```

[Senate Hearing 107-830]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 107-830

 
        ACCOUNTABILITY ISSUES: LESSONS LEARNED FROM ENRON'S FALL

=======================================================================

                                HEARING

                               before the

                       COMMITTEE ON THE JUDICIARY
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                            FEBRUARY 6, 2002

                               __________

                          Serial No. J-107-56

                               __________

         Printed for the use of the Committee on the Judiciary

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                          WASHINGTON : 2003
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                       COMMITTEE ON THE JUDICIARY

                  PATRICK J. LEAHY, Vermont, Chairman
EDWARD M. KENNEDY, Massachusetts     ORRIN G. HATCH, Utah
JOSEPH R. BIDEN, Jr., Delaware       STROM THURMOND, South Carolina
HERBERT KOHL, Wisconsin              CHARLES E. GRASSLEY, Iowa
DIANNE FEINSTEIN, California         ARLEN SPECTER, Pennsylvania
RUSSELL D. FEINGOLD, Wisconsin       JON KYL, Arizona
CHARLES E. SCHUMER, New York         MIKE DeWINE, Ohio
RICHARD J. DURBIN, Illinois          JEFF SESSIONS, Alabama
MARIA CANTWELL, Washington           SAM BROWNBACK, Kansas
JOHN EDWARDS, North Carolina         MITCH McCONNELL, Kentucky
       Bruce A. Cohen, Majority Chief Counsel and Staff Director
                  Sharon Prost, Minority Chief Counsel
                Makan Delrahim, Minority Staff Director

                            C O N T E N T S

                              ----------                              

                    STATEMENTS OF COMMITTEE MEMBERS

                                                                   Page

Cantwell, Hon. Maria, a U.S. Senator from the State of California    64
Feingold, Hon. Russell D., a U.S. Senator from the State of 
  Wisconsin......................................................    65
Feinstein, Hon. Dianne, a U.S. Senator from the State of 
  California.....................................................    57
Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa.    66
Hatch, Hon. Orrin G., a U.S. Senator from the State of Utah......     7
Kohl, Hon. Herb, a U.S. Senator from the State of Wisconsin......    67
Kyl, Hon. Jon, a U.S. Senator from the State of Arizona..........    68
Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont.     1
Sessions, Hon. Jeff, a U.S. Senator from the State of Alabama....    72
Thurmond, Hon. Strom, a U.S. Senator from the State of South 
  Carolina.......................................................    73

                               WITNESSES

Gregoire, Hon. Christine, Attorney General, State of Washington, 
  Olympia, Washington............................................    13
Koniak, Susan P., Professor of Law, Boston University School of 
  Law, Boston, Massachusetts.....................................    35
Lund, Nelson, Professor of Law, George Mason University School of 
  Law, Arlington, Virginia.......................................    30
Raynor, Bruce, President, Union of Needletrades, Industrial and 
  Textile Employees, American Federation of Labor and Congress of 
  Industrial Organizations, New York, New York...................    17
Schatz, Steven M., Esq., Senior Partner, Wilson, Sonsini, 
  Goodrich and Rosati Professional Corporation, Palo Alto, 
  California.....................................................    24

                       SUBMISSIONS FOR THE RECORD

Department of Justice, Lauren Pfeifle, Washington, D.C., 
  statement......................................................    65
Retirement Systems of Alabama, David G. Bronner, Chief Executive 
  Officer, Montgomery, Alabama, letter...........................    69
Schwarcz, Steven L., Professor of Law, Duke University School of 
  Law, Durham, North Carolina, letter and attachment.............    70

        ACCOUNTABILITY ISSUES: LESSONS LEARNED FROM ENRON'S FALL

                              ----------                              

                      WEDNESDAY, FEBRUARY 6, 2002

                                       U.S. Senate,
                                Committee on the Judiciary,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:03 a.m., in 
room SD-226, Dirksen Senate Office Building, Hon. Patrick 
Leahy, Chairman of the Committee, presiding.
    Present: Senators Leahy, Kennedy, Kohl, Feinstein, 
Feingold, Schumer, Durbin, Cantwell, Edwards, Hatch, Specter, 
and Brownback.

OPENING STATEMENT OF HON. PATRICK J. LEAHY, A U.S. SENATOR FROM 
                      THE STATE OF VERMONT

    Chairman Leahy. Good morning. I have been advised that 
Senator Hatch is on his way and he has no objection if we 
begin, as we will be having votes this morning and I thought we 
should. We have a distinguished panel here and I do not want to 
hold them longer than necessary.
    On November 8, as we all know, Enron announced that it had 
overstated earnings over the past 4 years by $586 million and 
they were responsible for $3 billion in obligations that were 
never reported to the public of a dollar here and a dollar 
there. Upon these disclosures, Enron stock fell to $8.41 a 
share from a figure many times that before. Then a month later, 
they filed for bankruptcy. It is the largest corporate 
bankruptcy in our nation's history.
    The worst part is it left thousands of Enron investors 
holding virtually worthless stock and most Enron employees lost 
out--most. Some did not. Those who profited seem to be the 
senior officers and directors who cashed out while assuring 
others that Enron was a solid investment, as well as the 
professionals from accounting firms, law firms, and business 
consulting firms who were paid millions of dollars to advise 
Enron on the practices that bankrupted their company.
    Now, how did this happen? It appears that Enron, with the 
approval and advice of its accountants, auditors, and lawyers, 
used thousands of off-the-book entities to overstate corporate 
profits, understate corporate debts, and inflate Enron's stock 
prices. Some Enron executives ran these entities and they 
reaped millions of dollars in salaries and stock options and we 
see conflict of interest waivers from a quiescent Enron Board 
of Directors.
    With the help of these professionals, both inside and 
outside of Enron, the company wove an elaborate web of 
corporate deceit. I want to just show you on this chart. These 
are just a few of the secret Enron entities used to hide debt, 
to fake profits, and to inflate stocks. Actually, being 
fanciful was not limited just to their bookkeeping. Some of the 
same corporate imagination was unleashed in naming these hidden 
Enron entities.
    Look at some of the names--Kenobi, Mojave, Chewco, Condor, 
Jedi. Whoever was naming them has probably been to a few too 
many movies. And, of course, some are named, perhaps the most 
aptly of all, after the Wild West--Rawhide, Ponderosa, Cactus, 
Mojave, Sundance.
    Now, they had different names in all of these but they all 
had one thing in common. They were never honestly disclosed to 
the investing public, and much about these partnerships is 
still secret, including who participated in them and who 
benefited from these corporate manipulations.
    Enron's web of deceit caught more than just its employees. 
In addition to thousands of Enron employees losing their life 
savings in the company's 401(k) pension plan, many other 
investors suffered losses because of the sudden collapse. 
Across the nation, pension funds for union members, teachers, 
government employees, policemen, firemen, and others lost more 
than $1.5 billion from investments in Enron stock. State 
attorneys general, individual investors, and Enron employees 
have filed private class action lawsuits against Enron 
executives, Arthur Andersen, and others for security fraud. The 
Department of Justice and the FCC are also investigating.
    Enron's web ensnared our financial market. Last week and 
again this week, the Dow Jones index fell hundreds of points. 
Why? Among other reasons, doubts emerged about the 
trustworthiness of balance sheets for other public companies. 
With more than half of Americans' households invested in the 
stock market today, the integrity of our financial markets is 
critical to our nation's economy.
    During his State of the Union Address, President Bush 
declared that ``corporate America must be made more accountable 
to employees and shareholders and held to the highest standards 
of conduct.'' I agree with the President and I hope that this 
hearing and our work in the committee and the Senate will help 
bring about that accountability.
    Enron Chairman Kenneth Lay was questioned about the use of 
off-the-book arrangements during a company e-mail chat on 
September 26 of last year. He assured Enron employees that he 
and Enron's Board of Directors ``were convinced both by all of 
our internal officers as well as our external auditor and 
counsel that these off-the-book arrangements were legal and 
totally appropriate.''
    Mr. Lay's accountability remains to be seen. Having said 
for weeks that he would testify before the Senate, of course, 
he abruptly canceled his appearance before he did testify 
before the Senate. Except for his part in a carefully 
orchestrated media campaign, he is not talking. No one has been 
able to get him to answer questions that test the accuracy of 
his statements from last fall, just before the fall of Enron. 
Nor have Mr. Skilling or Mr. Fastow or several others 
testified. And one who might have tragically committed suicide.
    What we do know is that the actions of Enron's professional 
advisors raise serious ethical questions for the legal and 
accounting professions. They also raise questions of 
professional accountability. The actions of Enron and its 
advisors raise serious questions about the current legal 
environment, where auditors and outside counsel enjoy special 
legal protections passed by the Congress in the 1990's. and we 
have to ask whether this legal environment serves to encourage 
lax corporate governance and questionable accounting and 
undisciplined legal practice.
    Then we had a five-to-four majority decision of the U.S. 
Supreme Court that gave accountants and lawyers a really big 
break from liability and private securities fraud actions. 
Chief Justice Rehnquist and Justices Scalia, Thomas, Kennedy, 
and O'Connor overturned what had been decades of well-settled 
law that allowed private fraud suits against a person, such as 
an auditor or attorney, who aids and abets the principal in 
accomplishing the fraud.
    Aiding and abetting liability is especially important in 
securities cases. It provides incentives for accountants and 
lawyers to police corporate fraud. It helps overcome the profit 
incentive that can otherwise motivate complicity in 
questionable conduct.
    Second, as the Enron experience shows all too well, 
securities fraud schemes are often very complex. They need 
experts, they need professionals to carry out these schemes. 
Instead of setting up huge financial incentives for these 
experts to assist in structuring corporate fraud, our laws 
should enlist the assistance of these professionals as 
guardians of the honesty of our corporate financial 
disclosures. Those who invest expect them to be honest in what 
they do. They should be helping stop fraud before it causes 
harm to the public and also before it undercuts the public 
confidence in the transparency and honesty of the market.
    The Supreme Court was not alone in chipping away legal 
protection for investors and creating an environment in which 
creative accounting can morph into off-the-books maneuvering. 
In 1995, Congress passed the Private Securities Litigation 
Reform Act. President Clinton vetoed it. We overrode the veto. 
This version of reform contributed to the loss of professional 
discipline and enacted restrictions making it more difficult 
for victims to recover.
    I recall that Senator Specter and I, along with some other 
members of the committee, voted against the Private Securities 
Litigation Reform Act when it was on the floor. We warned that 
its special legal protections might lead to future financial 
scandals. Well, beginning with Enron, the chickens have come 
home to roost.
    No matter whether a Member of Congress voted for or against 
the Private Securities Litigation Reform Act, no Member of 
Congress, Republican or Democratic, intended for it to be used 
to promote corporate greed. We cannot legislate against greed, 
but we can and should do what is possible to prevent greed from 
prevailing.
    In fact, the accounting industry liked the special legal 
protections in the Private Securities Litigation Reform Act so 
much that Arthur Andersen Worldwide made a trophy out of this 
conference report that they apparently have used in this. They 
shrunk it and encased it in plastic. Well, the law also shrunk 
the rights and protections of American investors. I could not 
help but think in looking at it, there is one thing that you 
cannot do with it. You cannot shred it.
    [Laughter.]
    Chairman Leahy. Now, there were contributions to this 
disaster, they are large, they are small, from the corporate 
officers and directors whose actions led to Enron's failure, 
from the well-paid professionals who helped create and carry 
out the corporate ruse, the regulators who did not protect the 
public, from the courts, from Congress, and others. So we have 
to make sure it does not happen again.
    The worst part about this travesty would be if we do not 
learn from it and if we walk away. We were reminded during the 
savings and loan failures of the 1980's, if you do not have 
discipline and professionalism and an effective legal structure 
and accountability, greed does run rampant. Unfortunately, 
business failures during a permissive era rarely happen in 
isolation.
    So Congress can do more and we should. When we forced 
through special exemptions for securities fraud, accountants 
and others made Congress a contributor to the Wild West 
mentality that came to be reflected in Enron's hidden 
partnerships. That was not what was intended and Congress 
should rethink and reform our laws in the other direction, so 
we prevent corporate deceit, we protect investors, get 
confidence back in our capital markets.
    I will comment briefly on the relevance of the Enron 
bankruptcy to bankruptcy reform legislation that is now in 
conference between the House and the Senate. I recently 
received a letter from 35 law school professors regarding 
Section 912 of both the House-passed and Senate-passed 
bankruptcy reform bills. It amends the Bankruptcy Code to 
provide a safe harbor from bankruptcy court review for certain 
asset-backed securities. It is sort of a type of off-the-books 
financial transaction. Well, the experts tell me that the 
provision would encourage more companies to recast liability so 
they no longer appear on balance sheets. They said that would 
be to the detriment of the investing public and other creditors 
of the business. So I have asked the Department of Justice for 
its views on this controversial provision in light of the Enron 
matter so that we can get it right before the bill comes out of 
conference.
    I am also concerned that Enron executives who made millions 
of dollars in sweetheart corporate deals could abuse Texas's 
unlimited bankruptcy homestead exemption by shielding unjust 
enrichment from defrauded investors by just putting it in 
multi-million-dollar estates. Last week on national television, 
the wife of Enron's former chairman disclosed that her husband 
is considering filing for bankruptcy protection. Under Texas 
law, there is no limit to the amount of money they could plow 
into a personal residence. I think that we have to enact a 
nationwide cap on homestead exemptions like the one that 
Senator Kohl and Senator Feinstein authored in the Senate-
passed bankruptcy reform bill.
    This is on our doorsteps. Our job is to make sure there are 
adequate doses of accountability in our legal system to stop 
this from happening in the future.
    I look forward to the panel after we have heard from our 
distinguished ranking Republican member, Senator Hatch.
    [The prepared statement of Senator Leahy follows.]

 Statement of Hon. Patrick J. Leahy, a U.S. Senator from the State of 
                                Vermont

    On November 8, Enron announced that it had overstated earnings over 
the past four years by $586 million and was responsible for $3 billion 
in obligations that were never reported to the public. Upon these 
disclosures, Enron stock fell to $8.41 a share. Less than a month later 
Enron filed for bankruptcy--the largest corporate bankruptcy ever. 
Enron's sudden collapse left thousands of Enron investors holding 
virtually worthless stock, and most Enron employees lost out. Those who 
profited appear to be the senior officers and directors who cashed out 
while assuring others that Enron was a solid investment, as well as the 
professionals from accounting firms, law firms and business consulting 
firms, who were paid millions to advise Enron on these practices.
    How did this happen?
    It appears that Enron, with the approval and advice of its 
accountants, auditors and lawyers, used thousands of off-the-book 
entities to overstate corporate profits, understate corporate debts and 
inflate Enron's stock price. Some Enron executives ran these entities, 
reaped millions of dollars in salary and stock options, and received 
conflict-of-interest waivers from Enron's Board of Directors.
    With the help of these professionals, both inside and outside of 
Enron, the company wove an elaborate web of corporate deceit. This 
chart shows just a few of the secret Enron entities used to hide debt, 
to fake profits and to inflate stocks. Being fanciful was not limited 
to bookkeeping. Some of this same corporate imagination was unleashed 
in naming these hidden Enron entities. Some were named after Star Wars 
films characters--Jedi, Obi-One, Kenobi and Chewco (as in Chewbacca). 
Some were named after birds and fish--Condor, Egret, Peregrine, Blue 
Heron, Osprey, Dolphin and Marlin. And some were named, perhaps the 
most aptly of all, after the Wild West--Rawhide, Ponderosa, Cactus, 
Mojave and Sundance.
    Despite their different names, all these Enron-related entities had 
one thing in common: They were never honestly disclosed to the 
investing public. Much about these partnerships is still secret, 
including who participated in them and who benefitted from these 
corporate manipulations.
    Enron's web of deceit caught more than just its employees. In 
addition to thousands of Enron employees losing their life savings in 
the company's 401(k) pension plan, many other investors suffered losses 
because of sudden collapse of Enron's stock price. Across the nation, 
pension funds for union members, teachers, government employees and 
other workers lost more than $1.5 billion from investments in Enron 
stock. State attorneys general, individual investors and Enron 
employees have filed private class action lawsuits against Enron 
executives, Arthur Andersen and others for securities fraud to recover 
their losses. The Department of Justice and the SEC are also 
investigating.
    Enron's web has also ensnared our financial markets. Last week and 
again this week, the Dow Jones index fell hundreds of points as doubts 
emerged about the trustworthiness of balance sheets for other public 
companies that may have dabbled in creative financing similar to 
Enron's. With more than half of Americans' households invested in the 
stock market today, the integrity of our financial markets is critical 
to the nation's economy.
    During his State of the Union Address, President Bush declared that 
``corporate America must be made more accountable to employees and 
shareholders and held to the highest standards of conduct.'' I agree 
with the President and hope that this hearing and our work in this 
Committee and in the Senate can contribute to increasing 
accountability.
    Enron Chairman Kenneth Lay was questioned about the use of off-the-
book arrangements during a company e-mail chat on September 26, 2001, 
and he assured Enron employees that he and Enron's Board of Directors 
``were convinced both by all of our internal officers as well as our 
external auditor and counsel that they [the off-the-book arrangements] 
were legal and totally appropriate.''
    Mr. Lay's accountability remains to be seen. Having said for weeks 
that he would testify before the Senate, he abruptly cancelled his 
appearance on Monday. Except for his part in a carefully orchestrated 
media campaign, he is not talking. No one has been able to get him to 
answer questions that test the accuracy of his statements from last 
fall, just before the fall of Enron. Nor have Mr. Skilling or Mr. 
Fastow, or several others, yet testified. Tragically, one senior Enron 
executive has apparently taken his own life.
    What we do know is that the actions of Enron's professional 
advisors raise serious ethical questions for the legal and accounting 
professions and questions of professional accountability.
    The actions of Enron and its advisors also raise serious questions 
about the current legal environment--where auditors and outside counsel 
enjoy special legal protections forced through Congress in the 1990s. 
Whether this legal environment serves to encourage lax corporate 
governance, questionable accounting and undisciplined legal practices 
is among the questions we explore today.
    A 5 to 4 majority decision of the United States Supreme Court gave 
accountants and lawyers a big break from liability in private 
securities fraud actions in 1994. Chief Justice Rehnquist and Justices 
Scalia, Thomas, Kennedy and O'Connor overturned decades of well-settled 
law that allowed private fraud suits against a person, such as an 
auditor or attorney, who aids and abets the principal in accomplishing 
the fraud.
    Aiding and abetting liability is especially important in securities 
fraud cases. First, it provides incentives for accountants and lawyers 
to police corporate fraud and helps overcome the profit incentive that 
can otherwise motivate complicity in questionable conduct. Second, as 
the Enron experience shows all too well, securities fraud schemes are 
often very complex. The assistance of experts and professionals is 
necessary to carry out fraud in complicated schemes. Instead of setting 
up huge financial incentives for these experts to assist in structuring 
corporate fraud, our laws must enlist the assistance of these 
professionals as guardians of the honesty of our corporate financial 
disclosures. They should be helping stop fraud before it causes harm to 
the public and undercuts public confidence in the transparency and 
honesty of our markets.
    The Supreme Court was not alone in chipping away at legal 
protection for investors and creating an environment in which creative 
accounting can morph into off-the-books maneuvering that is destroying 
pensions and savings and threatens to cut the heart out of investor 
confidence. In 1995, Congress passed the Private Securities Litigation 
Reform Act--over President Clinton's veto. This version of ``reform'' 
contributed to the loss of professional discipline and enacted 
restrictions making it more difficult for the victims of securities 
fraud to bring civil actions and recover their losses.
    This legislation prevents a defrauded investor from using the 
Racketeer-Influenced and Corrupt Organizations Act (RICO) and its 
remedies in almost all securities fraud cases. Securities fraud is the 
only exemption to our civil RICO laws. I recall that Senator Specter 
and I, along with other members of the committee, voted against the 
Private Securities Litigation Reform Act when it was on the floor of 
the Senate and warned that its special legal protections might lead to 
future financial scandals. Beginning with Enron, the chickens have come 
home to roost.
    In fact, the accounting industry liked the special legal 
protections in the Private Securities Litigation Reform Act so much 
that Andersen Worldwide made a trophy out of the conference report by 
shrinking it and encasing it in plastic. What the law did was shrink 
the rights and protections of American investors. Well, at least you 
can't shred it.
    There were contributions to this disaster, large and small, from 
the corporate officers and directors whose actions led to Enron's 
failure, from the well-paid professionals who helped create and carry 
out the complicated corporate ruse when they should have been raising 
concerns, from the regulators who did not protect the public and our 
public markets, from Congress and from the courts. Now we must 
contribute to making the Enron situation right and making sure that 
this does not happen again. This travesty will be compounded if we do 
not now learn from it and try to prevent it from happening again. 
Unfortunately, as we were reminded again during the savings and loan 
failures of the 1980s, without discipline, professionalism, an 
effective legal structure, and accountability, greed can run rampant, 
with devastating results. And unfortunately, business failures during a 
permissive era rarely happen in isolation.
    Congress can do more to make sure that our laws help deter 
corporate fraud and we should help defrauded investors to recoup their 
losses. In fact, by forcing through special exemptions for securities 
fraud, accountants and others made Congress a contributor to the Wild 
West mentality that came to be reflected in Enron's hidden 
partnerships. The time has come for Congress to re-think and reform our 
laws in the other direction in order to prevent corporate deceit, to 
protect investors and to restore full confidence in the capital 
markets.
    I should also comment briefly on the relevance of the Enron 
bankruptcy to bankruptcy reform legislation that is now in conference 
between the House and Senate. I recently received a letter from 35 law 
school professors regarding Section 912 of both the House-passed and 
Senate-passed bankruptcy reform bills. This section amends the 
Bankruptcy Code to provide a safe harbor from bankruptcy court review 
for certain asset-backed securitizations--a type of complex, off-the-
books financial transaction. These bankruptcy experts believe that the 
provision ``would encourage more companies to recast liabilities so 
that they no longer appear on balance sheets, much to the detriment of 
the investing public and other creditors of the business.'' I have 
asked the Department of Justice for its views on this controversial 
provision in light of the Enron matter and intend to work with the 
other conferees to get this matter right.
    I am also concerned that Enron executives who made millions of 
dollars in sweetheart corporate deals could abuse Texas's unlimited 
bankruptcy homestead exemption by shielding any unjust enrichment from 
defrauded investors. Last week on national televison, the wife of 
Enron's former Chairman and former CEO, disclosed that her husband is 
considering filing for bankruptcy protection. Under Texas law there are 
no limits on the dollar amount that debtors may plow in their personal 
residences and then shield from creditors in bankruptcy. The Enron 
demise underscores the need for Congress to enact a nationwide cap on 
homestead exemptions, such as the cap that Senator Kohl and Senator 
Feinstein authored in the Senate-passed bankruptcy reform bill.
    Accountability and transparency help our markets work as they 
should, in ways that benefit investors, employees, consumers and our 
national economy. The Enron experience has arrived on our doorstep, and 
our job is to make sure that there are adequate doses of accountability 
in our legal system to prevent such debacles in the future, and to 
offer a constructive remedy if there are not.
    I look forward to the comments and questions of the Senators 
participating today and to hearing from our panel of witnesses. I will 
introduce them after we hear from our distinguished Ranking Republican 
Member, Senator Hatch.

STATEMENT OF HON. ORRIN G. HATCH, A U.S. SENATOR FROM THE STATE 
                            OF UTAH

    Senator Hatch. Thank you, Mr. Chairman. I want to first 
commend you for calling this important hearing on the lessons 
we can learn from the Enron collapse. I appreciate the 
willingness of all of our witnesses here today to testify on 
such short notice and I look forward to hearing all of your 
testimony. It is important. I would especially like to thank 
Washington State Attorney General Christine Gregoire for making 
the trip here to the other Washington to talk about the States' 
pension plan lawsuits. We are all concerned and feel for the 
many hard-working people who lost their pensions and their 
hard-earned savings.
    Mr. Chairman, we all know about the unbelievable chain of 
events that led so many innocent Enron investors to lose so 
much so very quickly. Enron's highest trading point was $90. 
