SEC AND CORPORATE AUDITS THURSDAY, APRIL 24, 1986 HOUSE OF REPRESENTATIVES, COMMITTEE ON ENERGY AND COMMERCE, SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS, Washington, DC. The subcommittee met, pursuant to notice, at 10 a.m., in room 2123, Rayburn House Office Building, Hon. John D. Dingell (chairman) presiding. Mr. DINGELL. The subcommittee will come to order. Today the Subcommittee on Oversight and Investigations will conduct the second in a series of hearings to examine the administration and enforcement of the Federal securities laws for banks and savings and loan institutions. At the subcommittee's previous hearing on April 10, 1986, we received testimony that Federal banking regulators may be falling into the same trap as the Federal Home Loan Bank Board by using accounting rules to cover up problem loans. The use of such accounting gimmicks in the savings and loan industry has brought the Federal insurance system to the brink of insolvency. This week, the press reported that the Securities and Exchange Commission may allow oil and gas companies to defer recognition of losses because an accounting rule has begun to pinch. These types of policies circumvent the early warning system for detecting problems, and will worsen the impact of bank and business failures when they do occur. Leniency in enforcing accounting regulations can present other serious consequences. The former Chairman of the Federal Deposit Insurance Corporation testified that 50 percent of the bank failures which occurred last year were directly attributable to management fraud. Without adequate enforcement and strict accounting standards, problems created by outright fraud can only be expected to increase. The subcommittee realizes that companies and lenders in energy, agriculture, and related industries are experiencing serious economic problems. We are also acutely aware that institutions facing such problems would prefer to pretend they do not exist when reporting to the public. However, the Great Depression, which necessitated the creation of the current regulatory system, showed us the dire consequences which can result when the public is not told the truth. Today, we will hear from the Securities and Exchange Commission, the Federal Agency responsible for assuring accurate financial reporting under the Federal securities laws. We will also hear (99) from the Financial Accounting Standards Board, the private organization which promulgates generally accepted accounting principles. This subcommittee expects all organizations with responsibilities for administering and enforcing the securities laws to perform their duties diligently. We will take all necessary steps to ensure that this is accomplished. The Chair wants to recall some reasons why this committee has special concerns in this. It is clear that accounting is the mainspring of the regulatory system. Without adequate information, one must question whether the accounting system is providing the necessary input to the regulatory structure of this Nation to assure that the regulators are able to carry out their responsibility. One can only look back to the failures to Penn Central and to the problems that attended that collapse. One can recall that less than 2 weeks before the collapse of Penn Central, ICC informed this committee that it had no knowledge of the situation which faced Penn Central and the collapse of that corporation and all of the consequences which flowed not only to investors, shareholders, creditors, but also the Federal Government which lost $6 to $8 billion in protecting and restoring rail service to the Northeast corridor of the United States. It is not the intention of this Chair that the regulatory system will fail because of the inadequate accounting practice or inadequate behavior by accountants or because rules are changed to suit the momentary convenience of regulators by permitting less than truthful reporting of information essential to the adequate functioning of the economic and the regulatory system of this Nation. Mr. Shad, we are delighted you are with us and we are pleased you are back before the committee again. The Chair is sure you are aware of the rules of the subcommittee and before we proceed with matters relative to your testimony, the Chair is going to recognize my colleague for his opening statement, the gentleman from Oregon, Mr. Wyden. Mr. WYDEN. Thank you very much, Mr. Chairman. First I want to associate myself with your remarks, Mr. Chairman, and commend you for going forward with this hearing. You have consistently said that sunlight is the best antiseptic to financial abuses and that certainly applies to this issue. I want to associate myself with your remarks and just make a couple of others in addition. I think what is going on here is the Federal Government has given the green light to accounting alchemy. The Federal Government has essentially allowed these accounting techniques which almost magically seem to turn troubled financial systems into ones that are healthy and sound. It just seems to me that restructuring bad loans does not miraculously create good ones. The accounting and financial reporting entities must fully disclose a fair and accurate picture of the health of our financial institutions. I am very concerned, Mr. Chairman, about the story I read in the paper with the SEC proposing to suspend the rules that force oil companies to