TESTIMONY OF WILLIAM S. KANAGA, MANAGING PARTNER, ARTHUR YOUNG & CO.

Mr. KANAGA. Thank you, Mr. Chairman.

Senator METCALF. I am informed that our next roll call is not until 12:15, so you have plenty of time.

Mr. KANAGA. Thank you.

My name is William Kanaga. I am the managing partner of Arthur Young & Co. I am pleased and we as a firm are pleased to have the opportunity to appear before you and to make ourselves available for your questions. Senator Metcalf said in the hearing's opening remarks: "We do not intend to dwell on the problems of the past," but plan on focusing on "improving the system" for the future. I will do

the same.

We have responded in writing to the recommendations and the commentary of the staff study itself. We do not agree with a number of areas in the staff study and have stated our reasons in that response. I do not intend this morning to repeat such detailed commentary, but wish to enter our printed statement in the record, if I might do so. Senator METCALF. Yes. The usual order will be made that the printed statement will be incorporated in the record in its entirety.

Mr. KANAGA. Thank you.

Our response does contain 14 recommendations in three basic categories: One, strengthening the regulatory and disciplinary process. Two, setting standards both in auditing and accounting and letting the Sun shine on these processees, and three, establishing codes of business conduct.

With regard to strengthening the regulatory and disciplinary process, in my opinion, the profession itself has an inescapable and nontransferable responsibility to insure that its members conduct their activities in accordance with standards of conduct at a high level and in the public interest.

No profession-be it law, medicine or any other-can long exist as a profession where Government takes over the primary responsibility for policing the performance of members of the profession. The hallmark of a profession is that its members are men and women of integrity-concerned, responsible, and constantly aspiring to higher levels of achievement in their professsional work.

These basic conditions with a few exceptions are being met in the accounting profession. Although criticisms voiced in these hearings that the SEC is inactive and inept are in my opinion overstated, I think, it is nonetheless my opinion that giving Government additional regulatory responsibility is not the solution for dealing with these few exceptions.

The profession is encouraging a number of current developments which are all aimed at the goal of improved performance.

One of our key concerns is the independence of C.P.A.'s and the perception, by the public, of that independence. It may be self-serving to state-but I feel it so strongly that I will-concern for the integrity, independence, and ability of our people is the cornerstone of our firm. This concern is reflected in our continuous interchange and review processes among all our people, in our education and training, and in

For example, this year we will have in the United States close to 30,000 man-days of education in formal firm education programs at a substantial cost-for our total programs, upward of $2,500 per year per professional.

Public perception of our independence is essential; in our response, we are recommending additional public disclosures related to two key ingredients, independence and competence, in the auditor selection process for publicly owned companies. Certain recommended disclosures are directed specifically at the audit committee itself. In addition, disclosures in shareholder proxy material should include: One, fees paid by a corporation to its auditors if they exceed a stated percentage of the auditor's total revenues; and, two, results of the latest professional peer review.

I agree essentially with the Cohen Commission recommendation that the audit committee of publicly held companies should have the power to recommend the hiring and firing of auditors. We recommend that the profession's peer review program can and should be further strengthened by bringing able and experienced industry, academic, and Government into the review process.

As a profession we have hundreds of thousands of members across the world. In addition to personal integrity, we have extensive firm and professionwide codes of conduct. However, and naturally, since we are dealing with human beings, there can be mistakes and there can be transgressors. We believe that the profession should have the prime responsibility for professional discipline, of course supplemented by existing court and regulatory agencies.

These disciplinary proceedings could be sped if information in them was made privileged so that we can proceed without waiting the outcome of related litigation.

This change and other revisions of the law relating to litigation against accountants should be considered when the entire Federal securities law is revised based on proposals of the American Law Institute.

Next, setting standards. The setting of standards, both accounting and auditing, should remain in the private sector. We should, however, take a leaf from the Government's book and let sunshine into the process.

There should be a full-time board to set auditing standards, and we recommend increased participation by individuals from outside the profession in that process. The FASB should improve its external communications, and alternative methods of funding should be devised which will reduce the substantial contributions of the major accounting firms.

We also agree with the recommendation that the FASB allow more sunshine on its deliberations, and we recommend the same for the auditing board's deliberations. The reservations expressed by some about a loss of candor and other practical disadvantages are more than offset by putting to rest any concerns about secrecy surrounding the establishment of such standards in the private sector.

With respect to the accounting used by government at all levelsFederal, State, and local, we recommend a massive effort by Government and our profession to improve accounting standards and end

The attention of this country in the past 4 years or so on standards of behavior by individuals in both the public and the private sector has been healthy, though painful to the country itself.

We have been surprised and disturbed by the extent of improper conduct that events have disclosed. None of us can afford to be smug, because most disclosures involve practices outside the country.

The corruption shown by some of the reports could easily spread to the United States, and indeed has, to insidiously corrupt our system. In addition, foreign bribery payments, whether made by representatives of the U.S. Government or by the private sector, can't help but tarnish the image of our country abroad.