Today, it is worth about 26 cents. Injured parties include 
pension funds that lost hundreds of millions of dollars, Enron 
employees, who lost virtually the entire value of their 401(k) 
plans, and individual investors, both large and small, who have 
suffered losses that may include many people's life savings.
    These are not just personal tragedies. This is a failure of 
the transparent system meant to protect investors in our 
securities market, and, of course, it is a national shame. I am 
glad that we are here today to learn about the lawsuits being 
filed against Enron, the business and ethical conflicts that 
got us where we are today, and suggested reforms to make the 
system work better in the future. No investor should ever lose 
confidence in our securities market and no American should ever 
have to fear for the safety of his or her retirement savings 
programs.
    As several witnesses will testify here today, in 1995, 
Congress overwhelmingly passed the bipartisan Private 
Securities Litigation Reform Act, overriding a Presidential 
veto. This law was meant to reform securities class action 
practices and to abate the epidemic of so-called ``strike 
suits'' that were plaguing American businesses, particularly in 
the nascent high-tech industry. For instance, I have been led 
to believe by one 1995 estimate that a majority of Silicon 
Valley firms have been sued by plaintiffs' lawyers in class 
action lawsuits, and one in every eight companies on the New 
York Stock Exchange was being sued for securities fraud every 5 
years. Whether that is right or wrong, we will have to try and 
determine that.
    But that law was meant to reform securities class action 
practices and to abate the epidemic of so-called strike suits 
that were plaguing American businesses, particularly in the 
high-tech industry. Now, in these suits, nominal shareholders 
and/or professional plaintiffs and their lawyers were holding 
American corporations hostage with causes of action based on 
non-performance of publicly traded stock. Every time the stock 
price would go down or an earnings report was off, lawyers 
would line up on the courthouse steps to allege securities 
fraud on the part of the corporation or its advisors. 
Ultimately, these class actions were not only damaging to the 
businesses that would get tied up in meritless suits, but also 
to American consumers who were losing the benefits of 
innovations that had to be put on hold while managers and 
directors were otherwise engaged in directing against frivolous 
lawsuits or litigation.
    The provision of the Private Securities Litigation Reform 
Act that is most squarely under the jurisdiction of the 
Judiciary Committee is the exemption for securities fraud under 
the civil provisions of the Racketeer and Corrupt Organizations 
Act, or RICO. In 1995, the Securities and Exchange Commission 
vigorously supported the inclusion of this provision in the 
PSLRA and the former chairman, President Clinton's appointee, 
Arthur Levitt, was one of its most vocal proponents. Chairman 
Levitt testified before Congress that, ``because securities 
laws generally provide adequate remedies for those injured by 
securities fraud, it is both unnecessary and unfair to expose 
defendants in securities cases to the threat of treble damages 
and other extraordinary remedies provided by RICO.''
    It is important to note, especially in light of the ongoing 
criminal investigation of Enron, that this provision does not 
exempt any person from being criminally convicted under the 
RICO statute in connection with securities fraud.
    Legislation has recently been introduced in the House and 
may also be introduced here in the Senate that would remove the 
civil RICO exemption for securities fraud. It is my hope that 
we will give such legislation measured and careful 
consideration while studying the lessons learned from Enron. 
The PSLRA was designed to weed out frivolous lawsuits, not to 
prevent legitimate claims, like the ones represented here 
today, from being prosecuted. I look forward to hearing 
testimony from the witnesses on this matter.
    I also look forward to hearing from the witnesses about the 
ethical questions that have been raised regarding the conduct 
of the attorneys who set up the Enron deals and the analysts 
rating Enron stock. In particular, I would like to know where 
the lawyers were when Andersen and Enron started shredding 
documents. Why would any attorney allow or even encourage a 
client to commit possible obstruction of justice in the face of 
civil lawsuits and criminal investigations? Now, maybe it was 
not. I do not know. We will have to hear, and we have to keep 
an open mind on these matters to make sure that we do not just 
jump all over people because of appearance irregularities. I am 
not just talking about the law firms involved, however, but 
also the in-house counsels who are held to the same ethical 
standards as every other member of the bar.
    The final aspect of the Enron debate that I would like to 
address here today involves the proper and appropriate, and I 
should add constitutional, oversight role of Congress. Of 
course, I am referring to the General Accounting Office's 
threatened lawsuit against Vice President Cheney. As I have 
often said elsewhere, I strongly believe that the GAO's 
original efforts to impose disclosure of White House policy 
discussions and meetings raise serious constitutional and 
privacy concerns. From a policy standpoint, I believe that the 
powers asserted by the GAO in initially seeking specific 
details of the meetings attended by the Vice President deserve 
our attention.
    From a constitutional perspective, I strongly feel that the 
GAO's interpretation of its investigative powers raises 
substantial separation of powers questions. I have looked 
carefully at the legal arguments on both sides of this issue 
and have real concerns regarding the GAO's novel case and look 
forward to hearing whether the exercise of such powers by the 
GAO can be reconciled with the basic constitutional principles 
that underlie the doctrine of separation of powers.
    I would like to just take a minute to comment on the asset-
backed securitization provisions in the bankruptcy bill. Let me 
say, when I first heard of the concerns raised in light of the 
Enron debacle, I did want to examine the policy implications of 
the provision in the bankruptcy reform bill, and after 
reviewing it, I must say that the provision would, to some 
extent, act counter to the goal of the bankrupt corporation's 
rehabilitation in bankruptcy.
    But it is important to recognize that in this instance, the 
enrichment of the corporate debtor's estate to pay off 
creditors may not be the greater good. For example, the 
proceeds of an asset-backed securitization could allow 
sufficient liquidity to help a company avoid bankruptcy 
altogether. It would provide for greater certainty in the 
financial markets, as well. At the very least, such 
securitization could well provide essential funds to help the 
corporate debtor to stave off an accelerated bankruptcy filing, 
a much preferred outcome for both employees and shareholders.
    Also, I should caution that the reforms of Section 912 
should be viewed in perspective. Most companies that engage in 
securitization transactions do not end up in bankruptcy, nor do 
they engage in the alleged fraudulent acts we have been reading 
about with regard to Enron's dealings, assuming the accounts 
are true, and I do not assume that. I just have noticed them.
    Moreover, Section 912, which, as my colleagues may know, is 
limited to securitization transactions and would not encourage 
the kinds of abuses that occurred in Enron. Those problems 
reportedly were caused by Enron's manipulative use of special 
purpose entities capitalized by Enron stock in order to, A) 
sell assets at inflated profits, enabling Enron to recognize 
the inflated profit for financial statement purposes and, B) 
sell assets that would be falling in value in order to book the 
sale proceeds and avoid having to later write down asset value. 
These are accounting, not bankruptcy law, failures.
    Finally, I should also note, and I would be happy to listen 
to any of our witnesses respond to my comments, that under our 
Federal securities laws, a company originating a securitization 
transaction is prohibited from capitalizing the special purpose 
vehicle, or SPV, a trust that is set up to enable the 
transaction with company stock, or pension funds.
    Contrary to some of the accusations of observers, most, if 
not all of whom have been part of the vocal minority of 
opponents to meaningful bankruptcy reform, I do not believe 
that Section 912 of the reform legislation, which has passed 
both houses of Congress, I might add, overwhelmingly, could 
cause Enron-style abuses.
    I would also like to comment on the concerns raised with 
respect to the now-famous homestead issue in the bankruptcy 
reform bill. Mr. Raynor will make a point in his testimony 
about the homestead exemptions in place in both Texas and 
Florida under those States' constitutions. I should also like 
to note and thank Senator Kohl and others who have been true 
and genuine leaders on addressing this issue in the bankruptcy 
reform legislation. Senator Kohl has not tried to use this, as 
some others have, to derail needed reforms and has been very 
open to compromise or compromises that address the underlying 
problem.
    I agree that it is an injustice that rich debtors conceal 
their assets from creditors in large homesteads in these and a 
few other States. I do not think anyone would disagree with 
that, especially now. However, it is important to know the real 
fact that either of the House and Senate bills, which are now 
in conference, would address the homestead issue quite 
effectively and would squarely address Mr. Raynor's concerns.
    As we know, the Senate bill contains a flat $125,000 cap on 
the homestead exemption any debtor can claim when filing for 
Chapter 7 bankruptcy. The House bill contains a $100,000 cap on 
the homestead exemption a debtor may claim when filing for 
Chapter 7 bankruptcy on property acquired in the 2-years 
preceding the filing. The House bill also contains an 
additional 7-year look-back for fraud or abuse. In any case 
where such fraud or abuse is found, the homestead exemption 
would not apply. Thus, a fraudulently rich Enron executive 
cannot shield such assets unless he or she has been really 
planning for both the debacle and to use bankruptcy for more 
than 7 years. That, I do not think, has ever been alleged by 
anyone and would be pretty remarkable.
    I should also say that the House language is the bipartisan 
compromise reached during last year's conference report, which 
passed overwhelmingly last year with veto-proof margins. I 
think the goal of the reformers, particularly with respect to 
the homestead cap, is to prevent forum shopping and abuse, and 
both the House and Senate provisions would do just that.
    Additionally, the means test reforms in the bill, these 
have a profound effect on the availability of the homestead 
exemption in every State. Under the means test, above-average-
income debtors will most likely be placed in Chapter 13, where 
they will have to come up with a payment plan, not liquidate. 
In fact, if last year's compromise had been enacted into law 
and not vetoed by President Clinton, we would not be sitting 
here today worrying about whether or not Enron executives are 
hiding assets in their homes as we speak. I think this calls 
for us to complete our work on the bankruptcy reform conference 
committee and get the bill to President Bush for his signature. 
That way, we will not have to talk again with the 20/20 
hindsight when and if the next Enron occurs, if that is the 
case.
    Again, I want to thank the chairman for calling this 
hearing. I look forward to hearing the witnesses and I 
appreciate the efforts that you have all put forth in being 
here today. Thank you, Mr. Chairman.
    [The prepared statement of Senator Hatch follows.]

Statement of Hon. Orrin G. Hatch, a U.S. Senator from the State of Utah

    I want to first commend you for calling this important hearing on 
the lessons we can learn from the Enron collapse. I appreciate the 
willingness of all the witnesses to testify on such short notice and I 
look forward to hearing all of your testimony. I would especially like 
to thank Washington State Attorney General Gregoire [Greg-waar] for 
making the trip here to the other Washington to talk about the States' 
pension plan lawsuits. We are all concerned and feel for the many hard-
working people who lost their pensions and hard-earned savings.
    Mr. Chairman, we all know about the unbelievable chain of events 
that led so many innocent Enron investors to lose so much so very 
quickly. Enron's highest trading point was $90; today, it is worth 
about 26 cents. Injured parties include pension funds that lost 
hundreds of millions of dollars, Enron employees who lost virtually the 
entire value of their 401Ks, and individual investors, both large and 
small, who have suffered losses that may include many peoples' life 
savings. These are not just personal tragedies; this failure of the 
``transparent system'' meant to protect investors in our securities 
market is a national shame. I am glad we are here today to learn about 
the lawsuits being filed against Enron, the business and ethical 
conflicts that got us where we are today and suggested reforms to make 
the system work better in the future. No investor should ever lose 
confidence in our securities market, and no American should ever have 
to fear for the safety of his or her retirement savings.
    As several witnesses will testify here today, in 1995 Congress 
overwhelmingly passed the bi-partisan ``Private Securities Litigation 
Reform Act,''overriding a presidential veto. This law was meant to 
reform securities class action practices and to abate the epidemic of 
so-called ``strike suits'' that were plaguing American businesses, 
particularly in the nascent high-tech industry. In these suits, nominal 
shareholders and/or ``professional plaintiffs'' and their lawyers were 
holding American corporations hostage with causes of action based on 
the non-performance of publically traded stock. Every time a stock 
price would go down or an earnings report was off, lawyers would line 
up on the court house steps to allege securities fraud on the part of 
the corporation or its advisors. Ultimately, these class actions were 
not only damaging to the businesses that would get tied up in meritless 
suits, but also to American consumers who were losing the benefits of 
innovations that had to be put on hold while managers and directors 
were otherwise engaged in defending against frivolous litigation.
    The provision of the Private Securities Litigation Reform Act that 
is most squarely under the jurisdiction of the Judiciary Committee is 
the exemption for securities fraud under the civil provisions of the 
Racketeer and Corrupt Organizations Act (RICO). In 1995, The Securities 
and Exchange Commission vigorously supported the inclusion of this 
provision in the PSLRA, and the former Chairman, President Clinton's 
appointee, Arthur Levitt, was one of its most vocal proponents. 
Chairman Levitt testified before Congress that: ``because securities 
laws generally provide adequate remedies for those injured by 
securities fraud, it is both unnecessary and unfair to expose 
defendants in securities cases to the threat of treble damages and 
other extraordinary remedies provided by RICO.'' It is important to 
note, especially in light of the ongoing criminal investigation of 
Enron, that this provision does not exempt any person from being 
criminally convicted under the RICO statute in connection with 
securities fraud.
    Legislation has recently been introduced in the House, and may also 
be considered here in the Senate, that would remove the civil RICO 
exemption for securities fraud. It is my hope that we will give such 
legislation measured and careful consideration while studying the 
lessons learned from Enron. The PSLRA was designed to weed out 
frivolous law suits, not to prevent legitimate claims like the ones 
represented here today from being prosecuted. I look forward to hearing 
testimony from the witnesses on this matter.
    I also look forward to hearing from the witnesses about the ethical 
questions that have been raised regarding the conduct of the attorneys 
who set up the Enron deals and the analysts rating Enron stock. In 
particular I would like to know where the lawyers were when Anderson 
and Enron started shredding documents? Why would any attorney allow, or 
even encourage, a client to commit possible obstruction of justice in 
the face of civil law suits and criminal investigations? I am not just 
talking about the law firms involved, but also the in-house counsels 
who are held to the same ethical standards as every other member of the 
bar.
    The final aspect of the Enron debate that I'd like to address here 
today involves the proper and appropriate - and I should add 
Constitutional - oversight role of Congress. Of course, I am referring 
to the General Accounting Office's threatened lawsuit against Vice 
President Cheney. As I've said elsewhere, I strongly believe that the 
GAO's original efforts to impose disclosure of White House policy 
discussions and meetings raise serious constitutional and policy 
concerns. From a policy standpoint, I believe that the powers asserted 
by the GAO in initially seeking specific details of the meetings 
attended by the Vice President deserve our attention.
    From a constitutional perspective, I strongly feel that the GAO's 
interpretation of its investigative powers raises substantial 
separation of powers questions. I have looked carefully at the legal 
arguments on both sides of this issue and have real concerns regarding 
the GAO's novel case and look forward to hearing whether the exercise 
of such powers by the GAO can be reconciled with the basic 
constitutional principles that underlie the doctrine of separation of 
powers.
    Again, I thank the Chairman for calling this hearing and I look 
forward to hearing from the witnesses.

    Chairman Leahy. I thank you very much for being here, but I 
would comment on two things. One, this came as a result of our 
last effort on legislation and we wanted to make sure we do not 
make that mistake again because nobody in the Congress, as I 
said, Republican or Democratic, intended that. I do not want to 
see, whether it is bankruptcy legislation or anything else, 
being in somebody's door stopper or paperweight saying, away we 
go. You cannot legislate against greed, but you can stop greed 
from succeeding.
    Christine Gregoire is the Attorney General for Washington 
State. She is here today to tell us about Washington State's 
pending securities fraud litigation, the one that recovered 
more than $100 million from lost Enron investments in the 
State's pension fund. General Gregoire is Past President of the 
National Association of Attorneys General. She is a lead 
negotiator for the States in the historic 1998 class action 
tobacco litigation.
    Bruce Raynor is the President of the Union of Needletrades, 
Industrial, and Textile Employees. He is here to testify on 
behalf of the UNITE Amalgamated Bank and the AFL-CIO. UNITE and 
its members suffered a double-whammy from Enron's fall since 
the union pension fund lost money and Amalgamated Bank, which 
UNITE owns, lost $10 million, I believe it is, in Enron 
investments. UNITE is engaged in private securities litigation 
against Enron executives and Arthur Andersen to recoup its 
losses.
    Steve Schatz is a partner with Wilson, Sonsini, Goodrich 
and Rosati in Palo Alto, California. He will be testifying 
today. He is the Past President of the Association of Business 
Trial Lawyers of Northern California. He has been a lead lawyer 
in more than 60 securities class actions suits. He will discuss 
securities litigation in light of the Enron debacle and the 
benefits of the Private Securities Litigation Reform Act.
    Professor Nelson Lund of George Mason University Law School 
is also joining us today. Professor Lund has held positions in 
the Department of Justice, the Office of the Solicitor General, 
and the Office of Legal Counsel. Professor Lund will testify 
about constitutional issues and the lessons that will be 
learned from Enron's fall.
    Professor Susan Koniak of Boston University School of Law, 
a leading expert in legal ethics and professional 
responsibility and securities law, will testify about the 
ethical issues raised by the roles of inside and outside 
advisors on Enron's finances. Professor Koniak is the co-author 
on the law on ethics on lawyering--how lawyers should act, the 
definitive treatise on the scope of an attorney's professional 
responsibilities to the public and legal profession. It is 
actually a book that more and more law firms are requiring 
their students to read and then maybe to keep on their desk.
    General Gregoire, welcome, and we will start with you.

  STATEMENT OF HON. CHRISTINE O. GREGOIRE, ATTORNEY GENERAL, 
            STATE OF WASHINGTON, OLYMPIA, WASHINGTON

    General Gregoire. Good morning, Mr. Chairman and members of 
the committee. Thank you for the opportunity to be here today 
and speak with you about this important and troubling issue. As 
Washington State Attorney General, I am working on several 
fronts to sort out the impacts on millions of our State 
residents from the secretive, questionable, and potentially 
illegal business practices of Enron.
    In Washington, we feel like Enron has been the gathering of 
the perfect storm. First, they gouged our consumers and 
ratepayers with highly questionable power prices last year, and 
now, sadly, they have defrauded our investors and others across 
the nation.
    Enron first came on our radar screen in June 2000, when the 
Western States began to experience a serious energy crisis. 
About 1 year ago, I joined the Attorneys General of California 
and Oregon in an investigation of whether the energy market was 
being manipulated. The price spikes, unplanned maintenance 
outages, transmission capacity restraints certainly were 
peculiar and warranted a closer look.
    Over a year later, I wish I could tell you the answer. 
While the companies, including Enron, keep insisting to you 
that they have nothing to hide, in fact, they have refused 
consistently to turn over documents in document production 
necessary for us to determine once and for all what role they 
played in the energy pricing atmosphere. I can tell you that 
the price of some unregulated long-term energy contracts in the 
West dropped as much as 30 percent when Enron declared 
bankruptcy in December. Now, that may be just a coincidence, 
but until Enron begins cooperating with our investigation, we 
simply will not know. So I applaud the efforts of Senator 
Cantwell and Senator Wyden to push for a 206 Federal 
investigation by FERC.
    Currently, I am also involved in a lawsuit against Enron on 
behalf of our State pension fund. At least 31 public pension 
funds across the Nation have lost an estimated $1.5 billion on 
their Enron investments. These are losses to our funds for the 
retirement obligations made to millions of police officers, 
fire fighters, teachers, and other public servants around the 
nation. I have joined attorneys general from Ohio and Georgia 
in seeking lead plaintiff status in the class action lawsuits 
filed on behalf of investors against Enron, its executives, and 
Arthur Andersen. There are 1.3 million employees and retirees 
covered by our three systems.
    Our suit contends that Enron and others violated the 
Securities and Exchange Act by improper accounting, disclosure 
of false and misleading information, and some outrageous 
examples of insider trading. We have alleged that Enron used 
offshore tax havens to hide its debt burden from investors and 
that it misstated its financial position and investors' equity 
in the company repeatedly.
    As a State Attorney General, I warned consumers about 
avoiding shady get-rich-quick schemes and I urged them to check 
a company out carefully before handing over their money. In 
Enron's case, investors followed the rules. They listened to 
Wall Street. They relied on the audits. They relied on 
published financial reports. They assumed there was adequate 
regulatory oversight by the Federal Government. They assumed 
that the seventh largest company in America was playing by the 
rules, and in the end, they found themselves ripped off just 
like the naive person who lost money in a pyramid scheme. Now 
investors find themselves having to sue, with a real question 
whether they will be able to recoup their losses, little or no 
accountability by the accountants, and an insurance policy 
likely to be denied because of fraud by the directors.
    Enron's ability to operate in secrecy with soft or limited 
regulatory overview and with apparently no independent audit 
oversight are the common factors behind our lawsuit and the 
energy price manipulation probe.
    I know Congress is discussing a number of lessons learned 
from the implosion of Enron and what we can do to avoid future 
problems. I have just a few thoughts.
    First, we must see that SEC has the quality staff and the 
necessary resources to investigate and take enforcement action. 
But before we try to rely on government and government 
regulation for the solution, it seems that first we should 
focus on what is a terribly flawed function that is going on. 
It appears that the accountants for Enron, and I fear for many 
other companies, have put their allegiance to money over their 
ultimate allegiance owed to the creditors, the stockholders, 
and the investing public. It is time to look at other ways to 
hold accounting firms more accountable.
    As we have learned in the Enron case, document retention 
rules obviously need more scrutiny. Clearly, we need to 
consider prohibiting accounting firms from collecting 
consulting fees from the companies they audit. I would also 
like to suggest recent amendments to the securities laws be 
reviewed to ensure responsible parties, such as auditors and 
others, are not improperly shielded from liability. In 
particular, I think a review of the statute of limitations, 
stay of discovery, denial of aiding and abetting liability, and 
proportionate liability all are in order.
    Finally, Senator Leahy and members of the committee, I 
would suggest that the fundamental problem here has to do with 
simple corporate culture. It is a problem, I am afraid, as you 
suggest, that is far more pervasive than Enron and not 
something about which we can legislate.
    As Attorney General, when we take consumer protection or 
antitrust actions, we find that those companies who are 
defendants have discarded their business ethics and values and 
replaced them with a goal of making money at whatever cost. The 
new economy may demand new ways to do business, but values from 
the old economy still are vital. Directors have a fiduciary 
responsibility to investors. Auditors have a responsibility for 
independent audits that the public can trust, and corporate 
executives should put investors before their hunger for profits 
and stock options.
    Again, thank you, Senator Leahy and members of the 
committee, for the opportunity to testify before you today.
    Chairman Leahy. Thank you, General.
    [The prepared statement of Ms. Gregoire follows.]

Statement of Hon. Christine O. Gregoire, Attorney General of Washington 
                                 State

    Good morning. Thank you Senator Leahy and members of the committee 
for the opportunity to testify here today and your work on this 
important and troubling issue.
    As Washington's Attorney General I am working on several fronts to 
sort out the impacts on millions of state residents from the secretive, 
questionable, and potentially illegal business practices of Enron. 
Clearly it is a corporation with a troubled culture that cared little 
for its customers, employees and investors, and now we all are left to 
try and pick up the pieces and see what can be done to make sure this 
never happens again.
    In Washington we feel like Enron has been the gathering of the 
perfect storm. First they gouged our consumers and ratepayers with 
highly questionable power prices last summer, and now, sadly, they have 
defrauded our investors and others across the nation.
    Enron first came on our radar screen in June 2000, when the Western 
States began to experience a serious energy crisis. About one year ago 
I joined the attorneys general of California and Oregon in an 
investigation of whether the energy market was being manipulated.
    The price spikes, unplanned maintenance outages and transmission 
capacity restraints certainly were peculiar and warranted a closer 
look.
    Wholesale market rates for a megawatt-hour of electricity 
skyrocketed from $30 to $300 and even as high as $3,000. Was that the 
result of natural market forces, or was there manipulation?
    Over a year later, I wish I could tell you the answer. But while 
the companies, including Enron, keep insisting to you that they have 
nothing to hide, in fact they have refused to turn over documents 
necessary for us to determine once and for all what role they played in 
energy pricing.
    I can tell you that the price of some unregulated long-term energy 
contracts in the West dropped by as much as 30 percent when Enron 
declared bankruptcy in December. It may be just a coincidence, but 
until Enron begins cooperating with investigators, we won't know.
    So I applaud the efforts of Senators Cantwell and Wyden to push for 
a federal investigation.
