[Senate Hearing 107-1142]
[From the U.S. Government Publishing Office]



                                                       S. Hrg. 107-1142
 
    PERSPECTIVES ON IMPROVING CORPORATE RESPONSIBILITY AND CONSUMER 
                              PROTECTIONS

=======================================================================

                                HEARING

                               before the

     SUBCOMMITTEE ON CONSUMER AFFAIRS, FOREIGN COMMERCE AND TOURISM

                                 of the

                         COMMITTEE ON COMMERCE,
                      SCIENCE, AND TRANSPORTATION
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 18, 2002

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation


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       SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

              ERNEST F. HOLLINGS, SOUTH CAROLINA Chairman
DANIEL K. INOUYE, Hawaii             JOHN McCAIN, Arizona
JOHN D. ROCKEFELLER IV, West         TED STEVENS, Alaska
    Virginia                         CONRAD BURNS, Montana
JOHN F. KERRY, Massachusetts         TRENT LOTT, Mississippi
JOHN B. BREAUX, Louisiana            KAY BAILEY HUTCHISON, Texas
BYRON L. DORGAN, North Dakota        OLYMPIA J. SNOWE, Maine
RON WYDEN, Oregon                    SAM BROWNBACK, Kansas
MAX CLELAND, Georgia                 GORDON SMITH, Oregon
BARBARA BOXER, California            PETER G. FITZGERALD, Illinois
JOHN EDWARDS, North Carolina         JOHN ENSIGN, Nevada
JEAN CARNAHAN, Missouri              GEORGE ALLEN, Virginia
BILL NELSON, Florida
               Kevin D. Kayes, Democratic Staff Director
                  Moses Boyd, Democratic Chief Counsel
Jeanne Bumpus, Republican Staff Director and General Counsel...........

     SUBCOMMITTEE ON CONSUMER AFFAIRS, FOREIGN COMMERCE AND TOURISM

                BYRON L. DORGAN, North Dakota, Chairman
JOHN D. ROCKEFELLER IV, West         PETER G. FITZGERALD, Illinois
    Virginia                         CONRAD BURNS, Montana
RON WYDEN, Oregon                    SAM BROWNBACK, Kansas
BARBARA BOXER, California            GORDON SMITH, Oregon
JOHN EDWARDS, North Carolina         JOHN ENSIGN, Nevada
JEAN CARNAHAN, Missouri              GEORGE ALLEN, Virginia
BILL NELSON, Florida


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on July 18, 2002....................................     1
Statement of Senator Boxer.......................................    43
    Prepared statement...........................................    44
Statement of Senator Dorgan......................................     1
Statement of Senator Edwards.....................................    45
Statement of Senator Fitzgerald..................................    46

                               Witnesses

Claybrook, Joan, President, Public Citizen.......................    18
    Prepared statement...........................................    24
    Article, dated July 17, 2002, entitled The Shareholder 
      Lawsuit: A Red Flag for Auditors?..........................    21
    Letters to Hon. Arthur Levitt................................ 39,40
Metzenbaum, Hon. Howard M., (Retired Senator), Chairman, Consumer 
  Federation of America..........................................     2
    Prepared statement...........................................     5
Minow, Nell, Editor, The Corporate Library.......................    48
    Prepared statement...........................................    51
Moore, Hon. Richard, Treasurer for the State of North Carolina...    10
    Prepared statement...........................................    13

                                Appendix

Smith, Hon. Gordon, U.S. Senator from Oregon, prepared statement.    61


    PERSPECTIVES ON IMPROVING CORPORATE RESPONSIBILITY AND CONSUMER 
                              PROTECTIONS

                              ----------                              


                        THURSDAY, JULY 18, 2002

                               U.S. Senate,
Subcommittee on Consumer Affairs, Foreign Commerce, 
                                       and Tourism,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 9:35 a.m. in 
room SR-253, Russell Senate Office Building, Hon. Byron L. 
Dorgan, Chairman of the Subcommittee, presiding.

          OPENING STATEMENT OF HON. BYRON L. DORGAN, 
                 U.S. SENATOR FROM NORTH DAKOTA

    Senator Dorgan. We call the Subcommittee hearing to order. 
This morning's hearing will be conducted in 2 parts. Beginning 
at 9:30 a.m., we will have the first portion of the hearing 
dealing with the perspectives offered to us by a number of 
organizations and individuals on corporate responsibility, 
consumer protections, and related issues; all of us know that 
we have had a crisis of confidence in this country--in many 
instances, for very good reasons--in the economy and 
corporations.
    Virtually every day, we hear additional news about some of 
America's best-known corporations restating earnings. We have 
news about corporations filing for bankruptcy. We have news of 
companies--such as Xerox, Global Crossing, Qwest, WorldCom, 
Merck, Enron, Tyco--restating earnings going back a quarter, a 
year, 2 years, 3 years, 4 years. It seems to me each and every 
day brings a new revelation about behavior and about practices 
inside the companies, about the actions of accountants and law 
firms that make you just shake your head and say, ``What on 
earth were people thinking about?''
    This is about public trust. The mechanism by which we 
accumulate capital in this country is such that people must be 
able to trust those who are running our companies, those who 
are preparing financial statements, those who are running 
accounting firms, those who are running the law firms. The 
faith in those institutions and those organizations has been 
sorely shaken in recent months.
    We recently passed a piece of legislation in the Senate 
dealing with corporate responsibility. Much more is yet to be 
done, however. That needs to go to conference. There are things 
that are left out of that bill. We will need to have a second 
round on that issue. We thought it was important to continue 
the work that we have done in this Subcommittee, much of it 
focusing on Enron following the announcements with respect to 
the Enron Corporation's scandals, I guess I would call it. The 
more we looked into Enron, I said it was a culture of corporate 
corruption, and I am more convinced of that now than ever. But 
it is not just the Enron Corporation. It goes well beyond that.
    We're going to have a hearing later this morning in which 
we hear about mark-to-market accounting in the State of 
California. Mechanisms by which I believe price fixing occurred 
in the State of California to the tune of billions of dollars. 
Billions of dollars taken out of the pockets of California 
consumers by manipulation of wholesale electricity prices and, 
therefore, the manipulation of retail electricity prices, as 
well. This isn't petty theft. This is wholesale fraud, in my 
judgment. We'll have some discussion about that later this 
morning.
    To give us a perspective from several different points on 
the compass about corporate responsibility, consumer protection 
and related issues--as a prelude to other activities this 
Subcommittee will have dealing with WorldCom, Global Crossing, 
Tyco, Xerox, and other companies, as well--we want to hear from 
four witnesses.
    I would ask the four witnesses to step forward and come to 
the table as I call their name--they are the Honorable Richard 
Moore, the State Treasurer for the State of North Carolina, the 
Honorable Howard Metzenbaum, a former colleague of ours; who is 
now Chairman of the Consumer Federation of America. Senator 
Metzenbaum, of course, served many years as a distinguished 
Senator from Ohio here in the U.S. Senate. Ms. Joan Claybrook, 
President of Public Citizen, and Ms. Nell Minow, Editor of The 
Corporate Library. And let me thank all of you for being here 
to testify this morning. My colleagues will be along in a bit.
    We are holding this hearing in two parts this morning. 
After receiving your testimony and asking some questions, we 
will reconvene the hearing at 11 o'clock, to hear from Army 
Secretary White on subjects that relate to the Enron 
Corporation, his former employer.
    Again, let me thank all of you for being here. As a matter 
of courtesy, I'll call on Senator Metzenbaum first. Senator 
Metzenbaum, we miss you here in the U.S. Senate, but we know 
that you are doing great work as Chairman of the Consumer 
Federation of America. Your voice has long been missed since 
your departure. We welcome you this morning and appreciate your 
willingness to offer testimony on behalf of the consumers of 
America.
    Senator Metzenbaum, please proceed.

