As to fraud, it is normal for the auditing firm to be somewhat vigilant, on the lookout, if you will, for fraud activity. But it is not an overriding form of activity. The client, if you will, has not engaged him to make a comprehensive study of its activity to ascertain whether fraud is being perpetrated. In the final analysis, Senator, I think it is a matter of being able to handle the sheer volume of cash and financial transactions that goes on in a business entity during the course of a

year.

We use various auditing techniques and procedures to determine the reasonableness or effectiveness of the internal controls of the business entity; as to fraud, we look for it, but quite frankly, we don't go way out looking for it, because it is not considered part of the ordinary

scope.

There are broad audits, special assignments that are not unusua. But in the ordinary course of events, the client does not request

Senator PERCY. It really just depends on what is the scope of the audit.

Mr. PASSERO. Yes, sir.

Senator PERCY. That is what you generally agree on ahead of time with an audit committee, what is the scope of this audit to be. Mr. PASSERO. Yes, sir.

Senator PERCY. The professsion is on notice now that there is a flagrant use of management discretion in the way corporate funds are used that has now brought corporations into disrepute, really, caused managements to be changed, caused tremendous embarrassment to the United States of America, its people, the Government, and its method of operation really, all over the world.

It is something that we are, in Government, moving to clean up. It now has the profession on notice that the practice of kickbacks, payoffs, or bribes, is now so pervasive or at least pervasive enough that it ought to be a part of the scope of the audit.

Therefore, if all auditing firms audit ethical standards, then it is not a question of your not having the personnel or funds for it or anything like that, it is part of the scope and you charge them for it.

Mr. PASSERO. If management would make that part of the scope, then quite obviously, we would perform.

Senator PERCY. What management is making payoffs and kickbacks is going to tell you to go find what they are doing. You are the auditors.

Mr. PASSERO. We are on the horns of dilemma.

Senator PERCY. I know. But you see, the dilemma is this: If I've said it once, I've said it 50 times, the profession is either going to do it, and the business system is going to do it, and this is a problem that I have taken to the business council 2 years ago. I made a speech that was probably the most unpopular speech to men that represent the control of a quarter of our productive assets in this country, 160 of them, saying, here is the problem. Business had better do something about it. To their everlasting glory, instead of being condemned, I had more commendations on that speech, the most uncomfortable speech I have ever given.

Many said, "You are right." Time after time corporations have sent me their code of ethics that have been adopted by the corporations,

profession going to now start catching up with Government and start to catch up with what the leading enterprises in this country are adopting as a code, because they know they have got to do something to protect the standing of American business abroad, lest it undermine the standing of this country abroad, and our people.

Mr. PASSERO. I think, Senator, it would be fair for the accounting profession to examine the expense accounts of the line officers and some of the key financial personnel of many organizations. I perhaps misunderstood Mr. Hanson. But I think that is an integral part of the ordinary scope; the expense accounts of any organization I think should be examined and tested using the same standard and procedure and technique employed elsewhere. I think that is a fair statement. I think it is a practical matter. It probably is done. I may have misunderstood Mr. Hanson. But I can't imagine that the expense accounts

are

Senator PERCY. I am not just talking about expense accounts, that is something else again. I am talking about dummy accounts that are set up, commissions that are extraordinarily high that are paid, taking into account that a large part of them are going to be used to bribe Government officials, to cause those Governments to buy military planes they don't need when they should be buying food.

They are buying jets in a developing country and, like Cook County, painting over everything. You can get the money back from the contractors. We know that. It has been going on for a long time. But you have got a one-party government up there that just hasn't been able to do enough. We don't audit cities. We probably ought to. But now that we know that this practice is going on, now that we know that it is such a discredit, that the U.S. Chamber, International Chamber of Commerce have taken action. Isn't this really a responsibility now that you are on notice that it is so widespread that SEC has probably spent the last 2 years of its life over there just ferreting this out. Taxpayers' money is being spent, why not the stockholders'? Catch

it at the start.

You mentioned expenses. I tend to think that there is a feeling growing that the disparity, that probably padded expense accounts by top executives, the use of corporate jets, all of those perks, the hunting lodges, we are on public notice now that those things go beyond normal business practices. I didn't mind entertaining for business purposes. But isn't this really taking it out of the employee's profitsharing plan?