    Currently I am also involved in a lawsuit against Enron on behalf 
of our state pension fund. At least 31 public pension funds across the 
nation have lost an estimated $1.5 billion on Enron investments. These 
are losses to our funds for the retirement obligations made to millions 
of police officers, firefighters, teachers and other public servants 
around this nation.
    I have joined attorneys general from Ohio and Georgia in seeking 
lead plaintiff status in the class action lawsuits filed on behalf of 
investors against Enron, its executives and Arthur Andersen. There are 
1.3 million employees and retirees covered by our three systems.
    Our suit contends Enron and others violated the Securities and 
Exchange Act by improper accounting, disclosure of false and misleading 
information, and some outrageous examples of insider trading.
    We have alleged that Enron used off-shore tax havens to hide its 
debt burden from investors and that it misstated its financial position 
and investors' equity in the company repeatedly.
    As a state Attorney General, I warn consumers about avoiding shady 
get-rich-quick schemes and I urge them to check a company out carefully 
before handing over money.
    In Enron's case, investors followed the rules. They listened to 
Wall Street. They relied on audits and published financial reports. 
They assumed there was adequate government regulatory oversight. And 
they assumed the seventh largest company in America was playing by the 
rules. In the end they found themselves ripped off just like the naive 
person who lost money in a pyramid scheme.
    Now investors find themselves having to sue with questionable 
financial restitution, little or no accountability by the accountants, 
and an insurance policy likely to be denied because of fraud by the 
directors.
    Enron's ability to operate in secrecy, with soft or limited 
regulatory review, and with apparently no independent audit oversight 
are the common factors behind our lawsuit and the energy price 
manipulation probe.
    I know Congress is discussing a number of lessons learned from the 
implosion of Enron and what we can do to avoid future problems. I have 
a few thoughts.
    First, the SEC must have quality staff and necessary resources to 
investigate and take enforcement action.
    But before we try to rely on government and government regulation 
for the solution, it seems we first should focus on the terribly flawed 
audit function.
    It appears the accountants for Enron, and I fear many other 
companies, have put their allegiance to money over their ultimate 
allegiance owed to creditors, stockholders and the investing public. 
The auditing role is not a business partner but an independent force in 
the market place that lets investors make decisions based on accurate 
financial information.
    The United States Supreme Court recognized this in a 1984 opinion 
in which it referred to the role of the accountant. "This 'public 
watchdog' function demands that the accountant maintain total 
independence from the client at all times and requires complete 
fidelity to the public trust."
    Something obviously went dreadfully wrong with this independent 
role with a duty to the public and I think we need to hold the 
accounting industry accountable.
    Approximately 67 percent of the class action litigation against 
publicly-traded companies today allege accounting fraud as a basis of 
liability.
    As Attorney General in case after case of Medicaid Fraud, we file 
against providers who claim they have simply followed accounting 
schemes approved by their accountants.
    The problem is, when the providers are found guilty of fraud, the 
accountants walk away. I don't think it is too strong to suggest that 
in many cases, the accounting firms are facilitating the commission of 
a white collar crime, but they aren't held accountable.
    For that reason I support the discussions I have heard to provide 
more accountability by accounting firms, and to end the peer review 
process which has resulted in negligible censure or discipline.
    And as an elected Attorney General, who is not beholden to my state 
agency clients and can give them independent legal advice, I strongly 
support proposals to prohibit accounting firms from collecting 
consulting fees from clients they are auditing.
    It is time to look at other ways to hold accounting firms more 
accountable. I don't have specific answers today, but I think there are 
some fertile areas to look at - particularly those areas where the 
industry has built up a shield from accountability.
    As we have learned in the Enron case, document retention rules 
obviously need more scrutiny.
    I would also suggest recent amendments to the Securities laws be 
reviewed to ensure responsible parties, such as auditors and others, 
are not improperly shielded from liability. In particular, I think a 
review of the statute of limitations and proportionate liability are in 
order.
    Finally, Senator Leahy and members of the committee, I would 
suggest the real problem here has to do with corporate culture. It is a 
problem, I am afraid, that is far more pervasive than Enron and is not 
something you legislate.
    As Attorney General, whenever we take Consumer Protection or 
Antitrust actions we find the company has discarded its business ethics 
and values and replaced them with a goal of making money whatever the 
cost.
    The new economy may demand new ways to do business. But values from 
the old economy still are vital. Directors have a fiduciary 
responsibility to investors. Auditors have a responsibility for 
independent audits that the public can trust. And corporate executives 
should put investors before their hunger for profits and stock options.
    Thank you for the opportunity to testify today.

    Chairman Leahy. Mr. Raynor?

 STATEMENT OF BRUCE RAYNOR, PRESIDENT, UNION OF NEEDLETRADES, 
 INDUSTRIAL, AND TEXTILE EMPLOYEES, AFL-CIO, NEW YORK, NEW YORK

    Mr. Raynor. Thank you, Mr. Chairman. I appreciate the 
opportunity to testify before this distinguished committee that 
includes my Senator, the Senator from New York, Senator 
Schumer.
    I am the President of UNITE, which is the 250,000-member 
union of garment, laundry, and textile workers. We also own the 
Amalgamated Bank of New York, which is a bank that is the only 
labor-owned bank in America that invests the pension funds, 
some $6 billion of pension fund money and custodians for $23 
billion, of workers' pensions. That is the retirement of 
hospital workers and teachers and janitors and textile workers 
and garment workers. The workers whose money we invest do not 
earn enough to save very much. Their entire future depends upon 
their pensions and we are outraged by what has happened in the 
Enron situation that has stolen their money and we implore you 
and ask you to help us do something about it.
    This is not the first time in my years as a labor union 
organizer that I have seen pension issues such as this. 
Unfortunately, it is not the first time. Fifteen years ago, we 
sued Cannon Mills in North Carolina when the owner of that 
company took the assets of the pension fund to make a corporate 
transaction and left those workers with $40-a-month pensions 
after working 35 years in a textile mill in North Carolina, 
which today they are drawing and cannot possibly live on.
    The Enron case, in our opinion, represents not simply a 
single horrible example of abuse but something that is 
systemic. Kenny Lay, who has become a national figure in our 
society these days--some of his close personal friends call him 
``Kenny Boy''--Kenny Lay said in 1997 that Enron intends to be 
the people's cops--I am quoting--``to blow the whistle on 
monopolies and to challenge legislators and regulators to get 
the job done, done right and done now.'' Kenny Lay was not the 
people's cop. Kenny Lay was the people's crook.
    The fact is that I wish Enron was an isolated example. We 
have seen over the years the rise in accounting fraud, 400 
instances of corporate accounting fraud that has cost 
retirees--this is not investors' pension fund money, this is 
the pension fund money of retired workers who work hard for a 
living--$31 billion in accounting fraud.
    Now, we have got Harvey Pitt, the Chairman of the SEC, a 
former Arthur Andersen lawyer, gives us a great deal of 
confidence that someone is watching what is going on here. And 
then we have the prospect that the administration has nominated 
two Big Five accounting representatives to round out the 
majority of the SEC. We implore the Senate and the committee to 
not let that happen. The American people, retired workers, need 
an SEC that will enforce the law and will not allow these 
corporate criminals to steal people's money, particularly 
workers in pension funds.
    Institutional investors are particularly vulnerable to 
accounting fraud because we invest our money largely in index 
funds. When you are a large institutional investor, it is the 
least expensive and safest way to invest money. We rely upon 
the market forces, which rely upon accurate information 
certified by auditors that the market can analyze and price 
securities at. Our pension funds, as most big public pension 
funds and all the union funds, invest in index funds. Index 
funds are the most vulnerable to accounting fraud and lack of 
information and something must be done about that.
    Our bank and our pension funds have been active 
institutional investors, trying to regulate corporate 
governance. We file resolutions aimed at corporations, and one 
of the practices that has become rampant is the ignoring of 
majority shareholder votes. Great Lakes Chemical has had five 
majority shareholder votes and ignored every single one of 
them. Management has a majority of the shareholders vote 
against a certain policy or for one and they choose to ignore 
it. Can you imagine what would happen in our country if a 
majority voted for a candidate for the U.S. Senate and that 
person was not put in office? It is absolutely amazing to me.
    The reform legislation a few years ago that Congress passed 
accomplished some good things. The reform legislation took 
lawyers away from controlling securities litigation and gave it 
to the plaintiffs, to the pension funds, to the retired workers 
who deserve to control it. But it also provided protections for 
executives, provided protections for companies that need to be 
changed.
    One of the items in that so-called reform legislation that 
needs to be looked at very carefully is the standard we use. 
The standard is intentionality. That is like making public 
prosecutors of our litigation. We cannot possibly be charged 
with the responsibility to uncover evidence to find out that 
someone intentionally defrauded us. Recklessness should be a 
standard. If you are reckless with retirees' money, then that 
ought to make you liable.
    Retirees also should be able to collect from any pocket 
they can find. There is joint and several liability that was 
part of that law that needs to be looked at very, very 
carefully. When someone defrauds retired workers who work hard 
all their lives, they ought to be able to go to any pocket that 
they can to get their money back, or at least a portion of 
their money back.
    And then there needs to be some effective regulation of the 
accounting industry, and then we also have to stop the Enron-
style so-called independent directors. Those are directors that 
depend upon the company, that do business with the company, 
that rely upon the company to earn a living and they cannot 
possibly be independent directors. The AFL-CIO and the Council 
of Institutional Investors has filed many motions against 
requiring companies--asking companies to have only real 
independent directors on auditing committees.
    Let me conclude by saying this, that we believe that this 
is not an isolated example but a part of the abuse of corporate 
power in our society. Retirees and workers need, deserve, and 
are ready to fight for some kind of control to protect 
ourselves from this and we ask the Senate to join us in that.
    Chairman Leahy. Thank you, Mr. Raynor.
    [The prepared statement of Mr. Raynor follows.]

Statement of Bruce Raynor, President, Union of Needletrades, Industrial 
                         and Textile Employees

    My name is Bruce Raynor. I am President of the Union of 
Needletrades, Industrial and Textile Employees, (UNITE). I am also a 
Vice President of the American Federation of Labor and Congress of 
Industrial Organizations (``AFL-CIO''), the Vice Chair of the 
Amalgamated Bank and a Co-Chair of the Council of Institutional 
Investors. My testimony today is given on behalf of the AFL-CIO, UNITE, 
and the Amalgamated Bank.
    UNITE represents over 250,000 workers in the apparel, textile, 
laundry, distribution and other manufacturing industries across the 
United States. UNITE members participate in over 35 multi-employer 
retirement and other benefit plans with total assets of over $4 
billion. The AFL-CIO's member unions represent 13 million American 
workers and sponsor pension plans with over $400 billion in assets. 
Amalgamated Bank acts as a financial advisor and custodian to defined 
benefit retirement plans. Amalgamated has over $6 billion under 
management in its LongView Collective Investment Trust Fund (``LongView 
Funds'') and over $23 billion in custodial accounts, which collectively 
represent a portion of the retirement savings of hundreds of thousands 
of electricians, operating engineers, hotel employees, service 
employees and public employees as well as textile and garment workers. 
I appreciate the opportunity to appear this morning before this 
committee.
    Over the past 30 years, as a labor organizer, elected labor leader, 
Bank official, and investor activist, I have witnessed first hand, at 
the bargaining table and from the picket line, the ongoing efforts of 
corporate leaders to bend the rules, hide the facts, and take whatever 
steps necessary to mislead investors and deny their workers a fair 
share of a company's gains. And far too often, these actions impact not 
only the wages and working conditions of active workers, but also the 
equally significant pension funds of retirees who have given a life's 
service to the very company that cuts them off. Ten years ago, I stood 
and fought alongside retirees from the Fieldcrest-Cannon textile mills, 
workers who had put 40 years into mills that filled their lungs with 
cotton dust and their wallets with meager paychecks. Those retirees had 
seen their monthly pension checks dwindle to $40 a month, because $39 
million from their pension funds had been given to a former owner of 
their mill as part of the mill's sale just four years before. And just 
as we've seen in the Enron case, that deal was done by insiders, hidden 
in the cost of a sale, for the single benefit of one corporate leader, 
as if it were a minor footnote. For those retirees in 1991, like so 
many retirees and former workers at Enron, losing one's pension defined 
their ability to survive at a time in life when they deserved to retire 
with dignity.
    This fight, like the one we were able to win in Kannapolis NC, is 
about workers who pay taxes, help build their communities, and deserve 
the right to trust an economic investment system that they want to 
support as they seek a stable retirement. And just as then, we hear the 
same basic refrain on factory floors, Athere ought to be a law against 
that kind of behavior.@ I hope my testimony today will provide this 
committee with basic ways that you can act to restore confidence in the 
public arena and the economic markets.
                     Worker Funds' Efforts at Enron
    On November 2, 2001, the Amalgamated Bank and the AFL-CIO wrote to 
Ken Lay and Dean Powers and to outside director in response to the 
initial revelations of insider transactions and false accounting 
statements. I should note the Amalgamated's Longview index funds held 
over $15 million in Enron's securities on behalf of our clients. We 
asked that Enron reform its board, riddled with conflicts of interest, 
some disclosed and some undisclosed. Receiving no answer, we wrote 
again on November 9, 2001, after the announcement of the Dynergy 
transaction, asking that persons of high integrity and reputation, with 
no prior connection to Enron, be asked to join the Enron board. We also 
asked that the company immediately disclose all the details of its 
financial situation in order to restore the capital market's ability to 
price Enron's securities and reduce the mounting uncertainty among 
investors.
    We received a perfunctory acknowledgement from a corporate staffer. 
It is quite possible that had Enron taken early on the steps we urged, 
much of the panic that occurred both among its investors and its 
customers would have been avoided and a more orderly and less 
destructive adjustment to the true state of Enron's finances might have 
been achieved. But as we all know, they did not, and Enron filed for 
bankruptcy on December 2, 2001.
    At that point, the Amalgamated Bank chose to litigate to try and 
recover some of our worker beneficiaries' money. On December 5, 2001, 
acting on behalf of the Long View Funds, Amalgamated Bank brought a 
class action lawsuit suit against Kenneth Lay, Enron's Board Chairman, 
and other high ranking Enron officials for insider trading, breach of 
their disclosure duties to their shareholders and other wholesale 
violations of the nation's securities law. We also sued Arthur 
Andersen. We are seeking recovery of billions of dollars in damages and 
the freezing of more than $1 billion in proceeds from insider trading.
    Unfortunately, the Enron debacle is no aberration. It is only the 
most recent and, perhaps, worst case in a series of securities frauds 
and self dealing acts by corporate executives centered around a 
corrupted relationship between corporate executives, their boards, 
attorneys, and public auditors. Absent systematic legal and regulatory 
reform, the Enrons of the future are a certainty.
                        Rise of Accounting Fraud
    Waste Management, RiteAid, Sunbeam Corporation, McKesson, Cendant, 
and, most recently, Enron--these large cap companies are included in 
many major indices and, as a result, are among the core holdings of 
public employee and union pension funds. These are also just a few of 
the companies that in the past few years have admitted to filing false 
financial statements with the SEC and have, as a result, restated 
billions of dollars in previously-reported earnings. More than 400 
other publicly-traded companies in the past several years have admitted 
to reporting inflated earnings statements. The resulting drop in share 
prices has caused over $31 billion of dollars in losses to investors, 
foremost of whom are workers' pension funds like UNITE's funds and the 
Amalgamated Bank's clients--funds that are responsible for investing 
and safeguarding the retirement savings of millions of working men and 
women in this country. A headline in USA Today (June 22, 2001) 
described accurately what is happening: ``Fuzzy Accounting Raises 
Flags--Crafty Accounting Can Steer Investors Wrong,'' That's why as a 
benefit plan trustee and fiduciary, I found it astounding to read the 
quote in Barron's magazine attributed to SEC Chairman Harvey Pitt that 
``there is nothing rotten with the accounting profession.'' The 
evidence suggests otherwise.
    The big five audit firms have been engaged in a race to the bottom 
in financial reporting which has undermined a core element of our 
capital markets-- the integrity of public company financial reporting. 
Accurate financial statements are essential to informed investor 
decisions, confidence in our markets, and the allocation of capital to 
credible businesses that create long-term economic job growth and 
positive investor returns. The collapse of Enron dramatically 
demonstrates the systematic failures in these vital controls that are 
intended to ensure transparency and fairness in business.
    Over 9,000 new public companies were created by the IPO boom of the 
1980s-1990s-- more than half of all existing public companies today. 
Many of these new public companies were smaller high-growth high-tech 
or bio-tech companies where the pressure to show earnings growth is 
intense. Others were Dot-Com enterprises which have no earnings and 
were under pressure to show revenue increases-- or create apparent 
profits by using so-called ``pro forma'' accounting to generate 
financial results which Generally Accepted Accounting Principles (GAAP) 
would never sanction.
    An article in the Journal of Business (Francois Degeorge, Jayendu 
Patel, Richard Zeckhauser, Earnings Management to Exceed Thresholds, 
Journal of Business, 1999, Vol 72, no 1.) concluded: ``executives have 
both the incentive and ability to manage earnings.'' Manipulation was 
most frequently present when needed to meet bright line tests, i.e. 
earnings estimates, and occurred most often in the fourth quarter just 
when the supposedly independent auditors are arriving on the scene for 
the annual audit. What does this conclusion suggest about the 
effectiveness of annual audits by so called independent accountants? 
Another study concludes ``we have no doubt that short term earnings are 
being manipulated in many, if not all, companies.'' (W. Bruns and K. 
Merchant The Dangerous Morality of Managing Earnings. Management 
Accounting. 72. 1996)
    Worth Magazine ran a story, ``Taking the Lies Out of Earnings,'' 
which concluded, ``earnings are becoming an increasingly less reliable 
tool for investors, as changes in executive compensation and accounting 
practices give corporate officials both a reason to bend the rules and 
greater leeway in doing so.'' (February 1997 issue)
    According to Richard Walker-- the former SEC enforcement chief who 
resigned earlier this year--``If we had nothing else to do, the 
accounting investigations alone would keep us busy for the next five or 
10 years.'' (``SEC List of Accounting-Fraud Probes Grows, Stretching 
Agency's Resources,'' The Wall Street Journal, July 6, 2001.) In short, 
Enron was a disaster waiting to happen.
                           Auditor Conflicts
    At the center of the erosion in accounting practices are the 
conflicts of interest created when ``independent'' auditors are also 
providing consulting services to their audit clients. We have seen that 
at Enron, according to the Powers Committee report, Arthur Andersen was 
actually structuring, as a consultant, the partnerships whose 
accounting treatment it was then approving as the independent auditor--
in effect auditing itself. Andersen then flatly denied it had done this 
in appearances before the Senate Commerce Committee and the House 
Financial Services Committee.
    As a result of new regulations fought for by the SEC under former 
Chairman Arthur Levitt, with the support of the Council of 
Institutional Investors and the AFL-CIO and against fierce opposition 
from the accounting industry and the Congress, this year companies were 
forced to disclose previously secret information about their audit 
firms' consulting work. We now are learning how much companies pay 
their supposedly independent auditors for consulting services as 
compared to fees for ``independent'' audit work. The SEC had guessed 
consulting fees would run 25%-40% more than audit fees.
    In fact, of total corporate payments to auditors only about 27 
cents of every dollar is for audit work-- the rest is for consulting 
services. (``Auditors Exposed! Cozy Deals Alleged! How 'Independent' 
Are These Book Checkers?'' U.S. News & World Report, July 23, 2001.)
    There can be no question these huge consulting fees have undermined 
the independence of the big accounting firms. According to The Wall 
Street Journal, ``Study Faults Work of Auditors Who Consult'' (August 
1, 2001):
    Auditing firms are more likely to compromise and stretch the bounds 
of accepted accounting practices when they are receiving substantial 
consulting fees from the firms they audit, according to an academic 
study. . . .The study-- by professors at Massachusetts Institute of 
Technology, Michigan State University and Stanford University-- is one 
of the first to pore through financial filings to answer empirically 
one of the key questions facing the accounting industry: How objective 
can an accounting firm be in an audit when it is also making millions 
of dollars providing the same client with other services?. . . ``Our 
study suggests that paying an accounting firm more for nonaudit 
services impairs auditor independence and reduces the quality of 
earnings,'' said Karen Nelson, a co-author and accounting professor at 
Stanford.
    We also need to recognize the obstacles preventing the SEC-- the 
supposed ``cop on the beat''-- from doing its job. The resources of the 
SEC have long been outstripped by our surging markets. When Arthur 
Levitt tried to take on the accounting industry, Congress opposed him. 
Now the SEC is headed by a lawyer who used to represent Arthur Andersen 
and the other big accounting firms who fought to continue to conceal 
the billions in consulting fees they were pocketing from their 
corporate clients while certifying billions in phony profits. The White 
House has indicated it intends to fill two further seats on the SEC 
with Big Five audit firm partners--essentially giving the Big Five 
control of the Commission.
    Pressure to Manipulate Earnings Driven by Runaway Executive 
PayWhile the protections against accounting fraud have been weakened, 
the incentive on the part of executives to commit accounting fraud has 
been greatly increased by the phenomenon of runaway executive 
compensation. The AFL-CIO has been calling attention to this scandal 
since 1997 at its website www.paywatch.org. The explosion in executive 
pay was fueled by FASB's refusal, again under Congressional pressure in 
the mid-1990's, to require companies to account for the economic 
reality of executive option grants in their financial statements. These 
huge grants then became an overwhelming incentive for executives to 
pump up stock prices--even when their companies' real performance was 
less than stellar.
    According to a recent Watson Wyatt study (AStock Option Over-hang; 
Shareholder Boon, Shareholder Burden?@ 2001 study), an important cause 
of the recent devastation of tech stocks is the ill effects of enormous 
stock-option grants over the past several years. Stock options became 
an addiction of pandemic proportions in the 1990s. Companies liked them 
because they did not have to be counted as an expense and made earnings 
look better than they really were. Executives liked them because they 
provided easy riches as the greatest bull market of all time pushed 
stocks higher and higher, regardless of individual corporate 
performance. But this had hidden costs. It overstated real corporate 
earnings by billions of dollars during the past decade. And the more 
options there were, the less valuable the underlying stock became, 
creating real dilution that lowered actual earnings per share even 
more.
    The Watson Wyatt study documents that even before the recent 
Nasdaq/NYSE collapse, companies giving the biggest option grants 
produced lower total returns to shareholders and higher stock 
volatility. The study, which examined option grants and stock price 
moves at 850 of the nation's largest companies, concluded that the 
heavy use of stock options had motivated executives to pursue riskier 
business strategies, like adding debt and making high-priced stock buy-
backs. These strategies reflected the difference between an option 
holder, which has an upside but not a downside, and a stockholder, who 
paid real money for the stock and for whom the downside is very real..
    Companies with a high percentage of outstanding options also suffer 
from option overhang. In 1998 and 1999, companies with the highest 
growth in option overhang produced much lower returns to shareholders. 
Now, the bill for all these options is coming due. The study concludes 
companies should encourage outright stock ownership instead of options. 
Companies that do so show higher returns to shareholders. As it becomes 
clearer that options exacerbated corporate stock declines, perhaps 
executives at companies with option excesses will be forced to rethink 
their strategy. But it is doubtful. Executives know that stock options 
mean having their cake and eating it too; but now comes the 
indigestion-- unfortunately it's for their shareholders, not them.
    And, it is even worse. We not only have executives getting 
compliant boards to re-price their options lower when the stock 
declines, but to keep doing it, literally chasing the stock price 
downward to continue to protect the insiders from either the vagaries 
of the market or their own mistakes. Amazon.com fell from over $120, 
re-priced at $23 and then again at $13. Clarent re-priced at over $50, 
then $26, and now $13. Excessive stock option grants and abusive re-
pricing actions are clear examples of ignoring the interests of the 
true owners of corporations and of the need for better corporate 
governance procedures to make executives more accountable to the true 
owners of the enterprise.
         Institutional Investors Vulnerable to Accounting Fraud
    Now let me take a moment to explain why institutional investors are 
particularly vulnerable to accounting fraud. Large institutions with 
billions of dollars invested in the equity markets typically invest 
most of their assets in index funds. Index funds buy the entire market 
and hold each company's stock in proportion to its market 
capitalization. Index funds rely on the market to accurately price the 
securities in which they invest--and their track record of beating the 
average active manager is testimony to the depth of the liquidity of 
our markets and the effectiveness of our system of market regulation. 