   STATEMENT OF HON. HOWARD M. METZENBAUM (RETIRED SENATOR), 
            CHAIRMAN, CONSUMER FEDERATION OF AMERICA

    Senator Metzenbaum. Thank you, Mr. Chairman, and I miss 
being in the U.S. Senate, miss the opportunity to work with 
you, and I appreciate your invitation to offer my comments on 
this very important issue.
    I am particularly pleased to appear before you, Senator 
Dorgan, because you personally have done so much to highlight 
corporate abuses and to propose real reform.
    I spent my career in the U.S. Senate working to prevent 
corporations from running roughshod over the rights of 
consumers and workers. I have to tell you that I have never 
seen a more appalling example of the heartless, unfettered 
corporate greed than that revealed by the present widespread 
accounting scandals. Companies like Enron and WorldCom lied to 
their investors, lied to their employees, hid crucial 
information about their finances, and, in some cases, actually 
tried to influence, improperly, government officials. The 
executives behind what appears to have been a massive fraud--
massive frauds on a grand scale should be brought to justice 
quickly.
    This country finds itself in the midst of a corporate crime 
wave. It's astounding. It's incredible. It's unbelievable. And 
while the average citizens ponder their diminishing retirement 
accounts and wonder whether they will be next to lose their 
jobs, a debate rages in Washington over whether this is the 
product of a few bad apples or evidence of a systemic 
breakdown. The outcome will determine whether Congress and the 
Administration adopt an effective policy response.
    Back in the early 1940s, the number of corporate 
restatements used to run at a pretty predictable 45 or so a 
year. But around the middle of the last decade, it just took 
off. From 1997 through 2001, there were 1,089 restatements, 
including well known companies like Waste Management, Sunbeam, 
Cendant, Rite-Aid, and, of course, Enron. Today, we are fast 
approaching the point where 1 in 10 Americans--1 in 10 of 
America's public companies will have recently been forced to 
restate its earnings. That's more than the few bad apples the 
President claims have a problem.
    Our system of investor protections was ostensibly designed 
with these many bad apples in mind. It was designed to work, 
not just when corporate executives are honest and forthcoming 
and aboveboard, but also when they are greedy, unethical, and 
deceptive. That's why we have standardized disclosure rules and 
SEC oversight and ratings agencies and corporate board audit 
committees. And, above all, it is why we require an outside, 
independent auditor to review and approve a company's financial 
statements.
    In the recent rash of accounting frauds and failures, all 
of those safeguards failed. The accounting rules failed to 
produce an accurate picture of company finances. Corporate 
boards failed to ask tough questions, challenge questionable 
practices, or require more transparent disclosures. Auditors 
signed off on financial statements that clearly presented a 
misleading picture of companies' finances or missed altogether 
Mount Everest-sized reporting errors. In many cases, years had 
passed since the SEC last reviewed the company and questioned 
its financial statements.
    At the end of the day, one conclusion is inevitable. The 
system of corporate governance that we have long and rightly 
touted as the world's best is just not adequate to ensure that 
investors receive accurate information about the companies in 
which they invest. And that has led to the current crisis of 
investor confidence. Although most investors instinctively 
understand that not all companies are corrupt, they also know 
that they can't, on their own, reliably tell the difference 
between those whose finances toe the mark and those with 
troubling secrets hidden in the footnotes or kept out of the 
financial statements altogether. And they have experienced 
firsthand how quickly the bottom can drop out of a once high-
flying stock when questions about its accounting emerge.
    If we want average Americans to continue to view our 
financial markets as a place where they can entrust their long-
term savings, then we need to provide them with a reasonable 
assurance that our system of investor protections is once again 
functioning as it should, and that will require comprehensive 
reforms. Not just a little--not ``reforms,'' comprehensive 
reform. Not just a little reform; comprehensive reforms.
    While a strong civil and criminal enforcement program is a 
crucial element of such a plan, the President's plan just does 
not go far enough. First, he's given no indication that he's 
willing to fund the increased enforcement he's highlighting. 
His recent speech said nothing about new funding for the 
Department of Justice, which is already struggling with massive 
new responsibilities from the war on terror. And the added 
hundred-million dollars he has proposed for the SEC is like 
throwing a drowning man a toothpick when what he needs is a 
lifeboat.
    The House bill is even worse, much worse. It does nothing 
to enhance auditor independence beyond what the major firms 
have said they would do on their own. The bill's supposedly 
independent oversight board for auditors would have a majority 
of accountant representatives. How can you possibly stand up 
and support such legislation? It is sham reform that 
perpetuates the current system of self-regulation.
    Nor does the Senate's accounting reform bill do the job, 
although it is far superior to the President's proposal and the 
House-passed bill. It would be far better, for example, if it 
included your amendment, Senator Dorgan, to open up the 
proceedings of the Accounting Oversight Board to the public. 
It's a shame that that was not included. Or amendments offered 
by you and Senator McCain to ensure that the SEC imposes a 
broad ban on consulting services by accounting firms when they 
are also auditing a particular company. Or Barbara Boxer's 
amendment to prevent an accounting industry takeover of the 
oversight board.
    But the Senate bill does take a number of meaningful steps 
forward to strengthen oversight of the accounting industry. It 
is the minimum bill needed to improve investor confidence in 
the reliability of corporate disclosures. I believe the House 
should just accept the bill in the conference committee, 
because there is virtually nothing--and I mean nothing in the 
House bill worth keeping.
    If the House refuses, then, at the very least, Senators 
should insist that all conference negotiations are held in 
public. That would minimize the danger that opponents of reform 
would try to sneak in anti-investor proposals behind closed 
doors.
    In my written testimony, I mention a number of additional 
reforms that should be enacted. I will not talk at length about 
these measures now, but they include requiring corporations to 
list stock options as an expense. They are and they should be 
listed as an expense. Also requiring corporate boards to 
improve their oversight of company management and eliminating 
unwarranted restrictions in current law on private securities 
lawsuits.
    In closing, let me say that I am nervous--very nervous, Mr. 
Chairman--and uncomfortable that the current SEC will be 
overseeing the new accounting board when it is enacted into 
law, whether in the House or the Senate version. Unfortunately, 
the Chairman's ties to the accounting industry and his 
disappointing showing so far in addressing these issues 
undermines his credibility as the right man to fulfill this 
role. It is time for him to prove conclusively that he's 
protecting the public interest, not special interests, or step 
aside so that--for someone who will. Frankly speaking, the 
President never should have appointed him, who had represented 
so many of the accounting firms, in the position to which he 
had been named.
    To be specific, the Chairman needs to get off the sidelines 
and push the House to adopt the Senate bill. He needs to 
develop a real plan to restore independence to the so-called 
independent audit, and he needs to, and we need to, see to it 
that members appointed to the new oversight board will 
represent investors' interests, not the accounting industry, if 
the Senate bill becomes law.
    It would be good if the Chairman were to make his 
intentions known now. If the Chairman doesn't take these steps 
as soon as possible--he could move on the first two items 
immediately, for example--it is time for new leadership at the 
SEC. I want to repeat that. If he doesn't move immediately with 
respect to the first two items I mentioned, then it is time for 
new leadership at the SEC.
    Thank you, Mr. Chairman, for the opportunity to offer my 
comments. It's a privilege to appear with these other----
    Senator Dorgan. Senator Metzenbaum, thank you very much.
    You haven't changed very much since you've left the Senate. 
I must say, having listened to your testimony.
    Senator Metzenbaum. I'm sorry that I soft-pedaled it, Mr. 
Chairman.
    [Laughter.]
    [The prepared statement of Senator Metzenbaum follows:]

