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Interview: harvey pitt

Chairman of the Securities and Exchange Commission since August 2001, Pitt is a prominent lawyer who has represented Wall Street firms and the accounting industry. In this interview, he explains the reforms that the SEC is proposing under his leadership, including a Public Accountability Board with oversight authority over accounting firms. He also speaks to several issues that were at the center of political battles during the 1990s: the expensing of stock options, the tort-reform law of 1995, and the effort by his predecessor at the SEC, Arthur Levitt, to separate accounting firms' auditing and consulting practices. FRONTLINE correspondent Hedrick Smith interviewed Pitt on April 5 and May 30, 2002.

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Looking back at the Enron affair and, I guess, some other things ... what are the problems that we're facing here?

Well, I think we have a number of problems. But starting from an overview, we are dealing with a system that was constructed, in large measure, 67, 68 years ago. And in those days, we had no computers, no comparable technology. People communicated by pen and ink. We have a different world now, and the factors of disclosure and securities distribution have not been revisited in that 67, 68 years. That's one problem.

When I represented accounting firms, they were my clients. The reason I had a lot of clients was because I represented them well. Today, my client is the investing public, and they are my only client.

The second is that we have seen that the auditing profession, the accounting profession, needs vigorous regulation and oversight. Efforts were made in the 1970s and again in the 1980s to provide that oversight, but I think we are seeing that there's a need for tougher oversight, regulation and enforcement of the accounting profession.

I think the third area comes with respect to the fiduciary obligations of the people who run companies. People sometimes tend to forget that the chairman of a company is not the owner of the company. He works for the owner of the company, and the owners of a company are the shareholders. So it's our goal to try to come up with incentives for senior management to understand what their fiduciary obligations are, and then to make sure that they live up to them. ...

And what about a company like Andersen, which is there certifying that Enron's books are accurate? Where do we stand as ordinary investors? How do we know what's going on if somebody like Andersen -- which at one point was regarded as the U.S. Marines of auditing and accounting -- everybody was counting on them, and they say it's OK? Where are we left at that point?

There's always a possibility that, no matter how diligent people are, if there are individuals who are intent on committing fraud, they are going to be able to hide it from auditors as well as shareholders.

The difficulty I think we have is in making sure that our system has the right building blocks, and then that the accounting firms perform at the highest level. One of the things that Enron suggests is that there were two problems with the accounting. One was that they may have gotten some of it wrong. They must have, because there was a restatement.

But a bigger problem is that they may have gotten a lot of the accounting right. And that would be troublesome, because you have a lot of these special-purpose entities that were not reported on the books, and which had the effect of shielding certain liabilities from public observation. That may be technically appropriate in some cases under the rules -- it might be; I don't know that it is. But if it is, then our rules don't make sense. If it isn't, then our enforcement should have been much more attuned to looking to these kinds of problems.

I think investors can rely on the fact that the number of these situations are very few over the years -- particularly given the number of public companies we have. But I think they also are entitled to know that we can make the best system much better than it presently is. And that's what I'm determined to do. ...

You've answered this question in other forums before. But Sen. Corzine and others have said that your long representation of accounting firms, of AICPA, of the accounting industry, raises some questions about whether or not you're the right person to be sitting in charge of the SEC dealing with accounting problems now. What's your response to that?

Well, first, I don't think that that's what any member, including Sen. Corzine, of the Senate Banking Committee said. This issue was aired at my confirmation hearings, and I was confirmed through the committee with a 21-to-0 vote and confirmed through the Senate by a 100-to-0 vote.

But I think what it misses, in terms of people who try to worry about that, is who my client is now. When I represented accounting firms, they were my clients. The reason I had a lot of clients was because I represented them well. Today, my client is the investing public, and they are my only client. And I'm going to do the very best I can for the investing public.

What helps me is that I have an intricate knowledge of the accounting profession, and I know how to work on the problems -- in addition to which, I know a lot of the people who are involved in that, and I believe I have their respect. They know if I tell them that something is unacceptable, it's being said because it's unacceptable, not for the purpose of creating rhetoric. ...