Index funds are also by far the cheapest way to prudently invest in the 
equity markets. But index funds are also the perfect victim of 
accounting fraud--if corporate numbers are fraudulent, the markets will 
price stocks too high, and index funds cannot help but be the victims. 
That is why the Longview Funds have always seen good corporate 
governance, strong securities regulation and independent auditors, 
backed up by activist institutional investors ready to sue when 
victimized, as key to our money management strategy.
    For the past ten years, Amalgamated Bank has joined other 
institutional investors in seeking to persuade corporate America to 
adopt a wide variety of governance improvements-- smaller annually-
elected boards dominated by independent directors; appointment of only 
independent directors to audit, nominating and compensation committees; 
and, now that there is disclosure of fees paid to auditors, the hiring 
of auditors unencumbered by conflicts of interest. However, even facing 
scrutiny from institutional investors, corporations have ignored 
shareholder resolutions that passed with overwhelming votes. We cannot 
protect our interests effectively in corporate annual meetings or in 
our courts when the laws and the regulators are allowing the companies 
in which we invest and the auditors who are supposed to be protecting 
us to steal from us with impunity.
          Liability Limits in PSLRA Encourage Accounting Fraud
    When I talk about laws that protect the misconduct we saw at Enron, 
I am thinking particularly of the 1995 amendments to the federal 
securities laws, the Private Securities Litigation Reform Act@ 
(``PSLRA''). While parts of this legislation had positive consequences, 
such as the lead plaintiff provisions that took control of litigation 
from the lawyers and gave it to the investors, the bulk of this 
legislation imposed a series of often impossible hurdles for investors 
seeking to hold corporate executives and accountants liable for 
securities fraud. To put it bluntly, congress opened the door and Enron 
and its ilk drove right on through. The PSLRA was enacted on December 
22, 1995, when the Senate overrode a veto by one vote.
    Testimony by consumer and investor groups warned that the proposed 
drastic cutback on investor protections against and remedies for 
securities fraud would reduce corporate executives' and securities 
professionals' accountability for misconduct. This, in turn, would 
result in an increase in securities fraud and investor losses and 
impair investor confidence, thus harming capital formation and our 
nation's economy. Not only was the PSLRA opposed by Arthur Levitt's SEC 
and vetoed by President Clinton, but virtually every major consumer, 
labor and investor group in America and the vast majority of America's 
newspapers editorialized against the PSLRA. They all warned that it 
would grant those best positioned to profit from stock price inflation 
a license to lie and result in a massive upsurge of fraudulent conduct 
and investor losses. Those predictions have now come true with a 
vengeance.
  The Worker-Investor Reform Agenda: Securities Law, Bankruptcy Law, 
                              Pension Law
    Now Enron has exposed to widespread public attention a whole series 
of conflicts of interest and inadequate regulation affecting our 
capital markets and our retirement savings system--problems that the 
labor movement and institutional investors have been warning about for 
years. But with the exception of a few brave public spirited 
individuals like Arthur Levitt, few here in Washington heeded these 
warnings. But now is the time to act on a range of issues. I will begin 
with where this Committee has clearest jurisdiction. Congress needs to:
    (1) Restore meaningful access to the courts for investors 
victimized by accounting fraud. We need to restore the right of 
investors to sue accountants and lawyers for aiding and abetting their 
clients' securities fraud. Every major securities fraud case since the 
passage of the Private Securities Litigation Reform Act has had 
significant involvement on the part of auditors and attorneys, but the 
victims of their actions cannot sue them for their role in it. We also 
need to restore access to victims of Enron like conspiracies to claims 
under civil RICO. Nothing looks more like a racketeering conspiracy 
than the events involving Enron, Andersen, their law firms and their 
political allies, yet the PSLRA immunizes these racketeers against RICO 
liability. Congress also needs to establish one clear and fair standard 
nationally for liability for securities fraud, and that standard should 
be recklessness. The intentionality requirement some federal courts 
have inferred is in the PSLRA effectively makes it impossible for 
investors to recover in most securities fraud cases. It requires 
private litigants to essentially find an informant--a task more suited 
to a criminal investigation by the government. Finally, the PSLRA 
repealed joint and several liability, which has a particularly harmful 
impact in the most serious cases like Enron where the company itself, 
as a result of its conduct, is bankrupt. Joint and several liability 
should be restored.
    (2) Reform the bankruptcy laws so that rich miscreants in Texas and 
Florida can't sit in their million dollar homes while their victims 
across town get thrown out of their apartments--as is literally 
happening in Houston today. In this regard the bankruptcy bill this 
Congress passed last year is a shocking travesty--it would punish the 
victims of Enron who have to file for personal bankruptcy while 
legitimizing the very transactions Enron used to hide its liabilities. 
(Prof. Elizabeth Warren and 34 Bankruptcy Law Professors letter to 
Chairmen Leahy and Sensenbrenner, January 23rd, 2002) It should die 
where it is now in conference.
    (3) Put into place an effective public regulatory organization over 
the accounting industry and end the practice of so-called 
``independent'' auditors collecting millions of dollars of non-audit 
fees from companies they are auditing. The AFL-CIO has petitioned the 
SEC to enact further rules ensuring auditor independence, but in light 
of the lack of responsiveness and the conflicts of interest potentially 
affecting a majority of the Commission on this issue, we believe 
Congress must act either by mandating rulemaking or by enacting a ban 
on consulting by audit firms into law.
    (4) Ensure corporate directors are really independent of the CEO's 
they are supposed to be overseeing by ending the practice of having 
Enron-style independent directors who were really financially and 
politically dependent on Enron executives. The AFL-CIO and the Council 
of Institutional Investors have both petitioned the SEC to enact rules 
that would have this effect, but there has been no response from the 
Commission and we frankly believe that Congressional action is needed 
either to mandate rulemaking or to enact the principles of independence 
into law.
    (5) Reform the accounting treatment of stock options given to 
corporate insiders and put meaningful restrictions on how those options 
may be exercised and sold so that we won't see again executives who are 
running a company into the ground simultaneously taking a billion 
dollars out of the company by exercising options.
    (6) Reform 401(k)-type retirement savings plans to prevent 
employers from pushing employer stock into worker retirement accounts--
a practice which is great for employers because it is cash-free but 
terrible for workers whose retirement savings are bet entirely on one 
company. In this regard President Bush's proposals are completely 
inadequate to this problem, and in fact would put employees' retirement 
savings further at risk by repealing ERISA's current ban on conflicted 
investment advice by 401-k money managers trying to promote high fee 
and high risk investment options.
           Conclusion: People Are Hurting--Congress Must Act
    The corruption of our securities markets which Enron symbolizes has 
hurt a lot of people. While it is too early to tell how long or severe 
the current recession will be, no one can deny that significant 
economic harm has occurred due to collapse of our securities markets. 
Financial and accounting scandals have plunged companies into crises 
leading to many bankruptcies. Investor losses have turned into a 
Areverse wealth effect.@ Massive layoffs abound. Capital formation has 
been impaired as burned investors shun the IPO market. New public 
offerings are sparse in today's environment..
    Baby boomers without defined benefit retirement plans are 
considering what to try to do next now that their 401(k)s have been 
hit. According to Business Week (``Retirement Gets Scary for Baby 
Boomers,'' July 30, 2001):
    Lulled by recent dreams of early and easy retirement, millions of 
Americans are suddenly facing the harsh truth that they will have a 
much harder time retiring.... Those with lots of high-tech company 
stock in their 401(k)s may be in the worst shape.... Stripped of the 
illusions fed by a booming stock market, retirement is shaping up to be 
a nightmare of cost and complexity.
    Or as an article in the New York Times puts it--``the inevitable 
bottom line of a 401(k) system--postponed retirement--is surfacing.'' 
(``Workers Find Retirement is Receding Toward 70,'' New York Times, 
February 3, 2002, Money and Business, p. 4.) The truth is what the 
labor movement has been saying for decades--401-k plans are a good 
supplement to a defined pension plan and Social Security, but a 
disastrous replacement.
    And then there are individuals like the many Enron 401-k 
participants who came to Washington last week--secretaries, vice-
presidents, electrical lineworkers--people in their 50's who gave a 
lifetime to their employer and were rewarded with layoff notices, 
bounced severance checks and empty retirement accounts. Surely these 
people should receive the ill-gotten gains of the insiders here.
    I will conclude by pointing out that the workers I represent are 
appalled by what happened at Enron. I wish I could say that they are 
shocked. But they are not. They are not shocked because what happened 
at Enron has exposed something that they know very well--the reality of 
excess corporate power in our society. That power manifests itself 
daily. It is demonstrated in the stimulus bill supported by the 
administration that provides a windfall for the wealthiest people in 
our society while giving workers almost nothing. That power was also 
behind a multi-billion dollar bailout of the airline industry, while, 
again, workers received almost nothing. The story of how millionaire 
executives used their wealth and political clout to rig the rules and 
free themselves from accountability, and then used that freedom to 
enrich themselves while workers, consumers, and small investors pay the 
consequences is becoming all to commonplace in our society.
    These then are the lessons of the last several years, only most 
dramatically demonstrated by Enron. It is now up to Congress to act, 
quickly and decisively to protect the American people's retirement 
income and prevent the Enron's of the future. The labor movement and 
institutional investor community stand ready to work with this 
Committee and this Congress to adopt true reform legislation. Thank you 
for considering our views.

    Chairman Leahy. Mr. Schatz?

 STATEMENT OF STEVEN M. SCHATZ, WILSON, SONSINI, GOODRICH AND 
     ROSATI PROFESSIONAL CORPORATION, PALO ALTO, CALIFORNIA

    Mr. Schatz. Thank you, Senator Leahy. Chairman Leahy and 
members of the Senate Judiciary Committee, it is an honor to 
appear before you today and offer my thoughts on possible 
responses to the Enron debacle. My knowledge of the specific 
details of what happened at Enron comes only from media 
accounts, but for purposes of today's discussion, I assume they 
are substantially accurate.
    As a former Federal prosecutor in the Southern District of 
New York, I am simply appalled by the rampant fraud that 
reportedly took place at Enron. As a member at Wilson, Sonsini, 
Goodrich and Rosati, which represents some of Silicon Valley's 
most innovative and successful companies, and someone who has 
personally represented technology companies ranging from multi-
billion-dollar enterprises to smaller but no less innovative 
companies, all of which depend on the country's capital and 
financial markets, I am deeply troubled by the Enron scandal's 
effects, those effects on the markets, investors, and 
employees.
    There can be no doubt that the perpetrators of this fraud 
must be punished, punished swiftly, and punished severely. In 
addition to punishing the culpable, I think we all agree that 
the Enron fraud and the fact that it continued undetected for 
so long and harmed so many people demands us to take a hard 
look at certain reforms to prevent such a reoccurrence.
    In crafting an adequate and well-reasoned response, 
however, we must not allow our anger at Enron's egregious and, 
I believe, aberrational conduct to have unintended negative 
consequences. Specifically, I am concerned that some of the 
recent proposals to revise provisions of the PSLRA may 
inadvertently and unfairly punish the many honest companies and 
employees that make our economy flourish.
    As you no doubt are aware, with broad and deep bipartisan 
support, Congress passed the Reform Act of 1995 to curb what it 
accurately perceived as substantial litigation abuses by the 
private plaintiffs' securities class action bar. As Senator 
Hatch previously indicated, prior to its passage, the 
announcement of disappointing quarterly results all too 
frequently led to a host of fraud by hindsight litigations. 
Indeed, some of the best companies in the valley had to endure 
such lawsuits.
    Three provisions of the Reform Act are particularly crucial 
to protecting companies and their employees from frivolous and 
abusive litigation. Those three are the safe harbor for 
forward-looking statements, the discovery stay, and the 
heightened pleading standard. None of these provisions 
facilitated Enron's accounting scandal and none will shield 
Enron from the consequences of its conduct. Let me consider 
each in turn.
    Roughly speaking, the Reform Act's safe harbor encourages 
companies to publicly disclose their predictions of future 
performance by insulating them from liability in the event that 
those predictions do not come true. This protection, in 
conjunction with Regulation FD, has allowed investors to 
benefit from increased information flow and to make more 
informed financial decisions. In order to limit potentially 
burdensome fishing expeditions, discovery in private securities 
class actions are stayed until plaintiffs survive a motion to 
dismiss, that is, until they establish that their complaint is 
not facially inadequate.
    At the same time, the Reform Act compels companies to 
preserve all relevant evidence while the case is pending and 
allows discovery when evidence is at risk. This expressed 
command not to destroy evidence is a strong protection for 
plaintiffs, and clearly, the Reform Act's pleading standard 
will not preclude the plaintiffs from proceeding in this case.
    In that regard, it is clear that what the pleading standard 
does do is it sets a barrier so that when meritless cases are 
filed, companies do not have to bear the expense of those 
lawsuits unless and until there has been a decision that the 
complaint is facially sufficient.
    The Reform Act did not cause the Enron scandal but it did 
help curtail the filing of lawsuits. But even with the Reform 
Act, this past year, 487 companies have been sued in private 
class action lawsuits, nearly double the next highest number of 
lawsuits.
    I would like to briefly comment on some of the proposed 
legislation. There is a proposed bill in the House that would 
allow plaintiffs to add legal claims to their securities class 
action complaints and thereby seeking treble damages. At first 
blush, it seems tempting to increase penalties for wrongdoers. 
However, cases such as Enron's already involve damages beyond 
any defendant's ability to pay, even absent the addition of 
RICO penalties. This proposal would do little to inflict 
additional pain on those that commit the fraud. Rather, it 
would allow plaintiffs' counsel to reflexively include a RICO 
claim and obtain unfair leverage and settlement negotiations in 
the typical case that they file.
    As Senator Hatch previously indicated----
    Chairman Leahy. Mr. Schatz, just to let you know, we have a 
vote coming up. If you could sum up, we will put your whole 
statement in the record.
    Mr. Schatz. Very well. I will just summarize it, Senator, 
that Chairman Levitt himself supported the exclusion of RICO.
    Senator Leahy, let me make just two other points if I 
could.
    Chairman Leahy. You are a good enough trial lawyer. I am 
sure you can make them in 15 seconds. Go ahead.
    Mr. Schatz. Your Honor----
    [Laughter.]
    Mr. Schatz. Senator Leahy, the current provision allows for 
joint and several liability for knowing misconduct and that is 
one of the virtues of the legislation, and again, I believe 
that the discovery stay here did not impede the prosecution of 
the case. It was the fact that individuals flaunted the 
provisions of the Reform Act.
    Chairman Leahy. Thank you.
    [The prepared statement of Mr. Schatz follows.]

  Statement of Steven M. Schatz, Esq., Wilson, Sonsini, Goodrich and 
         Rosati Professional Corporation, Palo Alto, California

    Chairman Leahy, Senator Hatch, and Members of the Senate Judiciary 
Committee:
    It is an honor to appear before you today and offer my thoughts on 
possible responses to the Enron debacle. As a former federal 
prosecutor, I urge you to bring swift and severe punishment to the 
wrong-doers who have apparently harmed so many innocent people. As an 
advisor to numerous honest companies that depend on the capital 
markets, however, I urge you to be sensitive to the indirect 
consequences your actions may have on those whom are frequently targets 
of frivolous litigation.
                            I. Introduction
    For four and a half years, I served as Assistant United States 
Attorney for the Southern District of New York in the Criminal 
Division. That experience has given me particular insight into the 
types of frauds that rapacious companies and rapacious individuals can 
and do perpetrate, and has impressed upon me the importance of harshly 
punishing those who would exploit their positions for personal gain at 
the expense of others. I applaud your efforts today to ensure that 
wrong-doers face appropriately severe consequences.
    Today, I am a senior member of the law firm of Wilson Sonsini 
Goodrich & Rosati, P.C., located in Silicon Valley and numbering over 
700 lawyers. We are proud to represent some of the most innovative, 
successful companies in the United States. Our clients include leaders 
in computers (Hewlett-Packard, Sun), semiconductors (Cypress, LSI 
Logic, Micron, VIA), disk drives (Seagate), electronics manufacturing 
(Solectron), software (Autodesk, Sybase), networking (3Com, Juniper, 
Broadcom), aviation (America West), and biotechnology (Genentech). We 
currently represent approximately 300 public companies. We also 
represent hundreds of start-ups that are working to become leaders of 
their industry sectors. Frankly, our clients depend on the availability 
of capital and the integrity of the financial markets, both of which 
the Enron scandal has jeopardized. I am heartened to know that you are 
considering measures to ameliorate these harms and protected against 
future abuses.
    As a litigator, I have devoted a significant portion of the last 
seventeen years of my life to defending securities class action, 
representing clients such as Hewlett-Packard, Informix, Convergent 
Technologies, InfoSpace, Unisys, Cirrus Logic, Critical Path, Splash, 
Ventana Medical Systems, Robertson Stephens & Co., Santa Cruz 
Operations, MicroAge, Pyramid Technology, STAC Electronics, Ventritex, 
Laserscope and Continental Savings. In defending more than sixty 
securities class actions over the past two decades, I have personally 
witnessed the explosive growth of frivolous litigation, the measures 
Congress has taken to curb abusive litigation tactics, and the salutary 
effects those measures have had.
    Others have detailed, and will detail, the specific conduct that 
allegedly gave rise to fraud at Enron, and I yield to their 
expertise.\1\ I think we all agree that the Enron fraud--and the fact 
that it continued undetected for so long and harmed so many people--
demands us to take a hard look at certain reforms. Simply put, we must 
prevent such a situation from ever recurring. In crafting an adequate 
and well-reasoned response, however, we must not allow our anger at 
Enron's egregious conduct to have unintended, negative consequences. 
Specifically, I am concerned that recent, and perhaps well-meaning, 
proposals to revise provisions of the Private Securities Litigation 
Reform Act \2\ may inadvertently and unfairly punish the many honest 
companies and employees that make our economy flourish.
---------------------------------------------------------------------------
    \1\ My knowledge of the specific details of what happened at Enron 
comes only from media accounts, but for purposes of today's discussion, 
I will assume that they are substantially accurate.
    \2\ H.R. Conf. Rep No. 104-369 (1965), reprinted in 1995 
U.S.C.C.A.N. 730 (``Conference Report'').
---------------------------------------------------------------------------
            II. The Private Securities Litigation Reform Act
    As you are no doubt aware, Congress passed the Reform Act in 1995 
to curb what it accurately perceived as substantial litigation abuses 
by the private plaintiffs securities class action bar. Congress took 
this action in response to ``significant evidence of abuse in private 
securities lawsuits,'' including, among other things, ``the routine 
filing of lawsuits against issuers of securities and others whenever 
there is a significant change in an issuer's stock price, without 
regard to any underlying culpability of the issuer, and with only faint 
hope that the discovery process might lead eventually to some plausible 
cause of action.'' \3\ These meritless cases diverted companies' 
attention from their core businesses and forced them either to spend 
millions in defense costs or millions on unwarranted settlements. 
Simply put, abusive litigation cost public companies--and hence the 
investing public--tremendous amounts of money each year.
---------------------------------------------------------------------------
    \3\ Conference Report at 31.
---------------------------------------------------------------------------
    Recognizing this serious problem, Congress adopted the Reform Act 
with broad bipartisan support. The Act contains numerous provisions, 
but three are particularly crucial to protecting companies and their 
employees from frivolous and abusive litigation. Those three are: the 
Safe Harbor for forward-looking statements, the discovery stay, and the 
heightened pleading standard. None of these provisions facilitated 
Enron's accounting scandal, and none will shield Enron from the 
consequences of its fraudulent conduct. Let me very briefly consider 
each in turn.
                             a. safe harbor
    The Reform Act's Safe Harbor encourages companies to publicly 
disclose their predictions of future performance by insulating them 
from liability in the event those predictions do not come true. 
Specifically, the Safe Harbor provides that ``[A defendant] shall not 
be liable with respect to any forward-looking statement, whether 
written or oral, if and to the extent that. . .the forward looking 
statement is. . .identified as a forward-looking statement, and is 
accompanied by meaningful cautionary statements identifying important 
factors that could cause actual results to differ materially from those 
in the forward-looking statement.'' \4\ The Safe Harbor also protects 
forecasts and projections of future results that are not accompanied by 
``meaningful cautionary statements'' by requiring plaintiffs to 
demonstrate that they were made with actual knowledge of falsity.\5\
---------------------------------------------------------------------------
    \4\ 15 U.S.C. Sec. 78u-5(c)(1)(A).
    \5\ Conference Report at 43-44.
---------------------------------------------------------------------------
    This protection, in conjunction with Regulation FD, has allowed 
investors to benefit from increased information flow and to make more 
informed financial decisions, by making companies less nervous about 
disclosing their necessarily uncertain hopes for the future. The Safe 
Harbor often serves as an effective tool for companies unfairly accused 
of fraud-by-hindsight. It does not, however, provide any protection for 
perpetrators of accounting frauds such as Enron's. Indeed, the Safe 
Harbor expressly does not apply to audited financial statements. In 
short, the Enron scandal and the Safe Harbor have nothing to do with 
each other.
                           b. discovery stay
    Congress enacted another core provision of the Reform Act, the 
discovery stay, in response to evidence that ``the abuse of the 
discovery process. . .impose[d] costs so burdensome that it is often 
economical for the victimized party to settle'' private securities 
class actions, regardless of guilt.\6\ In order to limit potentially 
unnecessary and burdensome fishing-expeditions, discovery in such cases 
is stayed until plaintiffs survive a motion to dismiss; that is, until 
they establish that their complaint is not facially inadequate.\7\ At 
the same time, the Reform Act compels companies to preserve all 
relevant evidence while the case is pending,\8\ and allows discovery 
when evidence is at risk.\9\
---------------------------------------------------------------------------
    \6\ Conference Report at 31.
    \7\ Id. at 37.
    \8\ Id.
    \9\ Id.
---------------------------------------------------------------------------
    The Reform Act's express command not to destroy evidence strongly 
protects plaintiffs. More importantly, in cases such as Enron's, in 
which the fraud seems clear and the likelihood of surviving a motion to 
dismiss seems almost certain, the Reform Act ultimately does nothing to 
prevent plaintiffs from getting the evidence they need.
                    c. heightened pleading standard
    Finally, the Reform Act provides a heightened pleading standard 
designed to weed out cases where plaintiffs lack a substantial basis 
for their fraud accusations.\10\ Specifically, it requires that every 
securities class action complaint ``shall specify each statement 
alleged to have been misleading, the reason or reasons why the 
statement is misleading, and, if an allegation regarding the statement 
or omission is made on information and belief, the complaint shall 
state with particularity all facts on which that belief is formed.'' 
\11\ It further requires plaintiffs to ``state with particularity facts 
giving rise to a strong inference'' of scienter.\12\ Given the extent 
of its fraud, Enron can hardly expect to benefit from this provision; 
undoubtedly there will be no issue with respect to the pleading 
standard in that case.
---------------------------------------------------------------------------
    \10\ It is worth noting that the Courts of Appeals have divided on 
the proper interpretation of this heightened pleading standard, compare 
Novak v. Kasaks 216 F.3d 300 (2d Cir. 2000) with  In re Silicon 
Graphics, Inc. Securities Litigation, 183 F.3d 970 (1999). The Ninth 
Circuit interpretation appears more consistent with Congressional 
intent, particularly in the light of the fact that certain amendments 
adopting other interpretations were rejected. See 141 Cong. Rec. S9170 
(daily ed. June 27, 1995). Should Congress decided to amend the Reform 
Act in response to recent events, it may with to take the opportunity 
to clarify and reaffirm that the Ninth Circuit's interpretation of the 
pleading standard is correct.
    \11\ 15 U.S.C. Sec. 78u-4(b)(1).
    \12\ 15 U.S.C. Sec. 78u-4(b)(2).
---------------------------------------------------------------------------
    The key Reform Act provisions did not cause the Enron scandal and 
will not allow Enron to escape punishment. They do, however, protect 
companies from frivolous lawsuits, onerous discovery and exposure to 
extortionary settlements. The concerns which motivated Congress to 
enact the Reform Act in 1995 and the Securities Litigation Uniform 
Standards Act in 1998 are equally valid today, as demonstrated by the 
fact that the number of private securities class actions filed each 
year continues to rise. The Reform Act remains of vital importance in 
defending honest companies against these often meritless suits.