  Prepared Statement of Hon. Howard M. Metzenbaum, (Retired Senator), 
                Chairman, Consumer Federation of America

    Good morning, Chairman Dorgan, Senator Fitzgerald and Members of 
the Subcommittee. My name is Howard M. Metzenbaum and I now serve as 
Chairman of the Consumer Federation of America (CFA). CFA is a non-
profit association of some 300 pro-consumer organizations with a 
combined membership of over 50 million Americans. Ensuring adequate 
protections for the growing number of Americans who rely on financial 
markets to save for retirement and other life goals is one of CFA's top 
priorities.
    I appreciate your invitation to offer my comments on the very 
important issue of corporate responsibility. I am especially pleased to 
appear before you, Senator Dorgan, because you have done so much to 
highlight corporate abuses of late and to propose real reform.
    I spent my career in the U.S. Senate working to prevent 
corporations from running roughshod over the rights of consumers and 
workers. I have to tell you that I have never seen a more appalling 
example of heartless, unfettered corporate greed than that revealed by 
the recent, widespread accounting scandals. Companies like Enron and 
WorldCom lied to their investors, lied to their employees, hid crucial 
information about their finances and, in some cases, tried to 
improperly influence government officials. The executives behind what 
appears to have been massive frauds on a grand scale should be brought 
to justice quickly. This includes officers at companies like WorldCom, 
if they are found to have committed fraud, as well as the individuals 
at accounting firms who should have known when their clients were 
cooking the books.
    The truth is this country finds itself in the midst of a corporate 
crime wave. And while average citizens ponder their diminishing 
retirement accounts and wonder whether they will be next to lose their 
jobs, a debate rages in Washington over whether this is the product of 
a few bad apples or evidence of a systemic break-down. While that may 
seem to be an arcane argument in the face of so much real world pain, 
the implications of this debate are significant because the outcome 
will determine whether Congress and the administration adopt an 
effective policy response.
    The administration has been cynically arguing the ``bad apple'' 
theory. They have used this theory to justify a policy that allows them 
to talk tough about sending corporate crooks to jail without forcing 
them to impose real reforms on the corporate interests that so 
generously fund their campaigns. Now most of us can agree that 
corporate crooks should spend some time behind bars, but this argument 
misses on two counts. First, what we are looking at here is more than a 
few bad apples. Secondly, what we have is a system of investor 
protections specifically designed to eliminate the bad apples; a system 
that clearly is not working.
    One measure of the scope of the problem is the recent dramatic rise 
in companies forced to restate their earnings. Back in the early 1990s, 
that number used to run at a predictable 45 or so a year, but around 
the middle of the last decade, it took off. From 1997 through 2001, 
there were 1,089 restatements, according to a recent study by the Huron 
Consulting Group. The number grew every year over that five-year 
period, from 116 in 1997 to 270 in 2001. The companies involved include 
such well-known examples as Waste Management, Sunbeam, Cendant, Rite 
Aid, and, of course, Enron--accounting failures that together cost 
investors hundreds of billions of dollars in lost market 
capitalization. But, they do not include Adelphia or Xerox or WorldCom 
or any of the other companies whose actions have promised to make 2002 
another record-breaking year. Today, we are fast approaching the point 
where one in ten of America's public companies will have recently been 
forced to restate its earnings. That is a lot of bad apples.
    Furthermore, the companies involved are not unknown fly-by-night 
operations, but the very symbols, in many cases, of innovative American 
capitalism--Enron, WorldCom, Qwest, and Xerox--a company that, as one 
writer put it is ``so established that its name has become both noun 
and verb.'' Even if you were to accept the argument that we are dealing 
with isolated cases of wrong-doing, when they involve the nation's 
leading companies, does that not tell you the system is fundamentally 
broken?
    But the real point is that our system of investor protections was 
ostensibly designed with the bad apples in mind. It was designed to 
work, not just when corporate executives are honest, forthcoming and 
aboveboard, but also when they are greedy, unethical, and deceptive. 
First and foremost, it is why we require an outside, independent 
auditor to review and approve a company's financial statements. It is 
why we have standardized rules that govern what companies have to 
disclose and how. It is why the SEC reviews financial disclosures for 
accuracy, completeness, and compliance with appropriate accounting 
rules. It is why rating agencies pore over massive amounts of 
information to determine the creditworthiness of companies that issue 
debt. It is why corporate boards have audit committees, made up 
primarily of board members who are supposed to be ``independent,'' to 
supervise the audit.
    In the recent rash of accounting frauds and failures, all of those 
safeguards failed. The accounting rules failed to produce an accurate 
picture of company finances. Corporate boards failed to ask tough 
questions, challenge questionable practices, or require disclosure that 
is more transparent. Auditors signed off on financial statements that 
clearly presented a misleading picture of company finances--or missed 
altogether Mt. Everest sized reporting errors. In many cases, years had 
passed since the SEC last reviewed the company in question's financial 
statements.
    At the end of the day, one conclusion is inevitable. The system of 
corporate governance that we have long, and rightly, touted as the 
world's best is not adequate to ensure that investors receive accurate 
information about the companies in which they invest. And that has led 
to the current crisis of investor confidence. Although most investors 
instinctively understand that not all companies are corrupt, they also 
know that they can not--on their own--reliably tell the difference 
between those whose finances toe the mark and those with troubling 
secrets hidden in the footnotes or kept out of the financial statements 
altogether. They have experienced first-hand how quickly the bottom can 
drop out of a once high-flying stock when questions about its 
accounting emerge.
    Another aspect of the current debate swirls around the question of 
whether this recent explosion of corporate greed is something new or 
not. The latter argument is based on the theory that the recent 
revelations of corruption in the boardroom are simply the inevitable 
hangover from the market boom--that this is simply how markets 
``correct'' themselves, and we should simply get out of the way and let 
the market do its work.
    This argument also ignores an important point--that our markets are 
no longer simply a place where the rich get richer. Increasingly, the 
financial markets are where average, middle class Americans put their 
money to save for retirement, to buy a home, or to send their children 
to college. Since the time when the first President Bush took office, 
the number of Americans investing in our markets has grown by roughly 
60 percent. Today, approximately half of all households have money 
invested either directly or indirectly in the stock of American 
companies. It is this massive new influx of capital from average 