In terms of reform and oversight for the accounting industry, I'd like to understand what it is you're proposing.

We proposed -- and we will be coming out hopefully in the near term with rules -- we proposed a very thorough private-sector regulatory body that would revamp and increase all of the regulation to which the profession is subject.

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What will it be called, and who's on it? How does it get financed?

We are calling the new oversight board the Public Accountability Board, or PAB. This PAB would be from the private sector. It would be funded, not by tax dollars, but it would be funded by those who benefit from the audits of public companies -- investors, corporations, auditing firms -- but there would be no choice on the part of auditing firms. So the revenues would be assured for this PAB.

The PAB would be dominated by individuals who are not affiliated with any accounting firm. If we had a board of, say, nine, we might have two or three that might have some affiliation with accounting firms. But they would not be allowed to vote on disciplinary matters or anything that might affect either their own firms or competitor firms.

The goal would be to provide three main areas of oversight. The first would be ethics, the second would be competence, and the third would be quality review. This body would be required on a yearly basis for the largest firms -- which we think would be any firm that does more than 75 public company audits a year -- to undertake a review of all of the accounting firms that fit within that category; not just to see whether they violated the law, but even if they complied with the law, whether they are functioning at the highest standards and the highest level.

They would have the power, if they found that a firm was not doing the highest-quality audit work, to dictate that the client pick another auditor. So the stakes would be exceedingly high for the audit firms to come up with high-quality controls and make sure they are performing at the highest level.

Would this oversight board have subpoena power? Would it set accounting standards? What would be its jurisdiction?

It would have disciplinary power, but it would not have subpoena power. We do not want it to have subpoena power. While subpoena power sounds like it might be very useful, only the government gets to have subpoena power. So if this board were created and it had subpoena power, it would have the same obligations as government.

Under our system, because there is no subpoena power, there will be a requirement that if you want to be an auditor, or if you want to be a public company, you must cooperate and make information available. If somebody came in and took the Fifth Amendment, refused to answer questions, they could be put out of business. They would not be able to continue as an auditor unless and until they satisfied the information needs.

How would they be put out of business?

They would be suspended from being a member of this PAB. Only members of the PAB could practice public accounting. We would make all the public companies affiliated members of the PAB, so if they didn't cooperate, they wouldn't be able to file periodic reports, and they would not be able to stay in business. Obviously, we're talking about very serious consequences if people don't cooperate.

But our goal is to make sure that the PAB can do effective enforcement. Under the government system, somebody can come in and take the Fifth Amendment, and if the government can't put together the case, that person may be able to go scot-free. We think the stakes are too high with respect to accountants and auditing, and so that's why we want a tougher system.

A lot of people have said that private self-regulation really hasn't worked over the decades. I don't need to tell you, after the Enron affair, all these restatements, but why not take a tougher approach and have a government agency, something affiliated with the SEC?

Well, first let me say that this will not be self-regulation. It will be private-sector regulation. Second, the requirements of this body are so demanding that we need a group that can do this full time. If the government were to do it, my assumption is that the budget of this entity would be anywhere between $250 million and $400 million a year.

If the government creates that entity and makes it part of the government, first, we think it will lose some of its effectiveness -- for example, the Fifth Amendment issues that I have indicated -- and second, we think that the cost will be prohibitive. The job will be done better if the people who benefit from audited financial statements are the ones who pay for the discipline of those in the system.

Sen. Corzine and others have gone back to the idea that Arthur Levitt proposed at one point -- separating auditing and consulting. Where do you come down on this issue? Should auditors be barred from doing consulting work -- minimally, as it relates to the audit itself?

My view is that combining functions can create clear conflicts. So there have to be clearly understood and bright-line tests for what auditors can do and what they can't do.

The problem with the total separation, as for example Mr. Levitt has proposed, is that it actually can produce lower-quality audits instead of higher quality audits. He's right to worry about whether people are focused on what they should be: namely, how good an accounting job and an auditing job is being performed.