                         III. Reform Proposals
    In evaluating proposals to modify the Reform Act, I urge you to be 
sensitive to potential spillover effects on frivolous cases. Reform is 
vital, but it is also imperative not to undermine key aspects of the 
Reform Act. In our zeal to respond to the Enron disaster, we must be 
careful to avoid creating new vehicles for frivolous litigation.
    For example, one proposed bill would allow plaintiffs to add RICO 
claims to their securities class action complaints, and thereby seek 
treble damages.\13\ At first blush, it may seem appealing to increase 
penalties for wrong-doers. In actual fact, however, cases such as 
Enron's already involve damages beyond any defendant's ability to pay, 
even absent the addition of RICO penalties. Thus, this proposal would 
do little to inflict additional pain on those who commit fraud.
---------------------------------------------------------------------------
    \13\ H.R. 3644, 107th Cong. (2d Sess. 2002).
---------------------------------------------------------------------------
    Rather, this provision would allow plaintiffs' counsel to 
reflexively include a RICO claim in every garden-variety securities 
class action complaint, providing additional--and typically 
unwarranted--leverage in settlement negotiations. By adopting this 
provision, Congress would simply increase the frequency with which 
``innocent parties are often forced to pay exorbitant 'settlements' '' 
\14\--precisely the sort of abuse this body sought to deter in 1995. 
Indeed, no less than then-SEC Chairman Arthur Levitt testified in favor 
of the RICO exclusion, recognizing that ``[b]ecause the securities laws 
generally provide adequate remedies for those injured by securities 
fraud, it is. . .unfair to expose defendants in securities cases to the 
threat of treble damages and other extraordinary remedies provided by 
RICO.'' \15\
---------------------------------------------------------------------------
    \14\ Conference Report at 32.
    \15\ Conference Report at 47.
---------------------------------------------------------------------------
    Similar proposals involve efforts to impose aider and abettor 
liability and/or joint and several liability for securities 
violations.\16\ In weighing these proposals, it bears mentioning that 
the Reform Act (in a section titled ``Reduction of Coercive Settlements 
'') already imposes joint and several liability--without exception--for 
knowingly violating the securities laws; in addition, the Act already 
specifies that if a defendant cannot pay its share of the damages due 
to insolvency, each of the other defendants must make an additional 
payment--up to 50% of their own liability--to make up the shortfall in 
plaintiff's recovery.\17\ The Reform Act provides for even broader 
contributions to make whole certain small investors. Also, in 
evaluating aiding and abetting liability proposals, it should be 
recognized that courts have taken a broad view of direct liability. 
Undue expansion of these doctrines could become a tool allowing 
plaintiffs to expose tangential defendants to enormous risk even in 
frivolous cases.
---------------------------------------------------------------------------
    \16\ H.R. 3617, 107th Cong. Sec. 3 (2d Sess. 2002).
    \17\ 15 U.S.C. Sec. 78u-4(f); Conference Report at 39.
---------------------------------------------------------------------------
    Effectively, expanding the scope of liability would give plaintiffs 
an undeserved bargaining chip with which to compel settlement of 
meritless cases. Congress recognized this risk in the enactment of the 
Reform Act, criticizing plaintiffs' ``targeting of deep pocket 
defendants. . .without regard to their actual culpability.'' \18\ These 
concerns remain equally pressing today, and should be fully considered 
in any reforms. In addition, keep in mind that the SEC is authorized to 
investigate and pursue civilly and/or administratively anyone who 
violates the federal securities laws, whether directly or as an aider 
and abettor, and, where appropriate, can refer the matter for criminal 
prosecution.
---------------------------------------------------------------------------
    \18\ Conference Report at 31.
---------------------------------------------------------------------------
    Another proposal would allow immediate discovery in cases where a 
company's accountant is named as a defendant.\19\ No doubt this was 
drafted to prevent Arthur Anderson-type document destruction abuses. 
Unfortunately, it would also allow plaintiffs to gut the Reform Act's 
discovery stay simply by naming company auditors in every lawsuit. 
(Moreover, as I explained before, the Reform Act itself prohibits the 
destruction of documents and provides severe penalties for violations.) 
Congress must carefully consider whether it wishes to punish every 
honest company with onerous and costly discovery obligations in 
response to Enron's extreme misconduct, particularly when early 
discovery will serve little purpose.
---------------------------------------------------------------------------
    \19\ H.R. 3617, 107th Cong. (2d Sess. 2002)
---------------------------------------------------------------------------
                            IV. Conclusions
    In addition to the proposals that have already been suggested, 
Congress has many other options. For example, Congress may wish to 
consider approaches that would require auditors to make affirmative and 
descriptive assertions about companies in their financial statements. 
In a recent speech, a former SEC Commissioner raised the possibility 
that auditors be required to supplement their audited financial 
statements with ``an opinion and report describing significant 
accounting treatments and judgments that comply with GAAP but that, if 
disclosed, would have a material effect on the valuation'' of the 
company.\20\ This sort of response suggests one possible remedy that 
should be explored and may be part of an overall approach to deter 
Enron-like abuses. Naturally, the various proposals offered in response 
to the Enron debacle will need to be carefully studied, and their 
advantages and disadvantages carefully weighed, before any decisions 
regarding the appropriate prophylactic actions and reforms are made.
---------------------------------------------------------------------------
    \20\ See Joseph A. Grundfest, Enron: Can We Craft an Efficient 
Disclosure-Based Policy Response?, Presentation to the Silicon Valley 
Chapter of The Federalist Society (Jan. 29, 2002). As proposed, this 
obligation would not expose auditors to private civil liability for 
non-compliance.
---------------------------------------------------------------------------
    Enron has hurt our financial markets, our economy, and millions of 
innocent investors. Reform is vital; we must act to prevent this from 
ever happening again. At the same time, we must make sure that our 
response does not do more harm than good, and thus must be sensitive to 
the collateral consequences that reforms may have for frivolous class 
actions. We should not let the extreme circumstances of the Enron 
matter cause us to forget the very real and tangible reasons for 
enacting the Reform Act.

    Chairman Leahy. Professor Lund?

   STATEMENT OF NELSON LUND, PROFESSOR OF LAW, GEORGE MASON 
         UNIVERSITY SCHOOL OF LAW, ARLINGTON, VIRGINIA

    Mr. Lund. Mr. Chairman, members of the committee, I am 
honored by your invitation to comment on the accountability 
issues that have arisen in connection with Enron's bankruptcy 
and its aftermath. These issues are obviously numerous and 
variegated. My testimony addresses questions of Congressional 
oversight and investigation that have suddenly attained renewed 
prominence. In particular, I will comment on the role of the 
GAO in obtaining information held by the executive branch. I 
have submitted detailed written testimony for the record, which 
I will very briefly summarize this morning.
    As you know, Congress and the executive have had a great 
many disputes with each other about Congressional access to 
information that the executive has preferred not to share. 
There was a significant dispute about this issue during the 
administration of President Washington and the tug of war has 
been going on ever since.
    Neither the Congressional right to conduct investigations 
nor the executive's right to resist disclosure of information 
to Congress is expressly granted by the Constitution. Given the 
implicit nature of both rights, it should not be surprising 
that Members of Congress have tended to have a somewhat 
different view of the constitutional allocation of power than 
Presidents and their lawyers have taken. Traditionally, these 
disputes have been settled through negotiation, compromise, and 
sometimes capitulation, but as far as I am aware, no court has 
ever issued a final judgment resolving such a dispute when the 
President has asserted his constitutional claims. That may be 
about to change.
    The Comptroller General has demanded that the Vice 
President disclose information about private meetings that he 
held while he was a member of the National Energy Policy 
Development Group, or NEPD Group, which was entrusted by the 
President with the task of developing recommendations for a new 
energy policy. After the Vice President resisted this request, 
the Comptroller General stopped pursuing it last September, but 
in the wake of the Enron controversy, he has announced that he 
plans to bring a lawsuit to compel the Vice President's 
compliance.
    I think this raises the question of whether the GAO's 
demand is authorized by the statute. It is possible, though not 
very easy, I think, to read the statute to authorize a GAO 
investigation of the NEPD Group's activities. But even assuming 
that the statute authorizes GAO to investigate the work of the 
NEPD Group, the statute clearly does not purport to authorize 
the GAO to use any and all means to conduct its investigations. 
Thus, the real question is whether the statute purports to 
require that the Vice President comply with GAO's demands for 
records about the nature of specific meetings, and I think that 
it does not.
    There is a general principle of statutory construction 
under which ambiguous statutes should be interpreted so as to 
avoid serious constitutional questions, and the constitutional 
questions raised by the GAO demand letter are very serious 
indeed. Beginning with George Washington, Presidents have 
consistently claimed that they may withhold some information 
from Congress and the Supreme Court has recognized that a right 
of executive privilege does exist. It is implicit in the 
Constitution.
    The most recent case law from the D.C. Circuit contains 
language that would appear to cover this case, although it 
arose in the somewhat different context of an independent 
counsel investigation. When one steps back from the case law, 
which in any event cannot provide a definitive resolution, the 
serious nature of the constitutional questions becomes even 
more apparent.
    In 1796 when the House of Representatives was debating its 
response to President Washington's refusal to provide the House 
with documents relating to the Jay Treaty, a Congressman, a 
Congressman named James Madison, argued that the House must 
have a right to ask for whatever information it saw fit. He 
also contended, however, that the President must have a 
correlative right to refuse the request if he saw fit. I think 
Madison's point was that the President could not be compelled 
to disclose information, just as the Congress could not be 
compelled to enact legislation without what it considered 
adequate information, and Madison subsequently did vote against 
an appropriation to implement the Jay Treaty.
    That has become the traditional way to resolve these 
disputes, with each party using its political leverage to 
bargain over the outcome. The resulting compromises have no 
doubt frequently left both sides dissatisfied, but neither side 
has ever had to concede a matter of principle to the other. 
Once the courts become involved, that may change.
    I believe that Madison did identify the constitutionally 
appropriate presumption. Applied to the present case, this 
suggests that Congress might refuse to enact President Bush's 
energy proposals if a majority of legislators believe that they 
first needed more information about the Vice President's work 
on the NEPD group. But that is not at all what is going on 
here. Instead, we have a situation where neither House of 
Congress or even a Congressional committee has demanded any 
documents from the Vice President, and the GAO's purpose in 
conducting the investigation is, so far as I have been able to 
ascertain, somewhat unclear.
    While I was thinking about these issues, I began to wonder 
what would happen if a staffer in the White House Office for 
Political Operations were to ask the FBI to investigate all 
meetings between Senators and private parties or even with 
their own staffs at which matters before the Congress were 
discussed or mentioned, such as energy or, for that matter, the 
regulation of the accounting profession. If the FBI then 
demanded the Senators provide documents and records like those 
that the GAO has sought from the Vice President, I imagine that 
quite a firestorm would ensue. The cases are not perfectly 
analogous, of course, but I think the hypothetical does suggest 
one reason why it might not make much sense for the Comptroller 
General to provoke a constitutional confrontation in this case.
    Elected officials in the legislative and executive branches 
have a long history of resolving their differences in the 
manner suggested by Congressman Madison without involving the 
courts. The lawsuit that the Comptroller General is threatening 
to bring will no doubt be very interesting to professors like 
me, but I am not sure it will serve the long-term institutional 
interests of Congress.
    Chairman Leahy. And I should also note, Professor, that I 
appreciate your defense of Vice President Cheney having a 
closed door hearing. We are not investigating the Vice 
President in this hearing.
    Mr. Lund. Yes, I understand that.
    Chairman Leahy. I just want to make sure we do not lead 
anybody astray here.
    Mr. Lund. Right. I understand that, Mr. Chairman. That 
concludes my presentation. I would be happy to answer any 
questions.
    Chairman Leahy. Thank you.
    [The prepared statement of Mr. Lund follows.]

  Statement of Nelson Lund, Professor of Law, George Mason University 
                             School of Law

    Mr. Chairman, Senator Hatch, Members of the Committee, I'm honored 
by your invitation to comment on the accountability issues that have 
arisen in connection with Enron's bankruptcy and its aftermath. These 
issues are obviously numerous and variegated. My testimony addresses 
questions of congressional oversight and investigation that have 
attained renewed prominence because of the Enron bankruptcy and the 
subsequent intense congressional interest in conducting its own 
investigations of this matter. In particular, I will comment today on 
the role of the GAO in disputes over access to information held by the 
Executive Branch.
    As you know, Congress and the Executive have had a great many 
disputes with each other about congressional access to information that 
the Executive has preferred not to share. There was a significant 
dispute about this issue during the administration of President 
Washington, and the tug of war has been going on ever since. Neither 
the congressional right to conduct investigations, nor the Executive's 
right to resist disclosure of information to Congress, is expressly 
granted by the Constitution. Given the implicit nature of both rights, 
it should not be surprising that Members of Congress have tended to 
have a somewhat different view of the constitutional allocation of 
power than Presidents and their lawyers have taken. Traditionally, 
these disputes have been settled through negotiation, compromise, and 
sometimes capitulation. But as far as I'm aware, no court has ever 
issued a final judgment resolving such a dispute when the President has 
asserted his constitutional claims. That may be about to change.
    The Comptroller General--acting in response to a request from 
Congressmen Dingell and Waxman--has demanded that the Vice President 
disclose information about private meetings that he held while he was a 
member of the National Energy Policy Development Group (``NEPD Group 
''), which was entrusted by the President with the task of developing 
recommendations for a new energy policy. The Comptroller General's 
demand letter was quite comprehensive, for it embraced all meetings in 
which the Vice President participated and it required a full account of 
every meeting, including ``any information presented'' as well as 
minutes or notes of the meeting. The Vice President responded that the 
GAO lacks statutory authority to enforce these demands, and argued that 
the demands would exceed Congress' constitutional authority even if the 
GAO was acting pursuant to statutory authorization. At one point, the 
Comptroller General appeared to withdraw his most intrusive inquiries, 
but he continued to seek a number of details about every meeting the 
Vice President and his support staff had, including the identity of 
everyone who attended every meeting, the agenda of the meeting, and the 
manner in which the Vice President or the staff decided who would be 
invited.
    The Comptroller General stopped pursuing his demands in September, 
but in the wake of the Enron controversy he has announced that he plans 
to bring a lawsuit to compel the Vice President's compliance.
    Is the GAO's demand authorized by the statute?
    Two sources of authorization have been suggested. First, the GAO's 
organic statute authorizes the Comptroller General to ``evaluate the 
results of a program or activity the Government carries out under 
existing law.'' A natural reading of the reference to programs or 
activities carried out ``under existing law'' suggests that these 
evaluations are meant to cover programs and activities established by 
Congress, rather than activities conducted under the President's 
independent constitutional authority to develop recommendations for 
future action. ``Existing law,'' however, could conceivably be 
construed to include the Constitution, which might enable this 
provision to cover the Vice President's ``activities'' in preparing 
policy recommendations for the President.
    The statute also authorizes the GAO to investigate ``all matters 
related to the receipt, disbursement, and use of public money.'' This 
statutory language is on its face so broad that it could conceivably 
cover any matter related in any way, no matter how remote or indirect, 
to the use of public money. Because the Vice President receives a 
salary from the Treasury, and because public funds were no doubt used 
in other ways in connection with the meetings that the GAO is 
purporting to investigate, the statute could be read to authorize an 
investigation of these meetings.
    Assuming for the sake of argument that the statute authorizes GAO 
to evaluate or investigate the work of the NEPD Group, however, the 
statute clearly does not purport to authorize the GAO to use any and 
all means to conduct its investigations or evaluations. The Vice 
President has already provided some records to the GAO, and the real 
question is whether the statute purports to require that the Vice 
President comply with GAO's demands for additional records about the 
nature of specific meetings. I think that it does not.
    The statute requires government ``agencies'' to supply information 
about their activities to the GAO, and the term ``agency'' is given a 
broad definition that includes every ``department, agency, or 
instrumentality of the United States Government'' other than the 
legislative branch or the Supreme Court. The bare language of the 
statute could conceivably be stretched to include the Vice President, 
either as such or in his role as a member of the NEPD Group, but it 
certainly need not be so interpreted. Under the interpretive principle 
adopted by the Supreme Court in Franklin v. Massachusetts, moreover, 
the statute should not be construed to cover the President, and 
probably not the Vice President either, because it does not expressly 
so provide.
    In any event, the express-statement rule invoked in Franklin v. 
Massachusetts is related to a more general principle of statutory 
construction, under which ambiguous statutes should be interpreted so 
as to avoid serious constitutional questions. And the constitutional 
questions raised by the GAO demand letter are very serious indeed. 
Beginning with George Washington, Presidents have consistently claimed 
that they may withhold some information from Congress, and the Supreme 
Court has recognized that a right of executive privilege is indeed 
implicit in the Constitution. Although the exact contours of the 
Executive's privilege of confidentiality remain subject to some 
uncertainty, the GAO's demands at the very least raise serious 
constitutional questions.
    The most recent major decision on executive privilege arose from 
the Independent Counsel investigation of Secretary Mike Espy. The White 
House refused to disclose a number of documents that had been generated 
in the course of the Administration's own investigation of allegations 
against Espy. Notwithstanding the fact that many of these documents had 
never been shown to the President, the D.C. Circuit held that most of 
them were immune from discovery by the Independent Counsel. The court 
explained that the privilege extends:
    to communications authored or solicited and received by those 
members of an immediate White House advisor's staff who have broad and 
significant responsibility for investigating and formulating the advice 
to be given the President on the particular matter to which the 
communications relate. Only communications at that level are close 
enough to the President to be revelatory of his deliberations or to 
pose a risk to the candor of his advisors.
    Vice President Cheney plainly qualifies under this or any other 
description of a high-level advisor, and much of what the GAO demanded 
amounts to ``communications authored or solicited and received by'' the 
Vice President and his staff. Even after the GAO's apparent narrowing 
of its demands, it continues to demand ``records providing the 
following information with regard to each of these meetings: (a) the 
date and location, (b) any person present, including his or her name, 
title, and office of clients represented, (c) the purpose and agenda, . 
. . and (f) how [members of the NEPDG, group support staff, the Vice 
President himself or others] determined who would be invited to the 
meetings.'' These records would appear to be ``communications'' and 
they were presumably authored or received by the Vice President's 
staff.
    Although the Espy court noted that its decision applied only in the 
context of judicial proceedings, it would be surprising if the courts 
were to give the privilege a narrower scope in the context of a GAO 
inquiry into the President's policy-development process than it has in 
the context of a serious criminal investigation.
    When one steps back from case law, which in any event cannot 
provide a definitive resolution, the serious nature of the 
constitutional questions becomes even more apparent. In 1796, when the 
House of Representatives was debating its response to President 
Washington's refusal to provide the House with documents relating to 
the Jay Treaty, Congressman James Madison argued that the House must 
have a right to ask for whatever information it thought fit. He also 
contended, however, that the President must have a correlative right to 
refuse the request if he saw fit. Madison concluded that ``[i]f the 
Executive conceived that, in relation to his own department, papers 
could not be safely communicated, he might, on that ground, refuse 
them, because he was the competent though a responsible judge within 
his own department.'' Madison's point was that the President could not 
be compelled to disclose information, just as Congress could not be 
compelled to enact legislation without what it considered adequate 
information. And Madison subsequently did vote against an appropriation 
to implement the Jay Treaty. This has become the traditional way to 
resolve these disputes, with each party using its political leverage to 
bargain over the outcome. The resulting compromises have no doubt 
frequently left both sides dissatisfied, but neither side has ever had 
to concede a matter of principle to the other. Once the courts become 
involved, that may change.
    Without claiming that Madison's theory would properly settle every 
dispute between Congress and the Executive, I believe that Madison did 
identify the constitutionally appropriate initial presumption. Applied 
to the present case, Madison's approach suggests that Congress might 
refuse to enact President Bush's energy proposals if a majority of 
legislators believed they first needed more information about the Vice 
President's work in the NEPD Group. But that is not at all what is 
going on here. Instead, we have a situation where neither House of 
Congress, or even a congressional committee, has demanded any documents 
from the Vice President, and the GAO's purpose in conducting the 
investigation is, so far as I have been able to ascertain, rather 
unclear. Construing a statute that is at best ambiguous to permit this 
kind of constitutionally dubious fishing expedition would seem highly 
questionable at best.
    While I was thinking about these issues, I began to wonder what 
would happen if a staffer in the White House office for political 
operations were to ask the FBI to investigate all meetings between 
Senators and private parties, at which matters before the Congress were 
discussed or mentioned (such as energy, or for that matter the 
regulation of the accounting profession). If the FBI then demanded that 
Senators provide documents and records like those that the GAO has 
sought from the Vice President, I imagine that quite a firestorm would 
ensue. And properly so.
    The two cases are not perfectly analogous, but the hypothetical 
does suggest one reason why it might not make much sense for the 
Comptroller General to provoke a constitutional confrontation in this 
case. Elected officials in the legislative and executive branches have 
a long history of resolving their differences in the manner suggested 
by Congressman Madison, without involving the courts. The lawsuit that 
the Comptroller General is threatening to bring will no doubt be very 
interesting to professors like me, but it seems unlikely to serve the 
long-term institutional interests of the Congress.
    Mr. Chairman, I'd be happy to answer any questions the committee 
may have.

    Chairman Leahy. Professor Koniak?

    STATEMENT OF SUSAN P. KONIAK, PROFESSOR OF LAW, BOSTON 
        UNIVERSITY SCHOOL OF LAW, BOSTON, MASSACHUSETTS

    Ms. Koniak. I want to thank the chairman, the ranking 
member, Senator Hatch, my Senator, Senator Kennedy, and Senator 
Edwards, who first suggested that I come here and testify.
    Financial scandals are not new. In the early 1970's, there 
was OPM. In the later 1970's, there was National Student 
Marketing. In the 1980's, there was the savings and loan 
debacle. and in each of those scandals, what ultimately became 
clear was that none of the fraudulent schemes could have 
succeeded without the assistance of very trained lawyers from 
very prestigious law firms. Now we have Enron, and I have no 
doubt that when the facts are known here, we will find that 
lawyers played a big role here, as well.
    The list of people and entities that may have broken the 
law in this Enron disaster is long--Enron itself, its Board of 
Directors, senior management, its accountants, Wall Street 
analysts, managers of pension funds, investment banks, 
partnerships with strange names, the people who invested in 
those partnerships, and, of course, Enron's lawyers. But Enron 
was not the only institution to have lawyers. Everyone on the 
list I just read had a lawyer, too.
    Tightening the reins on accountants is a good idea, but as 
I have just said, accountants have lawyers. Those lawyers are 
perfectly capable of helping accountants slip loose of whatever 
reins you devise, just as they apparently helped Enron slip 
loose of the reins of corporate and securities law. No reforms 
you enact will do much good unless you rein in the lawyers.
    Thus far, Enron's accountants have borne the lion's share 
of the blame, but let me put this as plainly as I can. To pull 
the wool over the eyes of the investing public, regulators, and 
the media for any considerable period of time, a corporation 
needs more than malleable accountants. It needs the help of 
lawyers.
    Vinson and Elkins, Enron's lawyers, have received some 
grief. They will undoubtedly receive more. But I want to start 
not with Enron's lawyers but Andersen's. Some group of people 
at Arthur Andersen shredded some substantial number of 
documents. This shredding not only left Andersen's reputation 
in ruins, it put Andersen in serious legal jeopardy under civil 
and criminal law. What were its lawyers doing while this was 
going on?
    The facts thus far suggest three possibilities, and none of 
them are good. First, they were encouraging the destruction, or 
they were recklessly ignoring the strong likelihood that 
documents would be headed for the shredder, or finally, they 
were acting carelessly in relation to whether or not Enron's 
documents ended up being preserved. What they should have been 
doing was issuing unequivocal direction that all Enron 
documents should be preserved and devising procedures to make 
sure that happened.
    On October 12, an in-house lawyer at Andersen wrote a 
hopelessly ambiguous memo referring people to a hopelessly 
ambiguous policy that was entitled, ``Retention and Destruction 
of Documents.'' Andersen now describes that document in 
euphemistic terms as being not robust and poorly written, to 
say the least.