Americans that provided the fuel for our recent period of unprecedented 
economic growth.
    When the bottom drops out, what these middle class families have at 
risk is not whether they can vacation in Tuscany this year, or if they 
will have to stay a little closer to home. It is not whether they have 
to give up the private jet, or delay their plans to build a vacation 
home in Aspen. What is at risk is whether they will be able to retire 
in reasonable comfort, or even retire at all. What is at risk is 
whether their children will be able to attend the college of their 
choice, settle for a less expensive alternative, or miss out on college 
altogether. What is at risk is whether they will have to delay 
indefinitely their ability to participate in the American dream of 
owning their own home. So, what is new is not just that the investor 
losses from the recent spate of accounting failures are unprecedented 
in their size, but that families who are far less able than the 
investing class of the past to absorb such losses are feeling them.
    If we want average Americans to continue to view our financial 
markets as a place where they can entrust their long-term savings, then 
we need to provide them with reasonable assurance that our system of 
investor protections is once again functioning as it should. That will 
require comprehensive reforms. While a strong civil and criminal 
enforcement program is a crucial element of such a plan, the 
President's plan does not go far enough. He has given no indication 
that he is willing to fund the increased enforcement he is 
highlighting. His recent speech said nothing about new funding for the 
Department of Justice, which is already struggling with massive new 
responsibilities from the war on terror. The added $100 million he has 
proposed for the SEC is like throwing a drowning man a toothpick when 
what he needs is a lifeboat.
    The House bill is a disaster. It does nothing to enhance auditor 
independence beyond what the major firms have said they would not 
oppose. Its supposedly independent oversight board for auditors would 
allow a super-majority of industry representatives. And the mechanism 
it relies on to create the board--where a board applies for the job--
invites an industry take-over. This is sham reform that, in all but 
name, perpetuates the current system of self-regulation.
    Nor does the Senate accounting reform bill do the job, although it 
is far superior to the President's proposal and the House-passed bill. 
It would be far better, for example, if it included your amendment, 
Senator Dorgan, to open up the proceedings of the Accounting Oversight 
Board to the public or amendments offered by you or your colleague 
Senator McCain to insure that the SEC imposed a broad ban on consulting 
services by accounting firms when they are also auditing a particular 
company. It would be far better with the amendments offered by Senator 
Boxer to enhance the independence of the oversight board.
    Although we were very disappointed that these amendments were never 
voted on and that this important opportunity to improve the bill was 
missed, make no mistake about it. The Senate bill is still by far the 
best reform proposal on the table. It is the only proposal to create a 
strong, effective new oversight board for auditors; to include 
significant provisions to strengthen corporate board oversight of the 
audit and enhance its independence; to lengthen the statute of 
limitations for securities fraud; and to protect the independence of 
the Financial Accounting Standards Board. Like the House, but unlike 
the President's proposal, the Senate bill authorizes a meaningful and 
much needed increase in SEC resources.
    In short, the Senate bill is the minimum needed to justify renewed 
investor confidence in the reliability of corporate disclosures. To 
ensure that the best possible bill is passed as quickly as possible, 
the House should accede to the Senate bill. If it refuses, then at the 
very least, Senators should insist that the conference is held in 
public. That would minimize the danger that the opponents of reform, 
who are nervous about gutting the bill in public, would be bolder in 
behind-closed-doors bargaining sessions.
    But even if the Senate bill is adopted intact, more needs to be 
done. In developing an agenda of additional reforms, policy makers need 
to recognize that one reason the system has run amok is that too many 
of the financial incentives reward doing the wrong thing. If you want 
to bring about a new era of corporate responsibility, you are going to 
have to eliminate those perverse incentives.
Stock Options Should Be Expensed
    The Senate bill would enhance the independence of the Financial 
Accounting Standards Board. Maybe that will give FASB the courage to do 
what it was intimidated to do nearly 10 years ago--require that stock 
options be reflected as an expense on corporate balance sheets.
    Proponents of stock option compensation argue that this practice 
benefits shareholders by aligning the interests of company executives 
with those of company shareholders. But that is clearly not true. As 
Paul Krugman recently wrote in The New York Times, options allow 
executives to ``get a share of investors' gains if things go well,'' 
but don't force them to ``share the losses if things go badly.'' As a 
result, and because of the massive size of many options grants, they 
offer executives massive personal financial incentives to take whatever 
risks necessary to drive up the stock price in the short term.
    Clearly, granting executives shares of company stock, and forcing 
them to hold that stock until after they leave the company, would do a 
far better job of aligning their interests with those of typical 
shareholders. But our accounting rules favor stock option compensation 
over grants of company shares. This is because the grant of company 
shares would have to be reflected immediately as an expense on balance 
sheets, while the stock options can be relegated to the footnotes 
without denting earnings. That makes no sense. As others have pointed 
out--while it may be difficult to pin a precise value on options when 
they are granted, the one thing we do know is that their value is not 
zero.
    If we truly want to align company executives' interests with 
shareholders--a laudable goal--we need to remove this perverse 
incentive in our accounting rules to use stock options rather than 
grants of company shares to provide incentive compensation to 
executives. But, despite the admirable efforts of Senators Levin and 
McCain, this aim was not included in the recent Senate corporate reform 
bill. The bill is incomplete without it.
Improve Corporate Board Oversight of Management
    With all the focus on stock options, it is important to remember 
that personal greed is not the only factor encouraging company 
executives to push share prices ever higher. As Steve Liesman wrote in 
the Wall Street Journal last January, ``stocks have become a vital way 
for companies to run their businesses.'' Companies use stock to make 
acquisitions and to guarantee the debt of off-the-books partnerships. 
They rely on the stock market as a place to raise capital. As a result, 
as Leisman said, ``a high stock price can be the difference between 
failure and success.''
    Clearly, simply fixing the accounting for options will not be 
enough to eliminate the incentive for corporate executives to do 
whatever it takes--including cooking the books--to create the financial 
picture necessary to produce a rising stock price. Corporate boards are 
going to have to do a better job of keeping management on the straight 
and narrow.
    In theory, corporate board members are supposed to represent 
shareholders. But shareholders don't pick board members, CEOs do. 