The key, in my mind, is not in attacking form, and in passing new laws criminalizing one new form of action and not another. The key is: In establishing codes of conduct for executives in business, as has already been done in Government and the professions; in requiring a substantially higher level of moral behavior than do the laws of this land or any land.

Each corporation or entity, be it public or private, should be required to report its conformance to that code and the corporation's general counsel and its C.P.A.'s should give assurance that they did not obtain any knowledge that the corporation has not so conformed. The reviews of such assurances by the audit and other board committees will strengthen the hand of outside directors and provide additional assurance of conformance with such codes of conduct. The key in any event, is the chief executive officer of any corporation—he sets the tone and if he means it, the codes will be effective.

There have been repeated reference in these hearings and in the press to the public's desire to receive corporation financial disclosure in simple and clear Layman's language. I believe the Cohen Commission recommendations in this area are excellent, making clear that the initial burden should fall on management, that uncertainties should be laid out, telling it like it is, and that the auditors' reports should be made less steretoyped and more descriptive.

We in the United States have the best and most credible corporate financial reporting system in the world; and that is why private accumulations of capital are tapped here, while they are still under the mattresses elsewhere. But we are torn between the need to provide comprehensive information to the experts and the desire to make information understandable to laymen.

Progress has been made in the past 2 years in this area through SEC requirements for textual discussion of financial information by management and our profession's broadening of the responsibilities of C.P.A.'s for information in the annual report but outside the financial statement. As an example of current trends, I have here the shareholders' report of Koppers Co. for 1976 which describes its financial information in clear and layman's terms.

I would like to distribute that to the members of the committee here present. You can see on page 39 I believe the simplistic form with which Koppers starts its discussion of the financial statements. They have captions there to explain in clear and layman's language what the captions in the income statement mean.

To sum up, we can do better. The process of improvement is

Reacting to the Cohen and Palmer reports. Based on discussions week before last at meetings of the board of directors and of council of the AICPA, the profession is supportive of both the Cohen and the Palmer reports. There are areas in each report which have to be clarified, but both are constructive and both indicate the profession's desire and intent to move under its own power.

Both of these reports help give us what I believe will prove to be an appropriate assignment of our responsibility to the public. In conclusion, let me recap our recommendations.

First, while we believe the setting of accounting and auditing standards should remain in the private sector, we recommend: A full-time auditing standards board, with participation from outside the profession; improved external communications by the FASB and addiditional outside funding of it. Improvements in the Government rulemaking process, and improved accounting standards and recordkeeping for Government.

Second, we believe the profession's regulatory and disciplinary process and the profession's independence can be further strengthened: One, make information from professional disciplinary proceedings privileged, perhaps as part of the proposed revisions of the securities law.

Two, include knowledgeable and experienced public representation in oversight of the existing professional peer review program. Three, increase the responsibilities of audit committees in oversight and in the process of retention and hiring or firing auditors, and four, provide additional disclosure about auditing firms relevant to their independence and competence in the shareholder proxy material.

Third, we recommend the adoption of a business code of ethical behavior governing corporations and their executives. We recommend that responsibilities for compliance rest upon the audit committee of the board, legal counsel, and the auditors. We do believe that the key is the leadership given by the corporation's chief executive officer, and that no code will be effective without his full support.

Let me conclude by saying that I really believe these hearings are healthy, and that they do in fact stimulate those of us in the profession to speed the pace of response to a changing world. We have done a poor job in many ways of communicating our profession's aspirations and limitations. We have rather enjoyed the anonymity of our labors. I can only say that day seems quite well past.

I know that I personally feel the commitment to being more outspoken and responsive about the direction and pace of change in the profession; you can rest assured we will be responsive.

Thank you for the opportunity to be here.

Senator METCALF. Thank you very much, Mr. Kanaga, for a statement that is consistent with other statements of the large accounting firms. I hope you go to the next meeting of the AICPA and the FAF to implement your suggestions and the provisions of the Cohen report. Mr. KANAGA. And the Palmer structure committee report.

Senator METCALF. Yes; all of which don't have uniform, universal agreement, but nevertheless must be considered the basis for the kind of reforms that many of us believe the accounting profession has to institute of its own volition in order to avoid further criticism and

Senator Percy isn't here. Senator Percy has consistently asked questions about the perquisites of various large corporations and the failure of the accounting firms to handle and report on such perquisites. Last Thursday, the New York Times carried an article, which I will insert in the record here, about the mass use of corporate jets by company officers.

The Times named 19 companies whose jets suddenly appeared in Atlanta when the Masters Tournament was on. Now, all of the 19 companies were audited by Big Eight firms, including 3 of the firms represented here today. I don't think we need a variety of generally accepted accounting principles or accounting standards for reporting and verifying these executive compensations.

I don't think Senator Percy does, either. I believe stockholders, however, are entitled to a clear statement of perquisites and facilities provided these officers, along with the salaries and retirement benefits. What do you require your clients to report in this area, when, for instance, they get on a company jetplane and fly down to the Masters Golf Tournament?

[The article referred to follows:]