The difficulty is, if you strip the firm of all of its consulting work -- it would give up a lot of its tax consulting, for example -- and we would probably not think that a firm that didn't have a broad-based tax practice would be competent to do public company audits. They simply wouldn't understand the intricacies of the tax code and the way individual companies were set up.

Tax work connected with audit work, and not have to do it as a consultant?

The issue isn't whether you do it as a consultant. The issue is whether there is an economic incentive for the firm and for individuals to pay less attention to the needs of the public investor. That's the problem.

There are two ways to solve that problem. The first is to say that the people who actually do the audits have to be the people who get no compensation for cross-selling consulting services. That has never been proposed until we have proposed it, and that, in my view, is a major and critical step we have to take.

The second issue deals with the firm as a whole, because if a large accounting firm thinks that it can get tens of millions of dollars of business from a client, it may have an incentive not to be as focused in terms of the audit work. The way to solve that problem is to leave the hiring, firing and retention of auditors in the hands of an independent audit committee. The independent audit committee [of a client's board of directors] doesn't have to show short-term results. Senior management is under a lot of pressure to produce short-term results. But senior management can also dole out lucrative assignments. You can see where the problems occur. But if you take that prerogative away from senior management, what you've done is, you've enabled a--

Who takes it away from senior management?

That would be part of our PAB proposal. We would say that the only way an auditing firm can be independent is if its selection, its retention, its firing, or the assignment of any other non-audit function is done by the audit committee [of the client's board] -- not by senior management.

You have to go into who appoints the audit committee.

That's correct.

If the audit committee is subject to the control of the CEO, it's just a back-door way of getting around the rule.

That's always an issue. But we have gotten the New York Stock Exchange and the NASDAQ to come up with very stringent standards about who can serve on audit committees and how they're selected. We are also working on perfecting the nominating committee's role and the compensation committee's role to clearly separate the role of management from managing the operations, but not influencing the kinds of critical issues that affect investors.

It seems to me you run a risk. There are people saying this is a time when tough action is needed and something fairly clear-cut is needed. These are all very intricate interlocking reforms. You do part of it, the New York Stock Exchange does part of it, the NASDAQ does part of it. There is no sense of where the buck stops. It's always elusive, and in fact that's the way it's been for decades, particularly for the last decade. One of the problems is FASB does part of it, public oversight board does part of it, the New York Stock Exchange does part of it, the corporate governance does part. It's like the Japanese government; you can't find anybody in charge. Isn't this a time to get tough and be clear?

Absolutely. That's why the proposal that we have will achieve the result and the other proposals I think fall short of the mark. We are getting tough.

... People are talking about your reforms as pussycat reforms, putting the fox in the henhouse, pulling your punches. How do you deal with that kind of [criticism]?

It's very simple. People are criticizing something that they haven't even read yet. We haven't put out our proposal.

That's not true. The kind of people who are commenting are commenting on the basis of what you have said publicly.

No, they are commenting on their interpretations. There is a lot of gamesmanship that's going on out there, and that's to be expected. There are people who have their own agendas, including people who one would think should be focused solely on the merits of these questions. That's up to them. But we have an obligation to serve the public interest, and we are the ones who have proposed a very dramatic shift.

All of the problems that you refer to -- oversight of the FASB, oversight of the public oversight board -- look at the oversight board, for example. That was in existence for 25 years under my predecessor and those before him. And that entity had no disciplinary powers. It had no independent funding; it was incapable of doing anything in the face of opposition from the accounting profession. We've proposed something that gets rid of all of that.

But the accounting profession is going to have seats on your board, and it didn't have seats on the old board, so this is bringing the accounting industry more into the board of oversight.

No, no, it isn't. What it is doing is the accounting profession will not have seats on our board. What they will have is the ability to bring up-to-the-minute understanding and expertise to influence and to assist in the judgments that get made about certain policies.

You said two or three seats.

There could be up to two or three on a board that had nine people, and they would not be allowed to vote on disciplinary matters. So that they would not be seated board members for all of the rigorous things that need to be done. But if you only have people whose contact with the accounting profession is from 20 years ago, they don't have the slightest idea of the problems that are going on today. That would actually hurt the public instead of helping it.

