. And I'd also like to say a special word about Mary Keefe for arranging, our head of our Midwest Regional Office, for arranging all of the facilities and to Susan Wyderko for pulling all of this together. So thank you all for attending.

(Whereupon the meeting was concluded at 3:33 p.m.)



Modified: 06/06/2002