write down the value of their oil reserves. I have great sympathy for some of the concerns of these small oil compa nies and small energy companies in these tough times but we cannot permit accounting rules that say the price of oil is different than what it really is. We can't magically through accounting rules instantly change the price of oil. So I am going to be interested in exploring that, among other subjects. I know the subcommittee has the opportunity to inquire into that, Mr. Chairman. I look forward to the inquiry and commend you for going forward. Mr. DINGELL. The Chair thanks the gentleman. Mr. Shad, we thank you and your associates for being present with us today. As you know, it is the practice of the committee that all witnesses who appear before us testify under oath. You or your associates, Mr. Lynch, or Mr. Sampson or Mr. Hodges, do you have any objections to testifying under oath this morning? Gentlemen, it is your right, each of you, to be advised by counsel if you so desire. Do any of you desire to have counsel to advise you during the period you testify? Mr. SHAD. I have got mine. Mr. DINGELL. That leaves us a different problem. For the information of each of you gentlemen, copies of the rules of the committee, the subcommittee, the House, are available to inform you not only of your rights under the rules of the committee and the House, but also limitations on the power. Mr. Lynch, will you be testifying or will you be serving as advisor to Mr. Shad? Mr. LYNCH. I will be testifying. Mr. DINGELL. Then we will have to swear you. If you testify, you post particular problems both for yourself and Mr. Shad and for the Chair and that is we can't have you testify and serve as counsel both but we will try and be as cooperative in working with you and Mr. Shad as we can to see to it there is minimum difficulty entailed in the application of that rule. Gentlemen, then if you will each please stand and raise your right hand? [Witnesses sworn.] Mr. DINGELL. You may each consider yourself to be under oath. TESTIMONY OF HON. JOHN S.R. SHAD, CHAIRMAN, SECURITIES Chairman Dingell, members of the subcommittee. First, it is requested that our testimony that has been previously submitted to the subcommittee be included in the record, if there is no objection, Mr. Chairman, to inclusion of our formal statement within the record. Mr. DINGELL. That is entirely appropriate. Without objection, your formal statement will be inserted in the record and we will recognize you for such summary as you choose to make. Mr. SHAD. Clarence Sampson, the SEC's Chief Accountant, and Gary Lynch, the Director of the Division of Enforcement, as well as myself, each have very brief opening statements. At the present time, the SEC administers the securities registration and reporting requirements for about 11,000 publicly owned corporations including over 1,000 bank and savings and loan holding companies. The only publicly owned companies that do not file with the Commission are about 400 individual banks and 300 S&L's that are not holding companies. Of the 400 banks that do not file with the SEC, about 240 file with the Federal Deposit Insurance Corporation, 130 with the Comptroller of the Currency, and 30 with the Federal Reserve Board. The 300 S&L's file with the Federal Home Loan Bank Board. Vice President Bush's task group on the regulation of finanicial services unanimously recommended consolidating within the SEC the securities registration and reporting requirements of all publicly owned banks and savings and loan associations. In addition to the Vice President and the Secretary of the Treasury, the task group included the heads of the bank and S&L regulatory agencies, the Comptroller of the Currency, FSLIC Board Chairman, the Federal Deposit Insurance Corporation Chairman, and the Federal Home Loan Bank Board Chairmen, as well as the Chairman of the SEC, the Council of Economic Advisers and others. Subsequently, in testimony before this subcommittee the Chairman of the Federal Home Loan Bank Board indicated that he believes that the 300 S&L's securities registration and reporting requirements should continue to be administered by the Bank Board. The 12 other members of the task group concluded that consolidation of the registration reporting requirements of the banks and S&L's within the SEC would result in more uniform and efficient regulation and enforcement of the securities disclosure require ments. The uniform disclosure and enforcement of these requirements would not only facilitate an analysis of individual companies, but also analyses of alternative investment opportunities as between corporations as well as between industry groups-such as banks as compared with savings and loan associations, finance subsidiaries and other industry groups. Such comparative analyses are fundamental to sound investment decisions and the efficiency of the securities markets. In addition, as a result of public disclosures, both investors and large uninsured depositors tend to shift out of weak into strong depositories. Also, the SEC's EDGAR electronic disclosure system will provide investors, security analysts, and others instant access to the timesensitive disclosure documents of all publicly owned companies except the 700 depositories that file with four other agencies. The other agencies' primary concerns are for the safety and soundness of the depositories. |