Recent proposals by the New York Stock Exchange and Nasdaq take a step 
in the right direction by strengthening the independence requirements 
for independent board members and by requiring that all members of the 
audit and compensation committees be independent members. However, they 
are not enough to overcome the influence management has by virtue of 
the fact that it selects the board--and can stack it with cronies and 
``yes'' men or boot those board members they view as trouble makers.
    If we want corporate boards to represent shareholders, we need to 
do a better job of giving shareholders a say in the selection of board 
members. This is an area that we believe deserves additional attention 
in the coming months.
Make the Independent Audit Truly Independent
    Ultimately, however, the ability to ensure reliable disclosures 
comes down to the effectiveness of the independent audit. Nothing else 
can substitute for having a skeptical, independent outsider who 
thoroughly looks over the books. But, here again, auditors faced with 
bogus accounting have overwhelming financial incentives to look the 
other way. Challenging management could cost them the audit engagement. 
Given the decades-long relationships that are typical between auditors 
and their clients, that means losing not just this year's audit fee, or 
next year's audit fee, but decades of expected income. If the client is 
a big one, the incentive to back down is enormous.
    One thing that dramatically ups the ante is the increasingly common 
practice among auditors of also providing consulting services to their 
audit clients. The practice has become all but universal among large 
companies, and the dollar amounts on the table for consulting contracts 
are typically two or three times the audit fees. In some cases, 
however, the imbalance is much greater, with consulting fees in some 
cases bringing in twenty or thirty times the audit fees.
    It is no wonder that expert after expert who testified before House 
and Senate committees said no reform would be complete without a broad 
ban on consulting services and mandatory rotation of audit firms. 
Unfortunately, these central reforms never made the cut. The House bill 
simply does what the major accounting firms said they would not 
oppose--it expands the current ban to include internal audits and 
financial system design and implementation. The Senate bill expands the 
list a little further. But neither bill requires the rotation of audit 
firms.
    Where the Senate bill stands head and shoulders above the rest in 
this area is with its requirement that board audit committees, made up 
exclusively of independent board members, pre-approve any decision to 
hire the auditor to perform non-audit services. Also key is the Senate 
bill's provision making audit committees directly responsible for 
hiring and compensating the auditor and for overseeing the audit and 
giving the audit committee the tools it needs to do that job 
effectively.
    While we respect the efforts the Senate has made to improve the 
oversight of the audit, we do not believe reform will be complete until 
auditors are forced to be truly independent from their audit clients. 
That means the kind of broad ban on consulting services that has been 
proposed by Senators Nelson, Carnahan, and McCain and mandatory 
rotation, as included in the Nelson-Carnahan bill.
Improve Audit Standards
    Because they lack those broad auditor independence reforms, the 
House and Senate bills rely heavily on the new auditor oversight board 
to ensure quality audits. But only the Senate bill gives its new board 
the standard-setting authority that is key to its effectiveness. The 
House bill leaves authority for setting standards with the accounting 
profession. Even under pressure from recent scandals, the accounting 
profession uses its authority to write audit standards that are full of 
suggestions rather than mandates--standards that are more geared toward 
minimizing accounting firms' liability than ensuring high quality 
audits.
    The Senate bill provides ample opportunity for industry 
participation in this process, but it charges the oversight board with 
final responsibility. That should ensure that those whose job it is to 
protect the public interest, not the special interests, make decisions. 
Of course, even if the House bill gave its regulatory board the 
necessary authority, it would not matter. That is because, as we 
mentioned earlier, the House bill is custom designed to ensure maximum 
industry influence over its new ``regulator.'' It is essential that the 
Senate oversight board structure and authority be adopted in the final 
bill.
Increase Deterrence
    The Senate bill includes an impressive package of criminal and 
civil penalties for corporate crimes. These should send the same 
powerful message to white collar crooks that we have sent to street 
criminals--don't do the crime if you can't do the time. The Senate and 
House have also authorized dramatically increased funding to put more 
cops on the beat at the SEC. You know as well as I do, however, that 
authorizing funding and appropriating it are two very different things. 
Particularly in light of the lack of administration support, members 
will need to be vigilant to ensure that this promise of increased 
resources is realized.
    We also continue to believe that private lawsuits form an essential 
supplement to regulatory enforcement efforts, particularly if you are 
unwilling to adequately fund enforcement, as the President appears to 
be. Unfortunately, the deterrent effect of such lawsuits is limited by 
a number of factors, including the unreasonably high pleading standards 
plaintiffs must satisfy before getting access to discovery, the 
unreasonably short statute of limitations that governs such suits, and 
the lack of aiding and abetting liability.
    The Senate bill would address one of those problems, lengthening 
the statute of limitations to 2 years from discovery, but no more than 
5 years from the wrongdoing. This will make it more difficult for those 
who commit fraud to escape liability simply by keeping their fraud 
hidden for a short time. It will also make it less likely that suits 
against secondary defendants are dismissed because the statute of 
limitations has run while the motion to dismiss was pending, blocking 
access to discovery.
    Senator Shelby was prepared to offer another important amendment, 
to restore aiding and abetting liability under the securities laws. 
Unfortunately, like so many other important amendments that we have 
discussed today, he was prevented from offering that amendment. This 
reform is highly relevant to the current crisis since the lack of 
aiding and abetting liability has been used by defendant after 
defendant in the Enron lawsuits to argue that they cannot be held 
accountable for assisting the fraud.
    If you cannot fix this glaring shortcoming in our laws now under 
the current environment, it is hard to imagine when that will be 
possible. But perhaps when these lawsuits have worked their way through 
the court system and we find that the victims have recovered only a 
pittance, if anything, of their losses, perhaps then will certain 
members be willing to abandon their phony rhetoric about frivolous 
lawsuits and recognize that our legal system stands in the way of full 
and fair redress in even the most meritorious of cases.
Conclusion
    The recent corporate crime wave has delivered a wake-up call. The 
system of corporate governance that we have grown accustomed to touting 
is broken. The Senate has started down the road to reform. But our 
system will remain vulnerable until we tackle the fundamental 
incentives that encourage our corporate executives to do the wrong 
thing and our auditors to turn a blind eye.
    We have been given a wake-up call.