One corporate executive I know refuses to have a corporate jet. He personally purchased his own. He said, "I wouldn't want the implication left that I am taking profit-sharing money to fly around someplace." So he would rather pay for it himself. He has to be able to afford it. But there are some who are leaning over backwards to make certain this does not occur. Doesn't the auditing profession have a responsibility to sit down and work with management on something now, that again may be something that would be a discredit to corporate management and to the business enterprise system?

Mr. PASSERO. Certainly the responsibility of the auditor is clear when expenditures are made that are in violation, or appear to be in violation of any statute, whether it is income taxes, or otherwise. I believe, generally speaking, the profession does stay in touch with the

appropriate management, or depending on the nature or size of it, simply makes the correct adjusting entries to the books of the corporation. That takes care of it.

Farther, as part of the auditing technique, it is the custom of the profession to request liability certificates from financial officers of the corporate lents.

Generally these liabilities have to do with such things as inventories, contingent liabilities of one form or another, adherence to all State an i Federal regulations and laws.

Perhaps. I think I have seen some written material on it, the profession should take one step further in requiring the same form of liability as a form of warranty, if you will, from affected corporate personnel.

Senator PERCY. Enough on this point. All my life I have heard of the charges by business executives that labor just gets by with murder, they are engaging in practices that should not be condoned and Government does nothing about it. I did notice a tendency to be light with labor unions here, organized labor, and not meddle into their affairs too much. But Senator Metcalf knows, we made a decision a couple of years ago to use the power of the Permanent Investigating Subcommittee on which I am ranking Republican with Senator Nunn as the acting chairman now. We decided to look at one union. We have had a team of investigators working in cooperation with the Justice Department. We have subpenaed records and files, we have taken depositions. We have literally discovered an unbelievable, unholy mess: the worst possible use of power that I have ever seen.

We are going after it. We are going to pursue it. We are not going to let up one bit. We are going to try to see that that kind of practice stops, because it involves their life insurance, their health and pension benefits, and everything else. I say also there is abuse in the business community in some areas. You know that.

We all know it. There is something very pervasive. I have stopped off in skiing resorts sometimes and seen as many as 30 corporate executive planes there. That is just wrong. They are not holding a business conference there. I don't know how they handle the accounting on it. But it is very easy to check the logs of airplanes to see what the purpose was, what the business purpose was in being there; and whether or not adjustments had been made for that.

I just say this ahead of time, for fear that it may just get blown into a great big scandal sometime. It is going to taint the whole system once again. It is up to management to correct these practices.

I hope the accounting firm can work with them in covering this in the scope of the audit, rather than have the Justice Department, the Senate use its power to do it. A lot can be done right there. I wonder if you could comment on the statement made by Mr. Biegler on Tuesday that all accounting firms auditing publicly held companies be regulated and licensed by the SEC. I have not had a chance to get the reaction back from the rest of the other accounting firms. It was put out publicly yesterday. You have heard some discussion, certainly. Could you give some personal views, as well as those you might have heard of reactions to it?

Mr. PASSERO. I received the testimony of Mr. Biegler yesterday af

sion is it would appear to be unnecessary to register the accounting firms with SEC. It would seem to me that that sort of thing is adequately taken care of presently.

Requirements for registration is something else, possibly. As it stands now, SEC gives recognition to any independent public accountant, irrespective of title, be he certified or otherwise. I think Mr. Biegler's proposal, as I understand it, having gone through it very quickly, would be to require some sort of standard required process for registration, instead of simply saying, "I am an accounting firm and consequently qualified."

Senator PERCY. I have been notified I have an overseas call. Could you finish your comment, and I will read it in the record?

Mr. PASSERO. Fine. It would appear to be unnecessary, Senator. Senator METCALF. Senator Percy said that he would not ask that you be held for further questioning. So I want to compliment you on your testimony. I think it is most important to have members of the accounting profession which you represent testify, and as I say, remind us of the impact of decisions that are made on the small accountants who work with closely held companies, as well as on the big public accounting firms.