    The policy, which was written undoubtedly by a lawyer, 
could have easily been read to say, shred everything you would 
like until a subpoena or litigation is actually filed. Then 
preserve everything, which is what the law would require.
    But this in-house lawyer at Arthur Andersen was not the 
only lawyer at the job at the time that this shredding 
occurred. Davis Polk was on the job representing Arthur 
Andersen from at least October 16, and according to Nancy 
Temple's testimony, the in-house lawyer, she consulted with 
Davis Polk on October 16 about the destruction and retention of 
documents at Andersen.
    The shredding party began on October 23. That means that 
Davis Polk was on the job for 1 week in which it let stand this 
ambiguous memo and ambiguous policy that, as I said, and I have 
read both documents, could have easily been read to say 
``shred'' as ``not shred.'' They were on the job for 2 weeks, 
and apparently nothing was done to withdraw the Temple memo. 
They were on the job for 3 weeks and nothing was done. Nothing 
was done until November 8, when Arthur Andersen finally 
received the subpoena and the correct legal advice went out at 
that point, advice that should have gone out at least 3 weeks 
earlier, which was to preserve the documents.
    We may never know because of the destruction of these 
documents what went on, but that is not the best part of the 
story. The best part of the story is that Davis Polk is now 
purporting to conduct an investigation into what went wrong at 
Arthur Andersen. Who is going to investigate Davis Polk? One of 
the first questions to be asked in such an investigation is 
what were your lawyers doing? Were they just sitting around? 
Did they understand the importance of preserving those 
documents? Did they do anything to make sure that happens?
    Vinson and Elkins has gotten a lot of grief, as they should 
have, for conducting an investigation when their own work was 
involved. Davis Polk seems to be doing that now. I raise that 
as an example of how pervasive this problem is. These are well 
respected firms.
    My testimony has detailed explanation. I just would like to 
say two other things before I close, and a list of 
recommendations.
    One is, this is when you can tell when a lawyer is in 
trouble. It is a three-part test. It is quite easy. Your lawyer 
is committing a crime or fraud. You have enough facts in front 
of you that you should have figured it out, that it was either 
careless of you not to or you were reckless not to have figured 
it out. And with that mental state, you then act anyway to help 
or sit around and do nothing when you know that you have a duty 
to act when you represent a corporation.
    Negligence here, from the material that we have already 
received, seems quite clear. That means malpractice was 
committed. Negligence means you have a little bunch of facts in 
front of you that suggests badness. Here, in front of the 
lawyers, there seems to be a mountain of red flags, flashing 
lights going off all over the place, which they ignored and 
continued to operate and help and not do anything by telling 
the Board. That is recklessness. The difference between 
negligence is this amount versus this amount of facts.
    Congress changed the law to make it that lawyers could not 
easily be sued when they were reckless. That has to change.
    Chairman Leahy. Professor, we are going to have to----
    Ms. Koniak. I am happy to conclude on that, to change.
    Chairman Leahy. Thank you, and we are going to go back to 
that with further questions.
    [The prepared statement of Ms. Koniak follows.]

   Statement of Susan P. Koniak, Professor of Law, Boston University 
                             School of Law

                            I. Introduction
    Twelve years ago in a court opinion dealing with some aspects of 
the Lincoln Savings and Loan fraud, Judge Stanley Sporkin wrote: 
``Where. . .were the. . .accountants and attorneys. . .?. . .[W]ith all 
the professional talent involved (both accounting and legal), why 
[didn't] at least one professional. . .[act] to stop the overreaching 
that took place in this case''? \1\ Now, there is Enron. And we are 
here asking the same questions, Judge Sporkin and others were asking 12 
years ago. To paraphrase Pete Seeger, ``When will [we] ever learn?''
---------------------------------------------------------------------------
    \1\ Lincoln Sav. & Loan Ass'n Wall, 743 F. Supp. 901, 920 (D.D.C. 
1990).
---------------------------------------------------------------------------
    No one should have been surprised in the aftermath of the savings 
and loan crisis to learn that lawyers and accountants had averted their 
eyes from the fraud being perpetrated by some in the banking industry 
during the 1980s. Before the savings and loan debacle, there was OPM, a 
computer leasing company in New York that was a virtual fraud-factory 
that bilked such venerable institutions as Manufacturers Hanover and 
American Express. After filing bankruptcy, OPM's Trustee issued a 
report that detailed how much OPM's lawyers knew about its client's 
shennanigans and how much help they provided their fraud-doing client; 
Stuart Taylor wrote a detailed expose of the involvement of OPM's 
lawyers in seeing to it that their client's fraud went undiscovered. 
And no one should have been surprised by that either.
    Before OPM, in the 1970s, lawyers and accountants aided and abetted 
the fraud that brought down National Student Marketing Corporation. And 
the law firms in most of these instances were not marginal players, 
they were pillars of the bar: venerable and well respected firms. Firms 
who settled with the government (and/or with defrauded investors) for 
their role in assisting Charles Keating, the head of Lincoln Savings 
and Loan included: Sidley and Austin, Kaye, Scholer and Jones Day. And 
participating as helpers in the National Student Marketing fraud were 
the law firms of Lord Bissell and Brook and White & Case. I hasten to 
add that had I had ``world enough and time'' those firms would appear 
on a much larger list, a list that would include many other prestigious 
firms. That is to say, the firms named above did nothing, 
unfortunately, that most other prestigious law firms haven't done 
themselves. And now we sit here in 2002 professing to be shocked, 
shocked that gambling is going on at Rick's saloon and that well 
respected law firms and accounting firms may have been involved.
    Thus far, Enron's accountants have borne the lion's share of the 
blame for helping the wrongdoers at Enron commit what appears now to 
have been massive fraud. Let me put this as plainly as possible: To 
pull the wool over the eyes of the investing public, regulators and the 
media for any considerable period of time a corporation needs more than 
malleable accountants, it needs the help of lawyers. Perhaps Lee Harvey 
Oswald acted alone, but Enron and its accountants did not. When all the 
facts that can be known about what happened here are known, one thing 
will be clear everyone in the drama had a lawyer whispering in its ear 
(Enron, Arthur Andersen, the investment banks, the questionable 
partnerships that hid Enron's losses and bilked Enron's funds, the 
investors in those partnerships and on and on). And one more thing will 
be clear: no lawyer stepped in to stop this calamity.
    Tightening the reins on accountants is a good idea, but, as I have 
just said, accountants have lawyers too.\2\ Those lawyers are perfectly 
capable of helping accountants slip loose of whatever reins you devise, 
just as they apparently helped Enron slip loose the reins of corporate 
and securities law unless Congress, the SEC and state regulators \3\ 
rein in lawyers too. Something needs to be done about the lawyers, if 
confidence is to be restored in the financial statements issued by 
companies. What the securities laws demand, is ultimately a legal 
question, not one for accountants. When documents must be preserved, is 
not simply a matter of some accounting convention; it depends on law: 
tax law, statutes prohibiting obstruction of justice, civil rules on 
spoliation of evidence, state laws on tampering with evidence and other 
such legal constraints.
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    \2\ Consider this exchange from the House Energy Committee:
    Representative Markey: Okay, let me--so you were--you were also 
worried that Andersen would be required to comply with the financial 
fraud reporting requirements of Section 10(a) of the Securities and 
Exchange Act, the Wyden-Dingell-Markey amendment that requires accounts 
to immediately report evidence of financial fraud to senior management, 
the board; and, if they take no action within five days to report the 
fraud to the SEC. You make that clear. If so, why didn't you order the 
shredding to stop?
    Ms. Temple [an in-house lawyer at Andersen]: Congressman, there was 
no conclusion that there was any financial fraud, or that--in fact, no 
conclusion that there was no misleading statement. After consultation 
with others in the firm, and Davis Polk, I was being careful in asking 
Davis Polk to look at all angles and all issues, and advise us. And the 
conclusion was there were no further steps to take.
    \3\ By state regulators, I mean primarily state courts and bar 
disciplinary authorities. they have a role to play too. They should 
reexamine the rules that govern lawyers licensed by the states. Bare 
disciplinary authorities should also be better funded. Having said 
that, I assure you that such authorities will never have the resources 
necessary to take on the large and quite powerful law firms that are so 
often the relevant players in major and even minor securities' frauds. 
the federal government thus has an important role to play here.
---------------------------------------------------------------------------
    All too often lawyers act as if they were wearing magic caps--hats 
that transport them to some alternative reality, a law free zone, in 
which they are free to do anything and everything for the person or 
entity paying the lawyers' fees, a magic land where lawyers need not 
fear that law will come crashing down on them.\4\ ``It may hit the 
client, but it will never hit me.'' There are no such magic caps. But 
the scant attention that has thus far been paid to the role of lawyers 
in this mess suggests that the myth of the magic cap has spread far and 
wide. With the report issued by Enron this weekend, Vinson & Elkins, 
Enron's primary outside law firm, which has thus far received 
relatively little grief, will undoubtedly receive much more scrutiny. 
Later on, I will get to that firm and the other firms that Enron may 
have employed to help it with its financial shennanigans later. But to 
make concrete just how pervasive the magic cap myth has become, I want 
to start not with Enron's lawyers, but with Arthur Andersen's, in 
particular with the lawyers who are advising Arthur Andersen right now. 
They're acting like they're wearing magic caps, and everyone appears to 
be going along. Let me explain what I mean.
---------------------------------------------------------------------------
    \4\ See generally Koniak, The Law Between the Bar and the State, 70 
N.Car.L.Rev. 1389 (1992).
---------------------------------------------------------------------------
     II. To Shred or not to Shred, To Investigate or to Step Aside
    Some group of people at Arthur Andersen shredded some substantial 
number of Enron documents. The shredding not only left Andersen's 
reputation in ruins, it put Andersen into serious legal jeopardy under 
civil and criminal law. What were Andersen's lawyers doing while 
Andersen's accountants and staff were doing that shredding? The facts 
disclosed thus far suggest three possibilities; none of them good. 
Andersen's lawyers were either (1) encouraging this destruction through 
none-too-subtle hints; (2) recklessly ignoring the strong likelihood 
that documents were headed for the shredder; or (3) acting carelessly 
in relation to whether the Enron files were preserved or not.
    What should they have done to prevent the wholesale shredding that 
apparently began on or about October 23rd and continued for 
some considerable time thereafter? What they did way too late: Issue 
unequivocal legal advice that all Enron documents were to be preserved 
and suggest procedures to Andersen's management that would have helped 
ensure that the documents were actually preserved.
    Instead on October 12th Nancy Temple, a member of 
Andersen's in-house legal staff, wrote the now infamously ambiguous 
retention/destruction memo that David Duncan, the Andersen partner in 
charge of Enron's account, has told congressional investigators he read 
as authorizing him to begin the shredding. I have read that memo and 
the policy that it says might be ``helpful'' and thus suggests should 
be followed. As I read those documents, it seems like Attorney Temple's 
memo was an effort to encourage others to destroy Enron documents, 
while preserving for its author the ability to deny that she meant any 
such thing. (Indeed, Andersen's retention/destruction policy seems 
designed to achieve that same result and was probably written by a 
lawyer too).
    Perhaps, Attorney Temple did not mean the memo that way She has 
testified that she did not. She says that she meant the partner in 
charge, Mr. Duncan, to read the policy and interpret what it meant for 
himself. Why? Was she unsure of what the policy demanded? If so, was it 
sensible to believe an accountant would have an easier time deciphering 
it, this document that resembles a legal regulation much more than an 
accounting rule? And what of the law's demands? Did she have no 
information to give Mr. Duncan and the other accountants on that 
either?
    But this is not a tale of one poorly-intentioned or careless 
lawyer, writing a reckless or slip-shod memo on one particular day. The 
story gets much worse. Attorney Temple wrote her incredibly unhelpful 
memo on October 12th. A few days earlier, Arthur Andersen 
hired the well respected firm of Davis, Polk & Wardwell to advise it on 
Enron-related matters. Now, according to the testimony of Mr. Andrews, 
a senior partner at Arthur Andersen, while Davis Polk was retained 
before the October 12th memo was written, it did not begin 
its work for Andersen until October 16th.\5\ No matter. 
Attorney Temple has testified that on Davis Polk's first day on the 
job, October 16th, she consulted with Davis Polk lawyers on ``document 
retention and destruction.''\6\ Thus, before the major shredding party 
at Andersen began, which was on or around October 23rd,\7\ 
Davis Polk was consulted on the steps Andersen was taking or not taking 
to see to it that documents were preserved.
---------------------------------------------------------------------------
    \5\ Testifying before the House Energy Committee, Mr. Andrews of 
Arthur Andersen said: ``Mr. Chairman, the firm was retained on October 
9th, and commenced work with us on October 16th.'' [All 
quotes and references in this testimony to the House Energy Committee 
Testimony were taken from the New York Times' website transcript of the 
hearing.]
    \6\ In testimony before the House Energy Committee, Attorney Temple 
said: I believe in my conversation on October 16th I 
discussed the documentation and retention issues that had arisen as of 
the date with Davis Polk.
    \7\ Generally see the testimony before the House Energy Committee.
---------------------------------------------------------------------------
    Did Davis Polk advise Temple or anyone else at Arthur Andersen to 
clarify Temple's October 12th memo when she talked to Davis 
Polk lawyers on October 16th?
    Davis Polk was on the job about a week before the shredding 
extravaganza began. Why didn't it take steps to see to it that 
Andersen's notes, drafts and e-mails on Enron were preserved? We don't 
know what, if anything, Davis Polk did advise because Arthur Andersen 
seems to be relying on attorney-client privilege when it comes to what 
Davis Polk said,\8\ but we do know that the Temple memo was not 
withdrawn and the Andersen retention/destruction policy was not 
clarified in the first week of Davis Polk's involvement in this case or 
the second week or the third.
---------------------------------------------------------------------------
    \8\ I said ``seems to'' because Ms. Temple did testify, albeit 
somewhat vaguely, on the advice Davis Polk provided on another of her 
acts that has received some negative attention: her request to have her 
name removed from some document and her suggestion that a reference to 
Andersen concluding something was ``misleading'' also be deleted. Her 
testimony before the House Energy Committee included these exchanges:
    Representative Whitefield: Okay. Now--and then Nancy Temple wrote a 
memo to Mr. Duncan on the 16th, which is one day after his 
memo to file, in which he's concerned about this misleading recurring 
charges statement. And she said, ``Dave, here are a few suggested 
comments. I recommend deleting reference to consultation with the legal 
group and deleting my name on the memo. I also suggest deleting 
language that might suggest we have concluded the release is 
misleading.'' Why did you write that memo, Ms. Temple?
    Ms. Temple: I wrote that after reviewing the draft and consulting 
with our outside legal counsel. First--Representative
    Whitefield: Outside? Which outside?
    Ms. Temple: Davis Polk.
    At numerous other times during the hearing she alluded to advice 
given by Davis Polk, sometimes with a little more content (which might 
affect a claim of privilege) and other times not. See also footnote 2 
above.
---------------------------------------------------------------------------
    Before October 22nd, Arthur Andersen's lawyers should 
have done something to make it clear to Andersen partners and staff 
that the Enron files were to preserved. The preservation of those Enron 
documents was necessary to protect Andersen's legal interests as well 
as its future viability as a respected accounting firm. First, how is 
Andersen to demonstrate its innocence, assuming it is innocent, when 
its files are not intact. Second, assuming someone at Andersen did 
something wrong on the Enron account, how is Andersen to convince 
people that it has not gotten to the bottom of the problem and made all 
necessary changes when its files are incomplete. Third, if your client 
destroys documents when it is reasonably foreseeable that it will be 
sued and the documents will be relevant to that suit, a judge can 
instruct the jury to assume that the destroyed evidence would have 
shown your client's guilt.\9\ And that is the least of the legal 
troubles that the destruction of these documents might bring.
---------------------------------------------------------------------------
    \9\ See e.g., Byrnie v. Town of Cromwell Bd. of Educ., 243 F.3d 93 
(2d Cir. 2001) (``We have defined spoliation as `the destruction or 
significant alteration of evidence, or the failure to preserve property 
for another's use as evidence in pending or reasonably foreseeable 
litigation.' West v. Goodyear Tire & Rubber Co., 167 F.3d 776, 779 (2d 
Cir. 1999). The spoliation of evidence germane `to proof of an issue at 
trial can support an inference that the evidence would have been 
unfavorable to the party responsible for its destruction,'  v. United 
States, 150 F.3d 112, 126 (2d Cir. 1998). (Emphasis added).
---------------------------------------------------------------------------
    On October 22nd, Enron disclosed that the SEC had opened an inquiry 
into the company's financial dealings, particularly the strange 
partnership transactions and Enron's fuzzy disclosures on those deals. 
As with most legal matters, there is some uncertainty on precisely how 
formal an investigation by a government agency must be before 
destroying documents might qualify as obstruction of justice.\10\ But 
there is precedent that holds that some, if not all, preliminary 
inquiries by the SEC qualify.\11\ Presumably, Arthur Andersen had no 
interest in being accused of obstructing justice, even if it could 
ultimately establish its innocence because the government could not 
quite prove that it had the requisite corrupt intent or because some 
court held that the SEC's inquiry of Enron was not formal enough to 
constitute ``a proceeding'' under the obstruction statute. Given that 
Andersen's very survival might be threatened, if it managed to Convey 
that as Enron started coming apart, Andersen was busy flirting with 
violations of the criminal code, Andersen's lawyers should have done 
everything possible to clarify the Temple memo and Andersen's poorly 
written policy--at the latewst--immediately after they became aware 
that an informal SEC inquiry of Enron was underway. They didn't.
---------------------------------------------------------------------------
    \10\ See generally, Construction and Application of 18 USCA 
Sec. 1505 Making It a Federal Offense to Obstruct Proceedings Before 
Federal Departments or Agencies or Congressional Committees, 8 A.L.R. 
Fed. 893
    \11\ See United States v. Batten 226 F Supp 492 (D.D.C. 1964) cert. 
den. 380 US 912, 13 L Ed 2D 799, 85 S Ct 898, reh den 381 US 930, 14 L 
Ed 2d 688, 85 Ct 1557 (preliminary investigation by the Securities and 
Exchange Commission). There is, however, some dispute about whether the 
fact that a subpoena had issued to the witness in that case, whom the 
defendant was accused of trying to influence, was critical to the 
holding. See particularly, US v. Edgemon, 1997 U.S. Dist. Lexis 23820 
(ED Tenn). On the other hand, in Rice v. US. F.2d 709 (8th 
Cir. 1966,) the court albeit in dicta, said:
    In our view, it would be absurd to hold that Congress meant to 
proscribe interference with the administrative process only after a 
Labor Board Proceeding had reached a certain formal stage and let go 
unpunished individuals who obstruct earlier preliminary proceeding. . . 
.Congress did not limit the term ``proceeding'' as used in 
Sec. Sec. 1505 to only those acts committed after a formal stage was 
reached, and we cannot so limit the term.
    And in United States v. Kelly, 36 F.3d 1118, 1127 (D.C. Cir. 1994) 
the court summarized Batten' holding this way: ``the SEC's authority to 
issue subpoenas and administer oaths in conjunction with its 
investigations made an SEC investigation a Sec. 1505 proceeding'' 
(Emphasis added).
---------------------------------------------------------------------------
    On October 25, Enron, getting good legal advice--at least at this 
point--sent e-mails to its employees worldwide and to its auditors at 
Andersen, directing everyone to preserve all Enron documents. 
Andersen's lawyers take no action to rescind the Temple memo or to 
clarify the policy to which the memo refers. A few more days go by, and 
on October 31, Enron announces that the SEC investigation has been 
upgraded to ``formal.'' Now any doubt about the potential applicability 
of Sec. 1505 should have been removed. Still Andersen's lawyers did 
nothing. Even assuming that they somehow imagined that Temple's memo 
and Andersen's nonrobust, poorly written retention policy \12\ were 
adequate to convey the ``don't destroy documents'' advice that they 
should have been giving, why weren't Andersen's lawyers checking to see 
what procedures Andersen was following to ensure that Temple's supposed 
directive was being followed by Andersen's Enron team?
---------------------------------------------------------------------------
    \12\ This is how Andersen executives testified that they now view 
the policy. See House Energy Committee hearing.
---------------------------------------------------------------------------
    Finally, Andersen receives its own subpoena from the SEC. That 
happened, I believe, on November 8th. The next day Attorney 
Temple calls Duncan, the head of Andersen's Enron team, and leaves him 
a message to preserve all documents. Apparently, that message managed 
to convey what Temple's October 12th e-mail and Andersen's 
woefully inadequate retention/destruction policy could not. Duncan's 
assistant now sends out an e-mail to those shredding Enron documents 
and tells them to stop. That e-mail went out the same day Temple left 
her voice message for Duncan with its clear legal advice. The following 
day, November 10th, Attorney Temple sends an e-mail memo to 
the personnel at Andersen, which said in part, according to press 
reports:
    One of the first things we must do in preparing to respond to this 
subpoena and the lawsuits is to take all necessary steps to preserve 
all the documents and other materials that we may have relating to the 
claims that are being filed. . . .
    To do this we must first insure [sic] that all documents and 
materials already in existence are preserved and that nothing is done 
to destroy or discard any documents or materials now in your 
possession.\13\
---------------------------------------------------------------------------
    \13\ Susan Schmidt and Kathleen Day, Testimony is Sought on File 
Shredding, Wash. Post, Jan. 20, 2002, at A5 (quoting Temple's November 
10th e-mail).
---------------------------------------------------------------------------
    What took her so long? And why didn't Davis Polk, Andersen's 
outside counsel, do any better than Attorney Temple and the rest of 
Andersen's in-house legal team managed to do?
    Most troubling, how is it possible that Davis Polk has agreed to 
conduct an investigation for Arthur Andersen to discover how so much 
shredding could have gone on at Arthur Andersen between October 
23rd and November 9th? That shredding occurred on 
Davis Polk's watch. Who is going to find out why Arthur Andersen's 
outside counsel, Davis Polk, did not properly protect its client and 
Enron's documents? Davis Polk? One of the first questions Andersen 
needs to ask in its internal investigation is: where were the lawyers? 
The lawyers who were out to lunch at the critical time should not be 
the ones Andersen or the rest of us should be depending on to explain 
what went wrong. It's that simple.
    Vinson & Elkins should have refused to investigate allegations of 
misconduct at Enron that happened on their watch, even if the firm had 
played no active part in any of the alleged wrongdoing.\14\ But they 
accepted an engagement that, if done right, would have required them to 
assess objectively their own competence, honesty and adherence to the 
law. That law firms routinely accept just such assignments is 
outrageous, but they do. It shows just how deeply they believe in those 
magic caps--deeply enough to imagine that they can assess a legal 
landscape that they were part of, as if they were not there at all. 
Vinson & Elkins had no magic cap and Davis Polk doesn't have one 
either.
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    \14\ See the report released by Enron, referred to as the Powers 
report, which details the investigation Vinson & Elkins conducted and 
criticizes the firm's investigatory work. Apparently, Sharon Watkins, 
the author of the memo suggesting Enron was committing massive fraud--
the memo whose allegations Vinson & Elkins was charged with 
investigating--said in that memo that Vinson & Elkins should not be 
given the investigatory task because they would be ruling on their own 
work. How is it Watkings could figure that out and not the lawyers at 
Vinson & Elkins?
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III. Assume there was Securities Fraud, Now Assume there Were Lawyers. 
                        You see I Repeat Myself
    The mere fact that there are always lawyers around when securities 
fraud is taking place does not mean that lawyers cause securities fraud 
nor does it demonstrate that they are always in a position to discover 
it or stop it from taking place. They aren't. In plain English, fraud, 
as I tell my students year in and year out, is lying to someone to get 
them to give you their stuff.\15\ Fraud-doers are by definition liars 
(sneaks, cheats) and many are slick enough at lying to fool a room full 
of experienced lawyers. On the other hand, not all fraud-doers are 
quite that slick, and I dare say when it comes to securities fraud 
being slick enough to keep it from one's lawyers for a significant 
period of time takes some considerable degree of skill. Don't get me 
wrong, even a sophisticated and careful lawyer may not be able to 
detect a complex and well crafted scheme to defraud others in 
connection with the sale or purchase of securities. But then again many 
a sophisticated lawyer is not careful, at least, not about detecting 
securities fraud, and all too many sophisticated lawyers are all too 
willing to turn a blind eye.