    Senator Dorgan. Next, let me ask for testimony from the 
Honorable Richard Moore, State Treasurer for the State of North 
Carolina. Mr. Moore, you may proceed, and we will include your 
entire statement in the record, so you may summarize.

  STATEMENT OF HON. RICHARD MOORE, TREASURER FOR THE STATE OF 
                         NORTH CAROLINA

    Mr. Moore. Thank you very much, Senators. Thank you for 
this opportunity.
    I come before you today as North Carolina's elected 
guardian of the State Treasury and as the sole trustee of $62 
billion in public money, most of which is the pension funds for 
the 600,000 active and retired public workers of our great 
state--the teachers, fire and rescue workers, nurses, police 
officers, sanitation workers, and state and local government 
employees of North Carolina.
    I come here today as an owner who needs help exercising the 
full rights of ownership--nothing more, nothing less. Now, in 
my prepared remarks, I have some quotations that go back and 
show that, since Alexander Hamilton's day and George 
Washington's first address to this body, we've always 
understood that the power of the marketplace needs to be 
regulated for the good of us all.
    We can go back through the Great Depression. I wanted to 
point out that the deep corruption of our public markets 
brought about the passage of the Securities Acts of 1933 and 
1934 and the passage of the Glass-Steagal Act. I am extremely 
proud that my grandfather, as a member of this body, played a 
significant role in drafting and championing many pieces of 
these necessary reforms. And we find ourselves, 70 years later, 
right back in very, very similar situations. Those reforms 
produced a fair and stable marketplace that's been the envy of 
the world for almost 70 years.
    And I give you this historical background to make what 
ought to be an obvious point. It is important to remember that 
we are addressing regulations that apply only to public 
companies and that no one forces a company to become public. 
The choice to do so means that its corporate leaders 
voluntarily give up some of their autonomy and agree to be 
regulated.
    The tradeoff, which has been significant over the past 20 
years, is that those companies may access capital at a severely 
discounted rate to traditional sources. Even today, most 
businesses and most of the folks I talk to in my home state are 
not regulated, the businesses on Main Street across America. 
And when they need additional capital, they pay a premium for 
it.
    Publicly traded companies have been and must always be 
regulated to make sure that the individual investor can 
properly value his or her risk before an ownership decision is 
made. This obvious point has been overlooked by many who are 
afraid that additional government regulation will foul the 
market.
    Today, more than 80 million Americans have decided to take 
part in these public marketplaces, either through mutual funds 
or pension plans. This, in itself, is remarkable. They have 
been enticed--and I want to repeat that--they have been 
enticed, through tax policy and professional advice, to 
participate and share in this part of the American dream. It is 
not your job, nor is it the job of corporate America, to ensure 
that this dream comes true. However, it is your job to make 
sure that the marketplace is fair to all so that some don't 
profit while others lose from the exact same investment.
    Our markets today contain about $12 trillion in assets. 
More than $2 trillion of that is held by pension funds, like 
the one that I run in North Carolina. Approximately--but here's 
the point that a lot of people don't understand--while $8 
trillion is controlled by mutual funds, most of the large 
mutual funds' largest clients are pension funds like myself. So 
we have tremendous clout in the marketplace, clout that I don't 
think we have fully utilized or understood how to wield.
    Institutional ownership has evolved over the last 30 years, 
and I think that's one of the reasons we're not prepared. As a 
result, we find ourselves, collectively, the largest 
shareholders in virtually every major company in America. The 
founder or the founder's descendants, at the same time, in many 
instances, are no longer seated at the board table advocating, 
out of self-interest, the interest for the shareholders. It is 
truly a setting very much like government, where people are 
spending other people's money.
    Therefore, we, as institutions, must act like the owners 
that we are. However, we cannot do it alone. We need Congress 
and the Administration to help make sure we can properly 
exercise our prerogatives of ownership. We need your help to 
make sure that we can tell whether the interests of management 
and shareholders are properly aligned. We need your help in 
making sure that we, as investors, can properly price risk. We 
need your help to make sure that the cops on this particular 
beat have the resources and tools to do their job effectively. 
We need your help now more than ever. And I won't recap all of 
the events that happened.
    I firmly believe that the vast majority of today's 
corporate managers are smart and honest, but it is 
disconcerting to see so many of them unmasked, not as captains 
of industry, but as captains of greed, with callous disregard 
for the welfare of the people whose money grows their company. 
Simply put, where I come from, we know that the fox cannot 
guard the hen house. No matter how well-meaning, at some point 
the temptation to gorge will prevail.
    Without proper regulation, history has proven that 
hardworking Americans always pick up the tab--the Great 
Depression, the savings and loan debacle, during which I was a 
white-collar federal prosecutor, with nowhere near the 
resources to do the job properly, 12 years ago; and, most 
recently, as the Chairman has referred to, the power shortage 
in California.
    In carrying out my fiduciary duty to 600,000 beneficiaries, 
we have begun to more actively exercise our ownership rights. 
Last month, I was joined by the Comptroller of New York--he and 
I are the two largest sole trustees in America--the Treasurer 
of the State of California, Phillip Angelides, and the Attorney 
General of New York, Elliott Spitzer, to announce important 
investment protection principles. These proposals embody 
simple, common sense, market-based solutions to some of the 
problems that we face.
    We, as owners, are exercising our ownership rights when we 
put new terms on the table. If you want our money, this is what 
we need from you. We're demanding that broker/dealers and money 
managers eliminate actual and potential conflicts of interest 
from the way they pay their analysts and conduct their affairs, 
and we appreciate your help in this. We are asking that the 
managers that we utilize look closer into the areas of 
financial transparency and corporate conduct. As fiduciaries, 
we must and will become more assertive in our ownership role.
    Now, in closing, I would like to say that, as investors, we 
cannot properly price our risk without getting fair and 
accurate information regarding financial transparency and 
corporate conduct. We must be able to assess accurate earnings 
and the future impact of corporate initiatives on those 
earnings. You have already signaled your willingness to help in 
that area. And for that, I thank you.
    In some areas, we need specific prohibitions. And Senator 
Metzenbaum has hit on many of those. In other areas, this may 
be unwise. I ask that in the areas that you feel outright 
prohibition is unwarranted or unnecessary at this point, do 
make disclosure standards tougher. Just as you have done in 
food labeling and countless other areas, it is prudent and 
appropriate to require that certain financial information be 
prominently displayed in plain language in proxy statements and 
annual reports. If you will help the large and small investor 
alike learn how to find the information to properly price 
``option overhangs'' and ``option run rates,'' the market will 
go a long way in ridding itself of the truly abusive practices.
    I would also ask--remind Congress that this situation has 
shown that the defined benefit plans, in many ways, are far 
more secure and better than defined contribution plans, as 
someone who runs both of them. My defined contribution 
investors--I had a lady stop me yesterday. Her money--they had 
put $300,000 away as a public investor. Today she has only 
$120,000 in that account, and she's grateful that my funds were 
properly diversified and we haven't taken that kind of hit. So 
I encourage you to look at those roles again.
    The importance of the task before us cannot be overstated. 
We must restore investor confidence. It is the pillar upon 
which one of the great institutions of our society rests, the 
open and fair marketplace.
    Thank you.
    [The prepared statement of Mr. Moore follows:]

 Prepared Statement of Hon. Richard Moore, Treasurer for the State of 
                             North Carolina