What's interesting, as I listen to you, I've listened to Barry Melancon [of the AICPA], I've listened to people in the accounting industry, I feel as though I am hearing the same person speaking. It sounds as though you're saying very much what the accounting industry itself wants and not what investors, investors' representatives are asking for.

I haven't sat in on your discussions with any of the others, so I can't tell you what I sound like and what I don't sound like. What I can tell you is that, based on expertise which I think is unique, we are in the process of forging an incredible new system for the benefit of individual investors. Something that should have been done five, ten years ago but was allowed to lie dormant. My view is that people have to watch what we do. They're going to have an opportunity to comment on it, and it will be an incredibly vigorous system of oversight and regulation -- one that we have needed for years.

How does your proposal compare with the proposal put forward by Mr. Oxley in the House, that was voted on by the House?

Mr. Oxley's proposal and the bill that was passed by the House provides for certain discrete separations of certain functions, but basically leaves the construction of what we call the PAB, or Public Accountability Board, to the efforts of the SEC. We have put flesh on what it is we think needs to be put in place.

We don't believe that we need legislation to achieve this result, so it is our view that this has to get done. We intend to have a Public Accountability Board in place before the end of the year.

Would your Public Accountability Board have a legislative mandate?

It would have all of the mandate it needs, because it would have the SEC's mandate. We have all of the power now and have had for years to solve these problems. They just haven't been tackled or solved.

You go back to Joe Kennedy and Paul Douglas [in the 1930s], and the argument they had when the SEC was started [in 1934], as to whether or not the SEC extended into a government, official body, or whether it should turned over to the private sector. You're essentially still sticking with what Joe Kennedy said and what Paul Douglas, as I understand it, opposed. Isn't that right?


With private industry without a legislative mandate, without subpoena power, without the teeth that other people say are needed?

First of all, I think it's backwards. First of all, what Congress decided in 1934 was that it did not want the government to become the auditors of American business. They wanted to have private accounting firms do this job. I think that was a wise decision.

I think there are problems in the system. I think they need to be solved. As for teeth in the system, the lack of subpoena power is a plus. It's not a minus. ...

Why wouldn't it be an advantage to have subpoena power?

It won't be an advantage if the entity becomes a government body, because then if people testify and are taking the Fifth Amendment when they are called upon to testify -- which you can do when you testify before the government -- what happens is the government cannot punish anyone who doesn't give them information. Whereas a private-sector body will be able to say to anyone, and this would be part of the rules, "If you don't cooperate, if you don't give us all of the information we need to make a determination and to discipline you, then you are out of the profession, you cannot practice as an accountant ever again for a public company." That's pretty powerful.

It also depends upon when it is exercised. It sounds powerful, but the experience of the past has been, look at all the settlements. There's a slew of settlements that are neither-admit-nor-deny settlements, because the process of getting to the point of an actual judgment or a conviction is so prolonged that the SEC is, by lots of people's accounts, outgunned, outmanned, doesn't have enough staff, doesn't have enough money to carry those out. That disciplinary action taken by the accounting industry only comes after there's been an absolute resolution of the criminal charge. Are you going to change that?



We're changing it a number of ways. First of all, there is no discipline by the accounting profession. That's out. That's the system that we had in the past that we have dismantled. We do not want the accounting profession to discipline itself. We want an independent board that will mete out discipline in the interests of investors. The other changes that will be made will be to have cases brought when they are ready to be brought. ...

One of the things that we have introduced at the SEC is "real-time enforcement." The criticisms that you have just alluded to are perfectly on point. It doesn't do anyone any good if the SEC takes five or six years to investigate a financial fraud, and then when the company is already in bankruptcy it produces a consent injunction without admitting or denying anything. That was the practice in previous administrations.

What we have done is to say we want real-time enforcement. Instead of our enforcers asking the question, "How can we make the best case, what additional steps do we have to take which would, might prolong it?" -- the first question they are now required to ask in every case is, "Are investors being hurt?" And if they are, what steps should we be taking immediately to prevent that harm?