Mr. PASSERO. I assure you the accounting profession as a whole is extremely sensitive to criticism to begin with, and more particularly. it appears that it has connotations that expose the accounting firm to some sort of civil liability or otherwise. Malpractice insurance is hard to get to begin with. It is extremely costly.

Senator METCALF. Thank you for coming.

TESTIMONY OF CHARLES T. HORNGREN, PRESIDENT, AMERICAN ACCOUNTING ASSOCIATION; T. R. LILLEY, PRESIDENT, FINANCIAL ANALYSTS FEDERATION; CHARLES C. HORNBOSTEL, PRESIDENT, FINANCIAL EXECUTIVES INSTITUTE; AND WILLIAM M. YOUNG, JR., EXECUTVE DIRECTOR, NATIONAL ASSOCIATION OF ACCOUNTANTS, A PANEL

Senator METCALF. Our next witnesses are a panel consisting of Mr. Charles T. Horngren, president of the American Accounting Association; Mr. T. R. Lilley, president of the Financial Analysts Federation; Mr. Charles C. Hornbostel, president of the Financial Executives Institute; and William M. Young, Jr., executive director of the National Association of Accountants.

We are very pleased to have you.

Mr. HORNGREN. My name is Charles T. Horngren. I am a Stanford professor and I am president of the American Accounting Association. I ask that the written statement I have submitted today be printed in full in the record.

My summary position is shared by many others: First, the setting of financial accounting standards is extremely complicated and time consuming; second, the SEC has been an active rather than a passive participant in the process; third, a cooperative effort between the public and private sectors is preferable to shutting out the private sector; fourth, change is a way of life for the SEC and the accounting

In an attempt to insure better and better quality, the profession has introduced many innovations in its structure and practices during the 1970's. Examples include the creation of the FASB and peer review programs. Moreover, the current reports of the Cohen Commission and of the committee on the structure of the FASB are evidence that the profession is actively seeking progressive change. Perfection is unattainable. Still, given the profession's continuous pursuit of progressive changes toward better quality, I think radical Federal action now would be unwise.

I would like to talk a little bit about the American Accounting Association, because it is the leading association of accounting educators in the United States. It has over 11,000 members. The association is dominated by university professors.

As the president, I have full and complete power only to speak for myself. After all, an association of professors is a collection of free spirits. Consequently, no lone professor or committee is authorized to speak for the association as a whole.

With one exception, the executive committee is composed of professors. During a recent meeting, the committee unanimously decided to convey its disagreement with the recommendations of your staff report that the Federal Government assume sole and direct responsibility for establishing professional accounting standards for publicly owned companies, which is the essence of recommendations 1, 2, 5, and 11. The committee said:

We believe the conclusions reached therein are at variance with the view of the vast majority of our membership.

The association is not an advocacy organization, and its Executive Committee rarely takes a position on public policy issues. In this case, however, the issue is of such fundamental importance that the Executive Committee in the public interest has unanimously decided to depart from its policy.

Our major concern is helping accountants to serve society as a whole. Because we are academicians, we are probably as impartial a group as you can find who are qualified to deal with the issues you confront.

The Executive Committee unanimously believes that the public interest is best served by having financial accounting standards developed primarily in the private sector (presently by the Financial Accounting Standards Board) with effective oversight by the Securities & Exchange Commission.

This cooperative public-service sector effort holds the greatest promise for continuous improvement in financial reporting. Eliminating or substantially decreasing the important role of the private sector in setting accounting standards is not in the public interest. We believe that such action would hinder, not help, the development of improved accounting standards.

Because the committee views are unanimous, and I have also talked to at least 100 professors, I don't hesitate to assert that an overwhelming majority of professors would agree with the thoughts of the executive committee.

Let me turn to the resources of this association. Many professors have expressed dismay at the staff study's failure to gather a spectrum of academic opinion. The association has negligible financial resources. Nevertheless, the association has no vested interest in the subjects of your inquiry, and it has abundant mental resources. We have an ample supply of researchers in accounting who are willing to aid your inquiry or any congressional inquiry in any way possible. Please call on us. Thank you.

Senator METCALF. Thank you very much.