---------------------------------------------------------------------------
    \15\ The lie can be a lie committed by omission if what is omitted 
is critical enough information to render that which is said seriously 
misleading (or as the law calls it ``material'' misleading).
---------------------------------------------------------------------------
    Enron released the Powers report this weekend. I have not yet had a 
chance to review it thoroughly, but it seems to support, not dispel, 
the idea that Enron, acting through its agents, was committing 
securities fraud and engaging in other violations of the securities 
laws and other laws as well, civil and criminal wrongs. Let's assume 
that's so for purposes of analyzing whether Enron's in-house and 
outside counsel did wrong.
    To make this as simple as possible a lawyer has done wrong and is 
likely to be in significant legal trouble when three things are true. 
One, the client is breaking the law. Two, the lawyer has enough facts 
in front of her to have been able to figure out, with the exercise of 
reasonable care, that number one is true. And three, with number one 
and number two in place, the lawyer either acts to help the client to 
break the law or does nothing to stop the client from breaking the law 
in those instances (which are not as few as some would like to think) 
when the lawyer has a duty to intervene.\16\
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    \16\ See generally the excellent article by my friend and co-
author, Geoffrey C. Hazard, Jr., How Far May a Lawyer Go in Assisting a 
Client in Unlawful Conduct, 35 U. of Miami L. Rev. 669 (1981).
---------------------------------------------------------------------------
    Using the three part test I have just laid out, we can gauge the 
universe of lawyers who might be in trouble by asking which clients are 
we likely, in the end, to discover were breaking the law? I started by 
assuming Enron will be in that category; possibly Arthur Andersen, 
possibly the partnerships that appear to have been part of what now 
appears to be a fraudulent scheme, some investors in those 
partnerships, maybe some investment banks. And while that list may 
include some innocent parties, it is at least as likely to have left 
out some individuals and entities who we will later discover were 
involved in violations of law.
    The lawyers for any of the individuals or entities that turn out to 
be on the ``broke the law'' list constitute the universe of lawyers who 
need to start worrying. Vinson & Elkins was Enron's outside counsel, 
but other law firms may have represented Enron during what may have 
been its crime spree and might have been in a position to have figured 
out that Enron was breaking the law and to have helped it to do so. 
Enron's in-house counsel were certainly in a position to satisfy all 
three parts of the test I set forth above, as were Andersen's in-house 
counsel, and any outside law firms who may have advised Andersen on 
Enron related-questions during the years Andersen was auditing and 
advising Enron. (Having given Davis Polk some considerable amount of 
grief above, I want to make clear that here I am not referring to that 
law firm because to my knowledge they were not providing Andersen with 
advice during the period of time when Andersen might have been 
violating the securities laws through its work for Enron).
    But as my list of potential law breakers was designed to emphasize, 
the lawyers who may be in trouble for assisting their clients' unlawful 
conduct (assuming those clients turn out to have broken the law) does 
not end with lawyers representing Enron and Andersen.\17\
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    \17\ Although I was not asked to testify on accountants, I have 
discussed some and alluded to other possible wrongdoing by Arthur 
Andersen as a necessary predicate to an analysis of the problems that 
may face Andersen's lawyers. I thus think it only fair to point out 
(and this seems as good a place as any) that Andersen may not be the 
only accounting firm with legal woes related to the Andersen mess. The 
Powers report says Pricewaterhouse Coopers did some work on the Enron-
partnership transactions. If that accounting firm also proves to have 
stepped over some legal line, its lawyers (in-house or outside) may be 
in the universe of lawyers-in-potential trouble that I have described. 
I just don't know enough at this point to say.
---------------------------------------------------------------------------
    Now, we move to question two: Did any of the lawyers for clients 
who were breaking the law have enough facts in front of them to have 
figured out with the exercise of reasonable care that law breaking was 
going on? Well, the Powers report strongly suggests that if Enron was 
breaking the law, its in-house counsel and Vinson & Elkins had enough 
facts in front of them to have figured it out, had they been exercising 
reasonable care. I hasten to add that does not make either in-house 
counsel or outside counsel, guilty of any crime, but it does leave them 
in legal jeopardy in malpractice actions brought on Enron's behalf by 
the Trustee in bankruptcy or whomever ultimately emerges as the new 
management or entity in control of Enron.
    To take just one example detailed in the Powers report, knowing 
that the Board had waived Enron's conflict of interest rules (and 
possibly having advised that it was a good idea to do so), it does not 
appear that any lawyer (within or outside) Enron bothered to worry much 
about the ``procedures'' that were supposed to prevent bad things from 
happening to Enron due to the conflicting roles its CFO was not 
licensed to play. The Powers report says whatever procedures were 
supposed to be in place, not only failed miserably but were not 
designed well enough to do anything but fail. It was Enron's lawyers 
who should have designed better procedures, or at least, monitored 
whatever procedures were designed to see to it that they had some 
reasonable chance of working. I do not know whether this was within the 
scope of Vinson & Elkins retainer, but in-house counsel was apparently 
not paying all this much mind. Some lawyer or group of lawyers appears 
to have been hopelessly careless on this matter. Indeed, it seems to me 
that a reasonably careful lawyer would have strongly advised the board 
not to waive the conflict rules in the first place, especially not as 
to the company's CFO.
    The fact that agents within Enron, including senior management, may 
have been actively engaged in fraud does not, in most states, relieve 
the lawyer from a claim of negligence for having failed to take steps 
to have saved her client, the corporation, from harm (legal and 
financial) that these wrongdoing agents may have been causing.\18\ 
Again, if a careful lawyer would not have discerned that agents within 
the client corporation were acting unlawfully, which includes breaching 
their duties to the corporation by self-dealing or taking actions that 
would leave the corporation open to a multitude of civil lawsuits and 
possibly criminal charges, the lawyer should not be found liable. The 
liability of the lawyer will turn on how many red flags were in front 
of him, indicating ongoing fraud. The Powers report suggests there were 
signs aplenty. A company's lawyers can avoid liability for negligence, 
but not if they are careless about detecting wrongdoing by the CEO or 
CFO or other senior management, and only if they take steps to bring 
any signs of serious wrongdoing to the attention of the board and 
advise management and the board that the wrongdoing must stop. The 
Powers report suggests that did not happen, although we have yet to 
hear from the lawyers involved.
---------------------------------------------------------------------------
    \18\ See O'Melveny & Myers v. FDIC, 512 U.S. 79 (1994). In that 
case the Supreme Court reversed the Ninth Circuit's opinion, finding a 
law firm could be liable for malpractice for having breached its duty 
of care to a bank by failing to have taken steps to alert its board to 
the ongoing fraud of the agent in charge of the bank, who was also on 
the board. But that reversal was on the ground that the Ninth Circuit 
had applied federal common law to reject the law firm's defense that 
the bank (its client) and the bank board already knew of the 
wrongdoing, so there was nothing more the law firm should have done. In 
reaching that conclusion, the Supreme Court mentioned that the FDIC's 
brief pointed out that ``in the vast bulk of decisions from 43 
jurisdictions, ranging from Rhode Island to Wyoming'' the fraud of an 
agent that harmed the corporation (as is the case with Enron) would not 
be attributed to the corporation so as to bar a successful suit of 
negligence against the lawyers for failing to take steps to alert the 
corporation of the fraud and stop it. Indeed, on remind the Ninth 
Circuit explained that California law would reach that result as well 
and affirmed its earlier opinion. FDIC v. O'Melveny & Myers, 61 F.3d 17 
(19th Cir. 1995).
---------------------------------------------------------------------------
    Malpractice, is of course a matter of state law. But extreme 
negligence amounting to reckless disregard of the fact that corporate 
actors are engaged in securities fraud has long been a matter of 
federal law, although that may no longer be the case. Before the mid-
1990s, federal securities law, as interpreted by the courts, provided 
that lawyers could be sued by shareholders in a derivative action and 
by the SEC for failing to take steps to stop securities fraud that 
those lawyers had to be deaf, dumb and blind not to have detected 
(i.e., fraud the lawyers recklessly ignored or to which the lawyers 
deliberately closed their eyes). This was ``aiding and abetting'' 
securities fraud. It should be the law today, but for a number of 
reasons it isn't. That should change.
    Before getting to why it should change. Let me explain why it is 
necessary for federal law to punish lawyer recklessness when state law 
allows a malpractice action for negligence and thus by definition 
presumably deters recklessness as well, both by leaving lawyers liable 
for less serious carelessness (negligence) and by providing punitive 
damages when that negligence gets out of control and rises to the level 
of recklessness.
    First, there is the fact plain for all to see: the existence of 
state negligence actions has not proven to be an effective deterrent, 
possibly because lawyers bet on the fraud-doers staying in control of 
the corporation through fraud and thus there being no ``clean, new'' 
management with an interest in suing them. Possibly because lawyers 
believe that the wrongdoing of high corporate officials will somehow be 
attributed to the corporation in such a way as to bar a negligence suit 
or that even if such a suit may legally proceed, a jury will be loathe 
to hit the lawyers hard when management was so dirty itself. Perhaps, 
some state tort law reform, e.g., laws capping damages, have rendered 
it worthwhile for lawyers to risk a negligence suit when the fees to be 
reaped are high enough to pay whatever damages may be imposed 
(discounted by the risk that the negligence may go undiscovered or 
unprosecuted).
    Perhaps it is as simple as lawyers believing (and being trained to 
act) as if the agents for their clients were their clients, making it 
much more difficult to internalize the notion that there is a client 
out there that doesn't know what's going on. Perhaps (and I believe 
there is something to this) the elimination of private causes of action 
against lawyers for aiding and abetting liability, the changes to RICO, 
restrictions on joint and several liability in many actions against 
lawyers, and other changes in federal law have encouraged lawyers to 
overlook that something as relatively trivial as negligently failing to 
take action to stop a fraud could still offend the law at all.
    ``That still couldn't be what state law says? Could it? Our magic 
caps undoubtedly will protect us.''
    The Supreme Court's decision in Central Bank \19\ and the changes 
Congress made in the Private Securities Litigation Reform Act \20\ that 
helped lawyers to imagine themselves free (or nearly free from the 
constraints of law) were monumentally bad ideas.
---------------------------------------------------------------------------
    \19\ Central Bank v. First Interstate Bank, 511 U.S. 164 (1994)
    \20\ Private Securities Litigation Reform Act of 1995, Pub. L. Non. 
104-67, 109 Stat. 737 (1995) (codified in scattered sections of 15 
U.S.C.) [hereinafter referred to as the 1995 Act].
---------------------------------------------------------------------------
    It really is no wonder that lawyers believe they are wearing magic 
caps. It is true that as a response to Congress' elimination of the 
private cause of action against lawyers for aiding and abetting 
securities fraud, many courts have not been shy about holding lawyers 
liable as primary violators of the securities law in cases that 
previously would have been framed as aiding and abetting cases.\21\ But 
the degree to which lawyers may be liable as primary violators for what 
used to be thought of as ``aiding'' a client's fraud is quite 
uncertain, and that uncertainty alone is enough to encourage lawyers to 
avoid ``knowing'' that fraud is being committed by their clients and to 
continue acting in a reckless manner that helps the fraud continue and 
makes it harder to discover. Lawyers are not dumb.
---------------------------------------------------------------------------
    \21\ For example, a materially misleading opinion may give rise to 
primary liability, which would allow investors who relied on it to sue 
the lawyers for damages. See e.g., Kline v. First Western Govt. 
Securities Inc., 24 F.3d 480 (3rd Cir. 1994)
---------------------------------------------------------------------------
    Consider the case of Kline v. Boyd,\22\ the lawyer there tried to 
sidestep liability as a primary violator of the securities laws by 
writing the materially misleading disclosure statements without putting 
the law firm's name, the respected firm of Drinker, Biddle, or his own 
name on any of the blatantly misleading disclosure statements that the 
lawyer drafted and which the lawyer knew the client would give to 
investors. The Third Circuit had a hell of a time explaining how that 
conduct--which was clearly enough to qualify as substantial assistance 
had private parties been able to recover for aiding and abetting--
amounted to a primary violation of the securities laws. It managed and 
I believe its effort was admirable because any other result would 
invite lawyers to further securities fraud behind the curtain of the 
lawyer-client relationship, free from the law's reach so long as they 
kept their participation secret from the investors. Surely, not a good 
result.
---------------------------------------------------------------------------
    \22\ Fed. Sec. L. Rep ] 90, 136, Vacated on Grant of Rehearing En 
Banc (3rd Cir. 1998).
---------------------------------------------------------------------------
    While I thus applaud the result in Kline, I recognize that the 
reasoning that called this bad behavior a ``primary'' violation instead 
of aiding and abetting stretched the law as far as it could go. (I do 
not think it broke it, but many others disagree.) And that stretch 
rendered the judgment quite vulnerable and ended up destroying its 
value as precedent. The entire Third Circuit apparently noticed the 
stretch and granted a rehearing of the case en banc. That rehearing 
never occurred because a settlement was reached while rehearing was 
pending, and the decision in Kline that I described above was vacated 
as part of that settlement.
    In the end then we really don't know whether a lawyer who did what 
the lawyer in Kline did may be successfully sued by investors harmed by 
the lawyers actions. We should know. A lawyer who does what the lawyer 
in Kline did is no different than one who puts his name on work product 
that he knew or should have known was materially misleading, except 
insofar as the anonymous draftsman may be somewhat more despicable. 
What sense does it make to let that guy escape damages in a civil suit?
    It is true that the SEC retains jurisdiction to bring a civil cause 
of action against lawyers who aid and abet their clients' securities 
fraud, but the statutory provision that now sets out that authority 
provides that the SEC must allege that the lawyer ``knowingly'' 
helped.\23\ Sounds fair enough on its face, but it's not. If one kills 
someone with reckless indifference to human life, most states call that 
murder and treat the defendant with little or no difference from one 
who kills someone with intent (premeditated murders are treated more 
harshly but I am not speaking here about them). If reckless 
indifference equals intent for ordinary folks charged with all sorts of 
crimes, not just murder, why should lawyers not be held to that 
standard too? Indeed, there is more not less reason to insist that 
reckless is as bad as actual knowledge when the defendant is a lawyer.
---------------------------------------------------------------------------
    \23\ 15 U.S.C. 78t(f) (Supp. I 1996).
---------------------------------------------------------------------------
    Lawyers are notorious for never ``knowing'' their clients are 
guilty. That inability is built into the ethos of the bar, which still 
takes its shape from the paradigm of the lawyer as advocate, And by and 
large, as to lawyers charged with defending client's in court, that 
ethos is okay. We do not want lawyers to substitute their judgment of 
the client's guilt for that of the jury or that of the judge. Although 
I hasten to add that this ``no judging'' attitude sometimes leads to 
abuse in courtrooms too, as when litigators believe they have a license 
in civil and criminal cases to assist perjury on the ground that they 
are incapable of ``knowing'' what the truth of the matter is. That 
caveat made, in general it is appropriate that the trial lawyer leave 
``judging'' the client to the finder of fact. That's what trials are 
for.
    But none of that applies to the lawyer who is not litigating a 
matter after the alleged wrong has occurred, but rather one who enters 
the scene before or during the client's wrongdoing--the lawyer in the 
role of a facilitator of the client's transactions. Indeed, very few 
lawyers practice in court compared to the number whose daily work is to 
facilitate transactions. The transaction or office lawyer, as 
distinguished from her trial colleagues, must understand what the 
client is doing and whether that is within or without the law. 
Otherwise, there is simply no reason for the lawyer being there.
    But transaction lawyers share the ethic of trial lawyers that makes 
it difficult to believe, difficult to ``know'' that their clients are 
breaking the law. Complicating that problem is the fact that every good 
transaction lawyer understands, what every good lawyer knows, the lines 
of the law are almost always fuzzy at the edges. It is simply not easy 
to ``know for sure'' when those lines have been crossed, particularly 
when clients want to walk on the wild side and expect their lawyers to 
support that behavior. The lawyer who seems too quick to judge his 
client is likely to be replaced rapidly with one much more willing to 
``believe'' that his client is right.
    Letting lawyers know that there is a price to be paid for failing 
to ``know'' what the facts in front of the lawyer plainly suggest--that 
the client is committing fraud--is absolutely necessary. Without that 
we create a world in which fraud doers can count on high-priced and 
savvy lawyers to help them with their schemes, as long as the fraud 
doer never directly admits to the lawyer precisely what he is up to. 
This is not a world we should encourage. It is a world our law should 
try to erase.
    In 1964, Judge Friendly said this about the importance of holding 
lawyers and accountants liable when they recklessly disregarded 
evidence of their client's securities fraud:
    Congress did not mean that every mistake of law or misstatement of 
fact should subject an attorney or an accountant to criminal liability 
simply because more skilled practitioners would not have made them. But 
Congress equally could not have intended that men holding themselves 
out as members of these ancient professions should be able to escape 
criminal liability on a plea of ignorance when they have shut their 
eyes to what was plainly to be seen or have represented a knowledge 
they knew they did not possess.\24\
---------------------------------------------------------------------------
    \24\ 328 F.2d 854 (2d Cir. 1964).
---------------------------------------------------------------------------
    Congress should change the securities laws to make clear once again 
that such recklessness on the part of lawyers and accountants is enough 
to subject a lawyer to a private suit for money damages from those the 
lawyer's recklessness has helped to harm. Such recklessness is rightly 
thought of as ``criminal,'' given the learning, privileged position, 
substantial financial rewards and expertise that come with being a 
securities lawyer. And if it's rightly thought of as criminal when such 
privileged folks behave recklessly, it should be a civil wrong as well.
    Were the lawyers who represented Enron negligent? Were they 
reckless? Did they actually know, what we now suspect, that Enron 
through its agents was committing securities fraud? I can tell you this 
much I am highly doubtful that they ``knew,'' if ``knowing'' means 
subjectively believing that Enron was breaking the law. I am sure they 
convinced themselves that however close to the legal line Enron was, it 
had not crossed it. I am sure they refused to see and took no steps to 
actively ferret out, facts that would have burst that bubble--facts 
that would have made it difficult to maintain their ``belief'' that 
nothing was rotten in the state of Denmark. Hard as I am on lawyers, I 
can hardly blame them. The law as ``reformed'' by Congress invited them 
to act that way. If they ``knew'' I am sure that it was only in the 
sense that it may have crossed their mind, but any agile legal mind can 
formulate a doubt about whether something is ``illegal'' to chase those 
occasional bogey-men away.
    But the facts (as we know them so far) do seem to suggest that at 
least some of Enron's lawyers and likely some of the lawyers for other 
actors in this drama went way beyond negligence. According to the 
Powers report there were not just red flags all over the place but 
cannons booming and music playing, all with the same message: Enron's 
financial condition is way different than what it (with its lawyers' 
help and its accountants' blessings) was leading everyone to believe. A 
jury need not accept a lawyer's denial of knowledge. It is perfectly 
free to infer that with so many major clues, some of these lawyers did 
``know,'' no matter what they were telling themselves or what they tell 
the jury under oath. That is, a jury can decide not to believe the 
lawyer, assuming a court allows the case to get to the jury, something 
Congress's reforms discourage judges from doing in cases when ``actual 
knowledge'' is in doubt.\25\
---------------------------------------------------------------------------
    \25\ I am referring here to the strong pleading requirements in 
securities actions that Congress has enacted. Whatever merit those 
requirements have, they operate perversely when combined with the 
elimination private cause of action against lawyers for aiding and 
abetting liability and the new ``knowingly'' standard for aiding and 
abetting actions that the SEC retains the power to bring.
---------------------------------------------------------------------------
    But whatever happens or doesn't happen to the lawyers in Enron, 
there is every reason to believe that there will be securities fraud in 
our future and every reason to believe that its success will depend in 
part on lawyer's being asleep at the wheel or acting with reckless 
abandon. Keep in mind that in the past, as will be the case here--
assuming lawyers are found to have substantially assisted fraud at 
Enron--the lawyers who have done wrong were (and will be) members of 
our finest law firms, not some nobodies from nowhere. The bar can 
complain all it wants about federal encroachment on self-regulation, 
but one thing should be abundantly clear by now: Without the discipline 
that fairly certain and substantial liability brings, the bar will not 
reform itself. Lawyers need law at least as much, if not more, than 
everyone else.\26\ You do neither the bar nor anyone else a favor by 
leaving them behind the curtain trusting in their magic caps.
---------------------------------------------------------------------------
    \26\ In the seminal case on lawyer liability for aiding and 
abetting securities fraud, which the bar fought vigorously when it was 
brought by the SEC, the National Student Marketing Case, 457 F.Supp. 
682 (D.D.C. 1978), lawyers at Lord Bissell & Brook were found to have 
aided and abetted securities fraud by sitting by and allowing a merger 
to go forward (without even speaking up to try and stop it) that the 
lawyers should have known (were reckless not to have known) was being 
consummated when the financial information in the proxy statements was 
materially misleading. The court, however, obviously quite sensitive to 
the storm of criticism that the SEC's action had engendered from the 
securities bar (something the court mentions) decided that although the 
lawyers had aided and abetted the fraud, no sanction was necessary 
because they were lawyers and we could trust them to go forth and never 
sin again. A few years later the same (quite otherwise respectable) law 
firm was charged with assisting another client to violate the 
securities laws, a claim the law firm settled for $24 million. In an 
interview with the press after that charge, the managing partner of the 
law firm admitted that the judge's decision on what constituted 
securities fraud--the decision the judge was so sure lawyers would take 
seriously even without a sanction--was never circulated to the partners 
of the firm and that no policies of the firm were changed as a result 
of the ``no penalty'' holding by the National Student Marketing judge. 
See Hazard, Koniak & Cramton, The Law and Ethics of Lawyeri8ng 3d ed. 
(1999) at 117 (footnote c).
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                       Recommendations for Reform
    1. Restore private causes of action against lawyers for aiding and 
abetting securities law (and against accountants too).
    2. Replace the ``knowingly'' standard that now defines the scope of 
the SEC's ability to bring civil actions against lawyers and provide 
that recklessness will suffice in actions brought by the SEC and by 
private parties as well.
    3. Pass legislation that removes the legal cloud that has long 
surrounded Rule 102(e), the securities regulation promulgated by the 
SEC to discipline securities lawyers and accountants.\27\ Make it clear 
in that legislation that the SEC need not first secure a ruling from a 
federal district court affirming that the lawyer has violated the 
securities laws before proceeding against that lawyer via Rule 
102(e).\28\ Finally, affirm a version of the standard that the SEC has 
been pushing for years: in-house and outside counsel who become aware 
of facts strongly suggesting that an agent of a corporation is involved 
in securities fraud must take steps, designed to be effective, to 
ensure that the board understands what the lawyer has discovered and 
must take steps to encourage the board to take action to disclose what 
it has discovered to the SEC and investing public.\29\ A lawyer who 
fails to take such action should be subject to discipline by the SEC 
whether or not he has been found liable or would ever be found liable 
by a court for aiding and abetting a violation of the securities law.
---------------------------------------------------------------------------
    \27\ While the rule has been upheld as a valid exercise of the 
SEC's rulemaking authority as to accountants, see e.g., Touch Ross & 
Co. v. SEC, 609 F.2d 570 (2d Cir. 1979). I am not aware of similarly 
definitive rulings when it comes to the rule's application to lawyers. 
Moreover, the fact that it is a rule and not a clear statutory mandate 
seems to cause court's to withhold deference from the SEC's 
interpretation of the rule and application. Cf. Checkosky v. SEC, 23 
F.3d 452 (D.C. Cir. 1994); and especially, Checkosky v. SEC, 139 F.3d 
221 (D.C. Cir. 1998) (criticizing the SEC's straddling of the fence on 
whether negligence sufficed in a 102(e) proceeding s or whether 
recklessness was the standard for discipline. That matter too should be 
decided. Moreover, I believe that some discipline, although perhaps not 
disbarment or suspension, should be provided on a finding of 
negligence. By definition negligence is the first step on the road to 
recklessness and it should be discouraged, at least when it comes to 
accountants, by the threat of SEC censure or reprimand.