If you look at the statistics just from the first few months of this calendar year, we have brought more asset freezes, more temporary restraining orders. We have suspended trading in more shares of company stock, and we are bringing cases in record time to try and get investors the protection they were entitled to all along, but weren't receiving.

I think steps to enforce are to be applauded, but that's the thing that can fluctuate. What matters is the standards and the procedures over a period of time.

Absolutely right.

It can rise and fall depending upon events up there, depending upon personnel here -- the commissioners, the enforcement.

Well, look at the standards. As you know, we have a private-sector group, the Financial Accounting Standards Board, which sets standards. Again, this has been in place for 20, 30 years. Here is the problem. First of all, it's not independently funded. It is getting its funding from voluntary contributions, which makes it toothless, as you had previously suggested.

Second, it sometimes takes as long as ten years for it to promulgate a standard. On off-balance-sheet entities, which were so prominent in the Enron situation, it was asked 10, 15 years ago to do something about off-balance-sheet entities, and it still hadn't done anything. Since we've been in office, what we have done is we have insisted that they come up with a solution. They already have a proposal out, and before the end of the year, there will be concrete guidance.

The third problem it had was that whenever it rendered accounting principles, they were so voluminous, they were so verbose, that what it did was create a "check the box" accounting mentality for auditors. We have said that that takes too long, and it doesn't deal with what the real problems are. So we're insisting that it move to a principles-based standard. It tells the accounting profession and public companies, "Here's what the goal is. Here's what the purpose is. Don't tell me if this complies with GAAP [generally accepted accounting principles]. Tell me whether we're meeting the goals of this."

The best evidence of that is the Edison case that we brought just a few weeks ago. Edison had a significant problem in terms of how it was reporting its revenues. We concluded, as they had argued, that what they did was in accordance with GAAP, but we sued them anyway. We sued them anyway, because we said it's not enough to comply with generally accepted accounting principles. It's critical that investors be told what really needs to be done. That's the first time the commission has done anything like that in decades.

One place where FASB was clear and managed to make a rule was the rule on expensing stock options -- in corporations, putting them on the bottom line. Where do you come down on that? [Levitt] backed off, and it was rejected back in 1994. But there are still people -- again, Sen. Levin and a number of others up on Capitol Hill -- saying we've got to have options expensed on the bottom line, the same way they are on the tax return.

Here's the problem. You have a lot of people who think that if they come up with a simplistic solution to a complex problem, they've done their job. But the investors wind up with no protection. The first problem is, why are senior managers getting the options in the first place? Our view is they should only get them for true performance. The second is, is it possible for management to profit from options when shareholders are losing a bundle? We saw that happen in Enron. We say that's not appropriate. That has to be prevented.

The third issue becomes, how do options get awarded? We say that they must have shareholder approval. For years, people have been begging the commission to require that shareholders get to vote on all options. We have now gotten all of the self-regulatory securities bodies to agree that shareholders will get to vote on every single option. That's the first time that's ever happened.

The fourth thing is, it's not a question of whether options are expensed; the question is, how and when? Because if options are truly long term, and, by the way, if they cannot be re-priced if the market tanks -- many companies just re-price the options and in effect reward senior management for a lack of performance -- we have said that should not be done without an independent compensation committee making certain that it serves the public interest. But if in fact you cannot achieve the benefits of an option unless you show long-term fundamental growth and gains, then the question will be, at which point along the line should you expense the option and what should be the formula?

Those, we think, are open to legitimate suggestions. But it's not a question of whether they should be expensed. It's a question of when and how.

Another issue that came up, and it has come up again during this last decade, is the question of the Securities Litigation Reform Act passed in 1995. Sen. Shelby feels as though the deterrent in private securities litigation has been weakened. What do you think? He's recommending that that law be reversed, and that it be revisited and reformed. Where do you come down on that?

First of all, I've said that in light of Enron, nothing is off the table. So if there are statistical and empirical data that establish that problem, then I think we all have an obligation to fix it.