    I come before you as North Carolina's elected guardian of the state 
treasury, and as the sole trustee of $62 billion in public money, most 
of which is the pension funds for the 600,000 active and retired public 
workers of our great state--the teachers, fire and rescue workers, 
nurses, police officers, sanitation workers, and state and local 
government employees of North Carolina. And, I have come here today as 
an owner who needs help exercising the full rights of ownership--
nothing more, nothing less.
    As a student of history, I recognize that capitalism has never been 
totally unrestrained in this country. Those leaders who have championed 
capitalism and the building of economic markets have understood that 
unregulated and unchecked, a pure laissez-faire marketplace is a 
dangerous thing. In arguing that markets could never regulate 
themselves, Alexander Hamilton wrote in his 7th Federalist paper that 
``the spirit of enterprise'' when ``unbridled,'' leads to ``outrages, 
and these to reprisals and wars.'' He later stated that we Americans 
had ``a certain fermentation of mind, a certain activity of speculation 
and enterprise which if properly directed may be made subservient to 
useful purposes; but which if left entirely to itself may be attended 
with pernicious effects.''
    This mindset put forth by the founders of our nation has always 
been understood by our nation's leaders. Agreeing with President 
Theodore Roosevelt, President Woodrow Wilson felt that without ``the 
watchful interference, the resolute interference of the government, 
there can be no fair play between individuals and such powerful 
institutions as [corporations].''
    The Hamiltonian views were again embraced after the Great 
Depression. The deep corruption of our public markets brought about the 
passage of the securities acts of 1933 and 1934 and the passage of the 
Glass Steagell Act. I am extremely proud that my grandfather, Frank W. 
Hancock, Jr., as a business-oriented member of the House Banking 
Committee, played a significant role in drafting and championing many 
pieces of these necessary reforms.
    The result of these and other reforms produced a stable and fair 
public marketplace that has been the envy of the world for almost 70 
years.
    It is important to remember that we are addressing regulations that 
apply only to public companies, and that no one forces a company to 
become public. The choice to do so means that its corporate leaders 
voluntarily give up some of their autonomy and agree to be regulated. 
The trade off, which has been a significant advantage over the last 20 
years, is that those companies may access additional capital at a 
discount to traditional sources. Even today, most businesses in this 
country--those located on main streets across America--are not publicly 
regulated, and when they need additional capital, they must pay a 
premium for it.
    Publicly traded companies have been and must be regulated to make 
sure that the individual investor can properly value his/her risk 
before an ownership decision is made. This obvious point has been 
overlooked by some who fret that additional government regulation will 
foul the market.
    Today, more than 80 million Americans have decided to take part in 
these public markets. Either directly or indirectly through mutual 
funds and other pension plans, they have placed their hard earned 
savings in these marketplaces. This in itself is remarkable. They have 
been enticed through tax policy and professional advice to participate 
and share in the American dream. It is not your job, nor is it the job 
of corporate America, to insure that this dream comes true. However, it 
is your job to make sure that the marketplace is fair to all so that 
this dream does not turn into the nightmare of losing the family nest 
egg.
    Our markets today contain approximately $12 trillion in assets. 
More than $2 trillion of that is held by pension funds like the one 
that I run in North Carolina. Approximately $8 trillion of this 
marketplace is controlled by mutual funds. Many of the largest 
investors in mutual funds are pension funds, so we institutional 
investors have tremendous market clout--clout that I do not think we 
have yet fully utilized to bring about positive change.
    Institutional ownership has evolved over the last 30 years. As a 
result, we find ourselves collectively as the largest stockholders in 
virtually every major company in America. The founder, or the founder's 
descendents, in many instances are no longer seated at the board table 
advocating--out of self-interest--for the interest of shareholders. It 
truly is often a setting where people spend other people's money.
    We must act like the ``owners'' that we are. However, we cannot do 
it alone. We need Congress and the Administration to help make sure we 
can properly exercise our prerogatives of ownership. We need your help 
to make sure that we can tell whether the interest of management and 
shareholders are properly aligned. We need your help in making sure 
that we, as investors, can properly price risk. We need your help to 
make sure the cop on this particular beat has the resources and tools 
needed to do their job effectively.
    We need your help now more than ever. The events of the last few 
months have shown that our system is currently missing effective and 
necessary checks and balances to insure that the fine line between 
proper incentive and destructive greed is not crossed. I firmly believe 
that the vast majority of today's corporate managers are smart and 
honest, but it is disconcerting to see so many unmasked not as captains 
of industry, but as captains of greed, with callous disregard for the 
welfare of the people whose money grows their company.
    Simply put, we know that the fox, no matter how well meaning, 
cannot guard the hen house. At some point, temptation prevails. Without 
proper regulation, history has proven that hard working Americans 
always pick up the tab--the Great Depression, the savings and loan 
debacle, and most recently, the power shortage in California.
    In carrying out my fiduciary duty to my 600,000 beneficiaries, we 
have begun to more actively exercise our rights of ownership. Last 
month, I was joined by the Comptroller of New York, H. Carl McCall, the 
Treasurer of California, Philip Angelides, and the Attorney General of 
New York, Eliot Spitzer, to announce important investment protection 
principles. These proposals embody simple, common sense, market-based 
solutions to some of the problems that we face. We, as owners 
exercising our ownership rights, have put new terms on the table--if 
you want our money, this is what we need from you. We are demanding 
that broker/dealers and money managers eliminate actual and potential 
conflict of interest from the way they pay analysts and conduct their 
affairs. We are asking the money managers we utilize to look closer 
into the areas of financial transparency and corporate conduct. As 
fiduciaries, we must and will become more assertive in our ownership 
role.
    To date, we have been joined by several other large funds in our 
initiative, with more who will likely follow.
    As investors, we cannot properly price our risk without getting 
fair and accurate information regarding financial transparency and 
corporate conduct. We must be able to assess accurate earnings and the 
future impact of corporate incentives on those earnings. You have 
already signaled your intent to help us in these areas, and for that I 
thank you.
    In some area, we need specific prohibitions. In other areas, this 
may be unwise. I ask that in areas where you feel outright prohibition 
is unwarranted, do make disclosure standards tougher. Just as Congress 
has done in food labeling and other areas, it is prudent and 
appropriate to require that certain financial information be 
prominently displayed in plain language in proxy statements and annual 
reports. If you will help the large and small investor alike learn how 
to find the information needed to properly price ``option overhangs'' 
and ``option run rates,'' the market will then go a long ways in 
ridding itself of truly abusive practices.
    In the past 25 years, retirement savings have been systematically 
shifted from defined benefit to defined contribution plans. While this 
shift has been highly profitable to the mutual fund industry and 
corporations, it has not strengthened overall retirement savings. The 
401(k), IRA and Roth IRA are excellent supplementary savings plans. 
However, they are insufficient, as has been evident in the past 2 
years, for many Americans attempting to prepare for a comfortable 
retirement.
    Moreover, defined contribution plans leave matters of corporate 
governance and transparency in the hands of individuals who have little 
time or money to study these issues. In 401(k) plans, these issues are 
left in the hands of trustees who have little incentive to press mutual 
fund managers or the underlying companies. Ownership in equities is a 
proven way to build retirement wealth. However, it requires careful 
attention to the demands of ownership.
    I urge Congress to enact legislation promoting the expansion and 
establishment of defined benefit plans. These plans are the foundation 
of retirement security, and without them, I fear many hard working 
Americans will face difficult retirement years. These plans should be 
portable. We must recognize that lifetime employment is no longer 
feasible or practical in our modern economy. These plans need to run on 
assumptions that are realistic and fair.
    The importance of the tasks before us cannot be overstated. We must 
restore investor confidence. It is the pillar on which one of the great 
institutions of our society rests--the open and fair marketplace.
 July 1, 2002--State Treasurer Richard Moore Announces Landmark Public 
                   Pension Fund Investment Initiative
    RALEIGH--As North Carolina's State Treasurer, Richard Moore manages 
the 10th largest public pension fund in the United States and the 24th 
largest in the world. Add to that the funds managed by Moore's 
counterpart New York State Comptroller H. Carl McCall, and you have a 
total investment portfolio of nearly $170 billion. When that much money 
talks, Wall Street takes notice.
    That's why Treasurer Moore and Comptroller McCall have teamed up 
with New York State Attorney General Eliot Spitzer to launch a major 
initiative to establish stronger corporate disclosure standards for 
investments made with public pension funds, the money that pays the 
retirement of public workers. Under this initiative, which Moore and 
McCall as sole trustees have implemented for their respective pension 
fund investment portfolios effective immediately, the North Carolina 
Public Employees' Retirement Systems and the New York State Common 
Retirement System will require the following of investment banking and 
money management firms that do business with the two pension funds:

