Letter from John H. Harwood, John H. Harwood & Co., regarding the Letter from Robert A. Shiff, president, Naremco Services, Inc., regarding Letter from Dana Devereux, president, The Emerson Consultants, Inc., Letter from Irving N. Gleim, associate professor, School of Accounting, Article in The Energy Daily describing efforts of the Securities Industry Page 2129 2131 2132 2134 2135 2138 2143 2145 Article in Forbes questioning why Price Waterhouse certified that Mercantile Bank & Thrust Co. was solvent, October 1, 1977. 2146 Board of Directors Manual, Connecticut General Insurance Corporation, 2147 ACCOUNTING AND AUDITING PRACTICES AND PROCEDURES TUESDAY, APRIL 19, 1977 U.S. SENATE, SUBCOMMITTEE ON REPORTS, ACCOUNTING, AND MANAGE MENT OF THE COMMITTEE ON GOVERNMENTAL AFFAIRS, Washington, D.C. The subcommittee met at 10 a.m., pursuant to call, in room 6202, Dirksen Senate Office Building, Hon. Lee Metcalf (chairman of the subcommittee) presiding. Present: Senators Metcalf, Jackson, Nunn, Percy, and Danforth. Also present: Vic Reinemer, staff director; E. Winslow Turner, chief counsel; John B. Chesson, counsel; Gerald Sturges, professional staff member; Lyle Ryter, minority counsel; Jeanne A. McNaughton, chief clerk; and Anne Boni, legislative assistant. OPENING STATEMENT OF SENATOR METCALF Senator METCALF. The subcommittee will be in order. I noted in the morning Washington Post that the accounting profession is going to be offensive and that I have been assuaged. I hope I am not going to be assuaged during these hearings. I don't anticipate the accounting profession is going to be offensive during the hearings. We are beginning public hearings on the role of the Federal Government in assuring that financial reports of publicly owned corporations accurately and meaningfully reflect the substance of corporate activities. In the Securities Act of 1933 and the Securities Exchange Act of 1934, Congress determined that the Federal Governmentthrough the Securities and Exchange Commission-should insure that corporate information reported to the public is fair and accurate. Accounting practices used in reporting corporate financial information are instrumental in achieving the fair disclosure intended by Congress. The independent audit of corporate financial results which was mandated by Congress is the key to instilling public confidence in the information reported by corporations. Today, we begin public hearings on the role of the Federal government in assuring that financial reports of publicly-owned corporations accurately and meaningfully reflect the substance of corporate activities. In the Securities Act of 1933 and the Securities Exchange Act of 1934, Congress determined that the Federal government— through the Securities and Exchange Commission-should ensure that corporate information reported to the public is fair and accurate. Accounting practices used in reporting corporate financing information are instrumental in achieving the fair disclosure intended by Congress. The independent audit of corporate financial results which was mandated by Congress is the key to instilling public confidence in the information reported by corporations. Independent audits for the bulk of the Nation's major corporations are performed by a relatively few large accounting firms. For the most part, auditing and accounting rules are established by private organizations dominated by those big accounting firms. The purpose of these hearings is to explore ways to make certain that the auditors of major corporations are independent in fact and appearance, and that they serve the public interest rather than the narrow interests of their clients. We do not intend to dwell on the problems of the past. Instead, we, plan to focus on suggestions and proposals for improving the present system to better fulfill the expectations of Congress and the public. This subcommittee issued a staff study entitled "The Accounting Establishment" last January. That study represents the first comprehensive effort by Congress to evaluate the present system of establishing auditing and accounting practices in the nearly forty-five years since the Federal securities laws were enacted. In preparing its study, the subcommittee staff attempted to fulfill two objectives which I believe are most important. The first was to provide a detailed analysis of the many organizations involved in establishing and applying accounting practices used by major publiclyowned corporations. The staff identified the accounting responsibilities of the Securities and Exchange Commission, the Cost Accounting Standards Board, and various private accounting and business organizations, as well as the interests represented by each organization and their relationships with one another. The staff's second objective was to provide a useful and convenient source of factual data on the "Big Eight" accounting firms and the public and private organizations comprising the accounting establishment. Such data have not been readily available to Congress and the public in the past. These firms and organizations exercise tremendous influence over the Nation's economy and its public policies through the performance of their accounting responsibilities. Thus, the subcommittee staff study is quite a good-sized volume. The staff analysis runs one hundred and ninety pages, and more than fifteen hundred pages of supporting factual data are included in the Many difficulties were faced in preparing this study. Relevant information had to be identified, then requested from the various organizations involved. The large volume of data received was sorted, compared, tabulated, and analyzed to determine the often complex. relationships among the organizations comprising the accounting establishment. I believe the subcommittee staff accomplished its objectives thoroughly and competently. It worked on the study for more than a year, and consulted continually with representatives of large accounting firms, small accounting firms, academia, and Federal agencies. I regard the staff's recommendations on improving accounting practices as sound guidelines for action by Congress and the appropriate Federal agencies. Some accounting firms and groups have criticized the staffs recommendations. If those firms and groups have alternate proposals which will effectively remedy the problems described in the staff study, then I hope they will share their ideas with the subcommittee. The staff's study of the accounting establishment reflects the concern of many of us in Congress that the present system has been incapable of developing effective accounting practices which will adequately protect and inform the public. It seems as though nearly every day we read in the Washington Post or the Wall Street Journal of some newly discovered fraud, slush fund, or unsuspected financial difficulty concerning a major corporation. In such cases as Lockheed and Penn Central, the difficulties have resulted in substantial Federal assistance. We have also been concerned about the quality of the information we receive regarding the earnings and financial position of major industries such as the oil companies and the electric utilities. Federal tax policies are based on reported corporate earnings, and inaccurate information may lead to inappropriate tax policies. Accounting practices used by publicly-owned corporations with the approval of their independent auditors have important direct and indirect impact on the operation of the Federal government. The economic welfare of individuals and even large institutional investors is also dependent upon sound accounting practices, but many have suffered unnecessary losses because corporate financial statements have been misleading. Before I discuss my basic views on improving the system of establishing and applying accounting practices, I want to clear up some misconceptions and misdirected criticism regarding the subcommittee's staff study of the accounting establishment. I believe such misconceptions and criticism have occurred for two basic reasons. The first is that the Government Printing Office did not foresee the tremendous demand for copies of the staff study. As a result, the GPO and our subcommittee had depleted our supplies of the study within |