What I think the statistics will show, however, is that since the passage of the Securities Litigation Reform Act, there have actually been more litigations filed. There have been more settlements, and the settlements have been for larger dollar amounts.

There have also been hundreds more corporate restatements, which might say something about corporate behavior that underlies the number of--

There's absolutely [what] seems like [a] clear question and problem with respect to the number of restatements. But the fact is if the PSLRA was creating a haven for people, there wouldn't be more litigation, and the recoveries wouldn't be exponentially higher than they were before the legislation. The only thing that's occurred has been to get rid of frivolous litigation, not to get rid of well-intended and well-balanced litigation.

It's also been an effort to get the most responsible institutional representatives of the individual investor to take a role in making sure that the litigation protects the investors, not the plaintiffs' lawyers who seek to recover. The plaintiffs' lawyers have a very, very effective political lobby, and they are very upset with anything that will challenge their ability to make fees. What we need is appropriate legislation like the PSLRA to make sure that investors are the ones who benefit from any litigation, not their lawyers.

Mr. Pitt, it seems that whether you're talking about expensing options, whether you're talking about the tort reform, whether you're talking about separating auditing and consulting, your basic message seems to be, "Go slow, don't be too radical and hasty on reform." Isn't this a time to be tough? Why do you say "Go slow?"

I don't say "Go slow." There are people who want you to believe that that's what we're saying. That is not what we are saying. We're saying it's not a question of more regulation.

On one of these issues, you said, "Well, this is complicated. We can't really do it that way." If you look into the expensing of options, it's not whether you do it, it's when you do it and how you do it, and we kind of get lost in that. We get into the separation of auditing and consulting, and you say, "Well, it's complicated. You need to take a look at all the different kinds of consulting that could be connected and you need to have certain skills across the board if you're going to do an effective audit." In issue after issue, what you're saying is, "It's too complicated. Just trust us to get it done, pretty much within the private sector."

Oh, no, that's absolutely not what we're saying. We are not saying it's too complicated. We don't think it's too complicated for us, and we're not saying it should be done in the private sector. We're saying we need to do it. We're saying that the problems that we are seeing today -- which all exploded fortuitously when I walked in the front door, and I don't believe it was my fault -- but the problems that we're seeing have been building for five, eight, ten years, and nobody in government did a thing about them. What we're now saying is--

But people were trying to do something about it.

No they weren't, there were people--

Are you saying that Arthur Levitt's efforts to make reforms were not sincere efforts?

Well, let me ask you this. I believe that Arthur Levitt was very well-motivated and wanted to serve the public interest. The question is, what did he achieve? What got done? In my view--

But Congress threatened to cut off the SEC's funding on the auditor independence thing. It wasn't whether or not Arthur Levitt was going to proceed with it.

Congress threatens many things. I'm getting threats every single day. The function of an SEC chairman is to do what's right, not what's expedient or politically acceptable or what will play well in the press. That's the critical issue, and what we're trying to do is what is in the interest of investors. ...

There are people who want to put words in our mouth. They may even want to put words in your mouth. But the truth of the matter is, we're not saying the problems are too complicated. We're saying, don't be gulled by these simplistic solutions, when the problems that have been allowed to fester for years weren't handled. The people who didn't solve these problems are now the ones who are critical of any effort to try and solve the problems. They're worried that the problems may actually get solved. That's an incredible situation for us to be in. ...

I guess where I'm having my trouble is, I'm picking up publications like BusinessWeek and The Wall Street Journal and USA Today, and one publication after another with financial commentators, and people are saying that the reforms you're proposing are half-hearted; [that] they don't have the teeth to do the job.

If you look at what we are doing and what we have put out and what we will be putting out, what you will understand is that the proposals we have advocated have incredible teeth and will solve problems that should have been solved years ago. I cannot account for the reasons why some publications prefer to talk about criticisms of proposals that aren't even in print. But they are criticisms from people who don't want the SEC to succeed. We are going to succeed. This is going to be done, and it's going to be done for the benefit of investors and be done the right way.

I hope you're right.

I know I am.

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