   Investment banking firms must adopt the conflict of interest 
        principles set forth in the agreement that New York Attorney 
        General Spitzer reached with Merrill Lynch in May of 2002 
        (referred to as the ``Spitzer Principles.'')

   Money management firms must make disclosures regarding 
        portfolio manager and analyst compensation, the use of any 
        broker dealers that have not adopted the Spitzer Principles, 
        and any potential conflicts of interest arising from client and 
        corporate parent relationships.

   Money management firms must adopt safeguards to ensure that 
        there are no potential conflicts of interest as a result of the 
        method compensation is provided to analysts that could 
        influence investment decisions made on behalf of the pension 
        funds.

   Money management firms must scrutinize more closely the 
        auditing and corporate governance practices of companies in 
        which pension fund monies are invested.

    ``Recent conflict of interest and insufficient corporate governance 
stories coming out of Wall Street firms have shaken the confidence of 
investors, big and small,'' said Treasurer Moore. ``On behalf of the 
hard-working public employees and retirees whose pension funds 
Comptroller McCall and I manage, we are using our clout as large public 
fund investors to set a higher standard. Because people are counting on 
us to ensure their pension funds are secure, we must be able to know 
the information we use to make sound, prudent investment decisions is 
reliable.''
    ``I have been working for months on common sense, market-driven 
solutions that will ensure that our funds are invested safely. I am 
grateful for Attorney General Spitzer's guidance and to Comptroller 
McCall for joining this effort.''
    California Treasurer Philip Angelides today also pledged his 
support for these measures, and will attempt to get them adopted by 
CalPERS and CalSTRS (both $100 billion plus California public employee 
pension funds).
    ``I am today sending out a letter to other pension fund managers 
encouraging them to adopt similar measures, and will also be reaching 
out to other large investors. Public pension funds also have assets of 
about $2.3 trillion. I am, therefore, confident that we can build 
enough support to bring about significant change, with or without 
Congressional or administration action.''
    The North Carolina and New York pension funds contract with dozens 
of investment banking firms, and requiring those firms to adhere to the 
Spitzer Principles will benefit all investors, not just pension funds. 
In addition, public confidence in the stock market has a great impact 
on the future growth of the pension funds. Adoption of these principles 
should help restore confidence in the marketplace, which will have a 
positive impact on both pension fund beneficiaries and individual 
investors.
    A copy of the Public Pension Fund Investment Protection Principles 
adopted by North Carolina and New York is attached.
State and Public Pension Fund Investment Protection Principles
    A. Effective July 1, 2002, every financial organization that 
provides investment banking services and is retained or utilized by the 
State Treasurer of North Carolina, the Comptroller of the State of New 
York, or the State Treasurer of California (hereinafter ``the State 
Investment Officers''), including but not limited to organizations 
retained by the North Carolina Public Employees Retirement Systems and 
the New York State Common Retirement Fund (hereinafter ``the Pension 
Funds''), should adopt the terms of the agreement between Merrill Lynch 
& Co., Inc. and New York State Attorney General Eliot Spitzer dated May 
21, 2002 (hereinafter ``the Investment Protection Principles''). In 
retaining and evaluating any such financial organization, the State 
Investment Officers will give significant consideration to whether such 
organization has adopted the Investment Protection Principles.
    The Investment Protection Principles are as follows:

   sever the link between compensation for analysts and 
        investment banking;

   prohibit investment banking input into analyst compensation;

   create a review committee to approve all research 
        recommendations;

   require that upon discontinuation of research coverage of a 
        company, firms will disclose the coverage termination and the 
        rationale for such termination; and

   disclose in research reports whether the firm has received 
        or is entitled to receive any compensation from a covered 
        company over the past 12 months.

   establish a monitoring process to ensure compliance with the 
        principles;

    B. Effective July 1, 2002, every money management firm retained by 
a State Investment Officer, as a condition of future retention, must 
abide by the following:

        1. Money management firms must disclose periodically any client 
        relationship, including management of corporate 401(k) plans, 
        where the money management firm could invest State or Pension 
        Fund moneys in the securities of the client.

        2. Money management firms must disclose annually the manner in 
        which their portfolio managers and research analysts are 
        compensated, including but not limited to any compensation 
        resulting from the solicitation or acquisition of new clients 
        or the retention of existing clients.

        3. Money management firms shall report quarterly the amount of 
        commissions paid to broker-dealers, and the percentage of 
        commissions paid to broker-dealers that have publicly announced 
        that they have adopted the Investment Protection Principles.

        4. Money management firms affiliated with banks, investment 
        banks, insurance companies or other financial services 
        corporations shall adopt safeguards to ensure that client 
        relationships of any affiliate company do not influence 
        investment decisions of the money management firm. Each money 
        management firm shall provide the State Investment Officers 
        with a copy of the safeguards plan and shall certify annually 
        to the State Investment Officers that such plan is being fully 
        enforced.

        5. In making investment decisions, money management firms must 
        consider the quality and integrity of the subject company's 
        accounting and financial data, including its 10-K, 10-Q and 
        other public filings and statements, as well as whether the 
        company's outside auditors also provide consulting or other 
        services to the company.

        6. In deciding whether to invest State or Pension Fund moneys 
        in a company, money management firms must consider the 
        corporate governance policies and practices of the subject 
        company.

        7. The principles set forth in paragraphs 5 and 6 are designed 
        to assure that in making investment decisions, the money 
        management firms give specific consideration to the subject 
        information and are not intended to preclude or require 
        investment in any particular company.
                                 ______
                                 
              North Carolina, Department of State Treasurer
                                          Raleigh, NC, July 1, 2002
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