    \28\ See Ann Maxey, SEC Enforcement Actions Against Securities 
Lawyers, 22 Del. J. Corp. L. 537 (1997) (discussing the SEC's 
declaration that it would not use 102(e) against lawyers without first 
seeking a court ruling that the lawyers had violated the securities 
laws.) The declaration was one of many retreats the SEC has had to make 
over the years from its efforts to see to it that securities lawyers 
were not recklessly assisting fraud. For a description of some of that 
history of retreat and how aggressively the bar reacts to any attempt 
by the SEC to rein in reckless securities lawyers. See Hazard, Koniak & 
Cramton, The Law and Ethics of Lawyering, 3d Ed. (1999) at pp. 117-188 
& 739-758. See also Koniak, The Law Between the Bar and the State, 70 
N.Car.L.Rev. 1389 (1992); and Koniak, When Courts Refuse to Frame the 
Law and Others Frame it to their Will, 66 S.Cal.L.Rev. 1075 (1993).
    \29\ This was what the court in National Student Marketing 
described as a lawyer's duty. 457 F.Supp. 682 (D.D.C. 1978). And see In 
re Carter, Fed. Sec. L. Rep ] 82,847 (Feb. 28, 1981); and In re 
Gutfreund Fed. Sec. L. Rep ] 83,597 (Dec. 3, 1992).
---------------------------------------------------------------------------
    4. Ensure that RICO can reach organizations, as Enron may yet turn 
out to be, whose profits are largely the product of fraud. To the 
extent that the restrictions now in RICO on securities fraud as a 
predicate act make that statute ineffective against organizations that 
are (or that evolve into) little more than giant fraud machines, the 
restrictions are unjustified and arbitrarily exclude a set of criminal 
enterprises that cause much more harm than some now covered by the 
statute.\30\
---------------------------------------------------------------------------
    \30\ The brief time I was provided to prepare this testimony did 
not allow me to refresh myself on the precise restrictions in RICO that 
might lead to the result I describe. I will be happy to supplement this 
statement at a later time with more details on this matter.
---------------------------------------------------------------------------
    5. Restore joint and several liability, when a defendant has acted 
recklessly, at least when the defendant is a lawyer, for the reasons 
given above on the problems and inadequacy of an ``actual knowledge'' 
standard of liability for lawyers. (I believe accountants too should be 
jointly and several liable, even when their mental state is 
``reckless'' and not ``actual knowledge.'' As to lawyers and 
accountants, as I explained earlier, their recklessness makes them 
liable to their corporate client for malpractice and punitive damages 
(in almost all states). Given that the corporation already has a claim 
against the lawyers for damages, it makes little sense to make 
defrauded investors wait until the corporation recovers from its 
lawyers (in a negligence action) to have access to money that will 
belong to the corporation sooner or later, assuming it pursues its 
lawyers (and accountants) for malpractice. By eliminating joint and 
several liability, you simply require that there be two lawsuits (the 
investor action against the corporation and the negligence action by 
the corporation against its lawyers and accountants) for the 
corporation to get its hands on the assets that it may have to 
distribute to those harmed by the fraud.
    6. Provide the SEC with sufficient funds to enforce Rule 102(e) (or 
preferably it's new statutory counterpart, see recommendation 4 above) 
and enough funds to bring enforcement actions against lawyers (and 
accountants) who aid and abet securities fraud.
    7. Make clear that language in the Administrative Procedure Act 
that provides that lawyers admitted to the bar of any state may 
practice before any federal agency does not preclude the SEC from 
setting standards for securities lawyers and imposing those standards 
through discipline, including disbarment, in a Rule 102(e) proceeding, 
an administrative enforcement action or any new statutory vehicle you 
may provide.\31\
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    \31\ See 5 U.S.C. 500(b). Note that it does not now appear to 
prevent this, see 500 (d)(2), but it would be wise to remove any doubt 
and save courts from deciding the matter.
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    8. Require, or at least encourage, the SEC and the Justice 
Department to announce that neither will accept for consideration of 
any sort any so-called ``internal investigation'' or ``compliance 
report'' or any similar document that purports to report on alleged 
wrongdoing of a corporation that was prepared by any law firm who was 
in the employ of the corporation at the time that the wrongdoing 
occurred, at least not if that law firm's representation of the 
corporation during the alleged wrongdoing included any matter that is 
covered by the investigatory report. All such reports should include a 
statement by the law firm attesting to its compliance with this 
statutory requirement or government policy.
    9. Finally, I am more than deeply conversant, having written 
numerous articles on the subject, with the abuses committed by 
plaintiffs' lawyers in class action suits, including the abuses that 
occur in securities suits. I am indeed so familiar with this problem 
that I know that much of the most serious abuse involves a form of 
joint venture between unlikely allies: plaintiffs' lawyers and 
defendant corporations (and defense lawyers, of course). The aim of the 
venture: to make money for the venturers at the expense of the absent 
class.
    I would be happy in the future to work with any member of this 
Committee, majority or minority staff, on meaningful reforms to cure 
class action abuse. But making it safe for lawyers and accountants to 
aid fraud-doers with reckless abandon is not the way to address abuses 
in class actions. The primary victims of most class action abuse, in 
securities cases and all other kinds of cases, are members of the 
absent class. Don't ``cure'' that problem by leaving them subject to 
injury by a different group of actors. That would make the cure worse 
than the disease.
                               Conclusion
    If Enron was the Emerald City, no matter what individual or groups 
of individuals end up to have been standing behind the curtain playing 
the Wizard of Oz (be it Enron's CEO, its CFO, some or all of its board 
of directors or whomever), I guarantee you one thing: A lawyer was 
standing beside them making sure the curtain stayed drawn and all the 
bells and whistles were hooked up and operating to fool Dorothy, the 
brainless scarecrow and the cowardly lion.
    You want to clean this mess up? Cherchez les avocats. Take off 
their magic caps by passing legislation that leaves them with no doubt 
that the law applies to them too, not just when they ``know'' what's 
going on but when they act recklessly with little regard for the harm 
they thereby help inflict on the rest of us and on their clients too.

    Chairman Leahy. General Gregoire, again, I thank you for 
being here. I know Senator Cantwell and others had urged that 
you be here. You were one of the leaders in protecting the 
public health with the States' tobacco litigation, so you 
understand as well as anybody in the room the role that State 
attorneys general play in holding corporations accountable.
    Under the civil RICO statute, the Attorney General of the 
United States is the only government actor who can bring a 
suit. Do you believe that it would be a good idea to give State 
attorneys general similar authority under our civil RICO?
    General Gregoire. Senator Leahy, I think I can speak not 
only on behalf of myself, but my colleagues, as well, in that I 
think it is clear that we believe the best law enforcement is 
done as locally as possible. So we would encourage you to 
consider such a move and we could work in partnership with the 
Federal Government, which we do in most actions, but it is 
troubling for us that we are without authority in this regard.
    Chairman Leahy. Another thing, as you know, again, using 
the tobacco case as an example, you are aided by corporate 
whistleblowers. Several of us around here have been prosecuting 
attorneys or plaintiffs' attorneys and we know that many times 
a corporate whistleblower is the first opening. When the window 
opens on wrongdoing, it is often a whistleblower, for whatever 
the reason, conscience or anything else, comes forward. Do we 
need to provide some protection to corporate whistleblowers in 
the securities fraud area?
    General Gregoire. I would urge you to consider this very 
seriously for the reason that with the amendments that were 
made in 1995 to call for a plaintiff to bring a complaint 
forward with particularity and without the ability to do 
discovery, more often than not, we are reliant now on 
whistleblowers bringing forward that kind of detailed 
information so we can plead the cases with particularity.
    If they are not given adequate protection, then I think we 
are going to find ourselves even more incapable of holding 
accountable companies like Enron and others and making it such 
that investors and those of us who represent the public funds 
cannot bring an action because we do not have the information 
and there has been a stay on discovery and we are incapable of 
getting access to it. So I think probably more importantly than 
ever, we have got to protect those whistleblowers.
    Chairman Leahy. In fact, there were whistleblowers at 
Enron. They took some risk in coming forward, did they not?
    General Gregoire. Considerable risk. I am, frankly, 
disappointed that, despite the fact they were shut down there, 
they did not take additional risk and go forward to the SEC or 
to the Justice Department, but I know there was considerable 
fear on their part, so I can also understand it. So protecting 
them, I think, is extremely important.
    Chairman Leahy. Thank you. Professor Koniak, looking back 
through your notes and your testimony, if I am stating it 
correctly, you said the 1994 Central Bank decision, the five-
four Supreme Court ruling that those who aid and abet 
securities fraud, such as accountants and lawyers, the Supreme 
Court held they can no longer be held liable by private parties 
under Federal law. Now, you disagree with that. In fact, you 
described it as monumentally bad, so I would take that as New 
England understatement that you thought the Supreme Court 
screwed up on that one.
    We know from Enron's own report released this week that 
these same types of firms received literally millions of 
dollars in assistance in actually setting up the very corporate 
arrangements which are sort of problematical, but what do you 
think that these financial incentives encourage lawyers and 
accountants to do when they learn about corporate fraud?
    Ms. Koniak. There is absolutely--the decision and the 
legislation that affirmed the Supreme Court decision encourage 
lawyers who already do not need any more encouragement in this 
direction not to know what is going on. Now, for lawyers, 
lawyers are trained not to judge their clients, and that is 
appropriate, particularly for trial lawyers. They are not 
supposed to supplant the role of the jury. Judgment is for the 
jury.
    But most lawyers are not trial lawyers. Most lawyers are 
facilitators of transactions, and their job is to know what is 
going on. But the Supreme Court decision and the legislation 
place a premium on not knowing, not understanding the signs 
that suggested that fraud or other criminal activity was going 
on by insulating a lawyer from liability unless the lawyer 
knew, had actual knowledge, and allowed and encouraged, 
therefore, reckless conduct. Encouraging reckless conduct among 
a profession that is trained to give their clients the benefit 
of the doubt, and for good reasons trained that way, is an 
invitation for disaster.
    Chairman Leahy. But you mention on trial lawyers, for 
example, a trial lawyer, say it is a defense lawyer in a 
criminal case, he cannot aid and abet his client in perjury. He 
could not if they realized, while there is a lawyer-client 
privilege, if he realized the client is planning ongoing 
criminal conduct, he cannot aid and abet that. He has certain 
duties to the court. But are you saying that in this area of 
security fraud, they have sort of specially carved out 
immunity?
    Ms. Koniak. Well----
    Chairman Leahy. Under today's law, using the Supreme Court 
decisions and all that--or maybe a better way of putting it, do 
we need to have the real threat of an aiding and abetting 
liability to keep people in line?
    Ms. Koniak. You need the real threat of aiding and abetting 
liability and the standard of recklessness to keep lawyers in 
line, because lawyers are helpers. The natural way in law to 
express helping is aiding and abetting. And lawyers, again, are 
trained, sometimes for good reasons, not to be the first to 
judge their clients. Lawyers are supposed to stand by, whether 
their clients were corporations, their clients were 
individuals, stand by their client. Knowing and believing in 
your heart that a client did wrong is a hard step for a lawyer 
to take. Understanding that your client very well may have 
conceded wrong because all of the signs are pointing in that 
direction is something that lawyers can see.
    Chairman Leahy. Thank you. Senator Hatch?
    Senator Hatch. Mr. Schatz, Rule 10(b)(5) is still alive and 
well, is it not?
    Mr. Schatz. Yes, Senator Hatch.
    Senator Hatch. It is a pretty broad rule, is it not?
    Mr. Schatz. I am sorry?
    Senator Hatch. It is a pretty broad rule of liability.
    Mr. Schatz. Yes, it is.
    Senator Hatch. Any corporate official or person 
manipulating that stock or making misstatements or errors or 
omissions can be found liable for what is called securities 
fraud, right?
    Mr. Schatz. Absolutely.
    Senator Hatch. It is not like people are left high and dry 
here.
    Mr. Schatz. No, 487 companies were sued this past year.
    Senator Hatch. I am clearly troubled by these events, there 
is no question about it, that led to the Enron collapse and the 
possibility that securities fraud was perpetrated not only by 
Enron executives, but also by analysts and auditors. Of course, 
I think we ought to wait and see what the facts are, too. You 
never know. Companies do fail. But this one looks particularly 
bad, at least according to the media reports.
    Now, based on your extensive experience in securities 
litigation, both before and after the enactment of the PSLRA, 
would any of the reforms made by Congress prevent any culpable 
party in the Enron debacle from being held accountable for his 
or her actions?
    Mr. Schatz. No, Senator Hatch. I think, as I indicated to 
you, the provisions of the Reform Act had nothing to do in my 
mind with the Enron debacle. I think it is apparent that all 
potential parties are going to be brought in as defendants in 
the various litigation and I think at the end of the day, the 
system will work.
    Senator Hatch. The laws are broad enough to catch 
manipulative or errors or emissions or false conduct?
    Mr. Schatz. That is certainly my belief.
    Senator Hatch. Could you go over again the impact of civil 
RICO allegations in security fraud cases? Is it not true that 
the plaintiffs' lawyers often use the threat of treble damages 
to leverage high-tech companies and individuals into settling 
cases they might otherwise defend? If you could also elaborate 
on some of the outcomes you have heard here today, as well.
    Mr. Schatz. First, let me be explicit. In securities class 
action cases, there is virtually never an instance where the 
theoretical plaintiff-style damages are not enormous. You never 
have an instance where you need to treble the amount of 
recovery, because even as it stands now, companies and 
individuals are faced with staggering potential liability. What 
RICO would do, in my opinion, would give an unwarranted tool, 
and by the way, Chairman Levitt agreed that it would give an 
unwarranted tool to plaintiffs' class action lawyers to, if you 
will, extort unreasonable settlements.
    Senator Hatch. Was I wrong in pointing out that a high 
percentage of big board companies are constantly sued and that 
the vast majority of the Silicon Valley firms have been sued by 
plaintiffs' lawyers in class action lawsuits?
    Mr. Schatz. Senator Hatch, I do not know the exact 
percentages, but I can tell you that an enormous number of high 
technology companies have been sued, including companies which 
I think we would all agree are sources of great pride for 
certainly the valley but also the country.
    Senator Hatch. As the chairman pointed out, we are not here 
today to specifically examine, and I am going to ask you this, 
Mr. Lund, the GAO lawsuit. However, the whole reason for the 
GAO suit is to obtain information about Enron, so I believe the 
two issues are interrelated and that is why I asked you to 
testify here today.
    So Professor Lund, as you know, Federalist Number 51, 
perhaps the most frequently quoted single commentary on the 
principle of separation of powers, James Madison wrote there 
that, quote, ``The great security against a gradual 
concentration'' of governmental powers in one of the three 
branches ``consists in giving to those who administer each 
Department the necessary constitutional means and personal 
motives to resist encroachment of the others.''
    In your testimony, you briefly discuss one of these 
``constitutional means.'' Could you please explain or elaborate 
on the appropriate constitutional oversight role of Congress 
and the legitimacy of the GAO's action in this area?
    Mr. Lund. Yes. Thank you, Senator. I think that the passage 
that you cited from Federalist 51, it is always good to think 
about that passage in connection with another passage from a 
different number of the Federalist where Madison pointed out 
that in a republican form of government, the most dangerous 
branch was always the legislature, was always the branch that 
was the most capable of unduly dominating the other departments 
of government.
    With Federalist 51, when Madison talks about giving every 
part of the government the necessary means to preserve its 
constitutional position, I think it is especially important in 
the case of the executive to recognize that that means must be 
adequate to the task, and over the course of our history, it 
has proven adequate to the task, I think in part because 
confrontations between the executive and the legislature have 
taken the form of the--the serious confrontations have taken 
the form of confrontations between elected officials, between 
the President exerting executive privilege, for example, and 
the Congress, the Members of Congress.
    What is a little worrisome about this GAO suit is, first, 
that it is not being--that the Comptroller General is a 
relatively independent and certainly unelected part of the 
legislative branch. It does not have the same political 
constraints on him that elected officials do.
    And second, that it threatens to involve the courts. These 
matters have been litigated to some extent, but the courts have 
been very reluctant, and properly so, to saddle with a kind of 
finality that judicial judgments have the exact nature of the 
proper relationship between the President and the Congress. The 
GAO suit, I think, threatens to bring the courts in in a way 
that may not be healthy.
    Chairman Leahy. Again, I am sure that Vice President Cheney 
is appreciating the defense of his closed-door meetings here, 
but again, I want to emphasize, that is not the purpose of 
this. Others will talk about that. Others have talked about his 
closed-door meetings. I believe the Republican chairman of one 
of the House committees has raised problems with it and others, 
but we are not investigating that.
    Senator Kennedy?
    Senator Kennedy. Thank you very much, and I want to thank 
all the panelists for very interesting and helpful testimony.
    To Mr. Raynor, just with regards to the current bankruptcy 
law and the one that is in conference now, I just give you 
these facts on the Enron situation. It is my understanding that 
just before Enron filed for bankruptcy, several steps were 
taken. First, mid-level and low-level workers were laid off. 
These workers were given nothing. These workers were given 
nothing.
    Then, second, derivative traders were given $50 million in 
retention bonuses, and then executives, 500 executives were 
wired $55 million in retention bonuses the day before the 
bankruptcy. Five hundred received $55 million, and I understand 
some of those employees are still collecting paychecks.
    The day after Enron filed bankruptcy, 4,500 workers were 
laid off, and although their severance packages would have 
totaled $150 million, they were given $4,500, a total of $20 
million under the bankruptcy wage priority. After taxes, they 
received $3,000. Enron told them that under the bankruptcy law, 
the company could not give the workers a larger package.
    Under current bankruptcy law and under the one that we are 
considering in the conference, the workers were not protected, 
were they?
    Mr. Raynor. No, Senator. Not only were they not protected, 
but we believe workers and their pensions should be first in 
line under bankruptcy law to receive funds, and also, as we 
have been saying, this law in Texas and in Florida that allows 
executives to protect mansions while individual workers and 
retirees get thrown out of their apartments and their homes has 
got to be changed.
    Senator Kennedy. Since you mentioned that, I understand in 
Texas, in 1999, their property code was amended to increase an 
urban homestead from one to ten acres, so the law permits a 
Texas resident to claim a residential and business homestead if 
they are on contiguous lots, a person lives and works on them. 
Accordingly, a person who lives and works in a condominium or 
penthouse or even an office building may purchase the entire 
office building to protect their wealth under Texas law.
    But the point I am trying to get at with regards to the 
existing bankruptcy law and the one that is in the conference, 
if we say we are interested in being fair to workers, we have 
learned a powerful lesson. We should not have to keep 
relearning it about what happens to workers under these 
circumstances, and you have made an eloquent case. If we fail 
to protect workers, even under our new bankruptcy law, I think 
it is a shame. I do not know whether you want to express an 
opinion about it.
    Mr. Raynor. Let me say this, that unfortunately, my union 
and America's unions and workers have experienced far too many 
cases where companies go bankrupt and the executives get taken 
care of under existing laws and under many that are being 
proposed and the workers wind up getting cheated. Enron is a 
widely publicized example, but it goes on, Senator, every day, 
and something needs to be done to protect workers in 
bankruptcies instead of corporate executives.
    Senator Kennedy. Tomorrow, our Human Resources Committee 
will be dealing with the pension aspects of the workers and 
what has happened to them and I want to just, if I could, ask 
both you and General Gregoire a question. You are both suing 
Enron because of the losses in the retirement benefit funds, so 
I would like to ask your thoughts regarding the 401(k)-style 
savings plans. Your suits contend improper accounting measures, 
disclosure of false and misleading information, inside trading.
    General Gregoire, you assert that Enron used offshore tax 
havens to hide its debt burden from investors, that it 
misstated its financial position and investors' equity in the 
company. Repeatedly, you point out that it was virtually 
impossible for investors to make educated financial decisions 
because Enron was able to operate in secret with limited 
regulatory review and no independent audit.
    Mr. Raynor, you point out that many of these problems are 
not confined to Enron. Enron is simply one of the worst cases 
of corporate corruption.
    So I share your concern about the business practices that 
led to the losses suffered by the benefit funds, and I am also 
concerned about 401(k)-style funds that hold workers hostage, 
prevent them from selling the matching company stock until they 
are near retirement age. In many cases, workers holding company 
stock have not been permitted to sell the stock as the prices 
tumble, and even if they have access to information, they 
cannot help themselves because they are trapped by the terms of 
their benefit plan.
    For example, like Enron, Polaroid, a major company in my 
State of Massachusetts, forced workers to invest their 
retirement savings in company stock and the employees were 
barred from selling until they quit or retired from the 
company.
    So, Mr. Raynor and General Gregoire, do you believe that 
Congress needs to consider reform legislation to address this 
problem, and if so, perhaps you could share your 
recommendations. Mr. Raynor, we often hear that the existent 
laws governing the 401(k) plans give workers choice and can you 
tell the committee if you believe that choice is meaningful and 
any of your own experience on this issue, any insights that you 
might have.
    Mr. Raynor. Senator, first of all, we think that it ought 
to be illegal for corporations to push the company stock in 
plans, because employees are susceptible to company pressure. 
They do not have the information that corporate executives 
have, and when companies push employees to buy stock, it 
becomes you are disloyal if you do not buy the company stock 
and that needs to be regulated and workers need to be protected 
from that.
    Workers, many of the ones that we represent, do not have 
the knowledge to make those kinds of investment decisions and 
they need protection from their employer, and also protection 
under the administration's proposal to allow money managers to 
use their high-pressure sales tactics on our members about 
investment decisions. That is going to be a disaster, allowing 
Fidelity, for instance, to try to sell----
    Senator Kennedy. That is in the President's proposal?
    Mr. Raynor. Yes, to allow them to sell to workers 401(k) 
investment decisions is something that workers need protection 
from, as well. The H.R. director of Enron was cashing in her 
money at the same time she was enforcing rules that did not 
allow the Enron workers to sell their stock. So, clearly, the--
and many of our members have 401(k) plans, but we believe they 
should be an addition to defined benefit plans and not in place 
of defined benefit plans and we think that Congress ought to 
legislate in that direction.
    General Gregoire. Senator Kennedy, I agree with Mr. Raynor. 
I might simply add that, you know, with respect to State 
pension funds like the one at hand in our State, we are well 
diversified, well diversified. We had every right to rely on 
everything that we did by way of our investment. So I do not 
think you can fault my investment board for what they did.
    But at the end of the day, because of our diversification, 
our employees are still going to get benefits. The problem with 
the employees of companies like Enron and 401(k) is they are 
held captive. That is all they have. They are not diversified, 
and at the end of the day, they end up with nothing.
    So I am here on behalf of the fire fighters and the State 
employees of the State of Washington and the other States to 
say what has happened here is a travesty and it should never 
have been allowed to occur, but I must say, on behalf of the 
workers of these companies, at the end of the day, they are the 
ones who have been most defrauded by this kind of conduct.
    Senator Kennedy. Thank you, Mr. Chairman.
    Chairman Leahy. Thank you. Thank you, Senator Kennedy and 
General Gregoire.
    Senator Specter?
    Senator Specter. I thank this distinguished panel for 
providing a lot of very important information on a great many 
very serious issues. I would like to pose three questions to be 
answered by the panel after the hearing because of the 
limitations of the 5-minute rule.
    First, I would like your opinion as to whether auditors 
should be precluded from doing both--or firms like Arthur 
Andersen should be precluded from doing both auditing and 
consulting work for the same firm, like Enron, since we have 
seen so much of professional opinions being for sale.
    Second, I would be interested in your judgment as to 
whether the Private Securities Litigation Act of 1995 should be 
repealed or modified in light of the testimony here about the 
very sharp limitations on pleading.
    And third, I would like your opinions as to whether 
Congress should legislate specifically by imposing criminal 
penalties on accountants and lawyers who advise their clients, 
like Enron, on how to break the law. The attorney-client 
privilege protects a lawyer on giving advice as to prior 
conduct, but is not applicable to working with a client, which 
is really a co-conspirator and I would like your advice as to 
whether we ought to legislate specifically in this field 
because the imposition of criminal penalties requires great 
specificity and certainly would be in dealing with 
professionals like accountants and lawyers.
    In the limited time I have, I would like to address to you, 
Professor Lund, questions on this issue of executive privilege.
    What I want to ask you specifically, the reference to 
Congressman James Madison is very illuminating on the 
President's right to decline to provide information and the 
Congressional right not to enact legislation if Congress is 
dissatisfied with the information which it has.
    I note the reference in your testimony to the Espy case, 
which articulates the broad doctrine of executive privilege on 
advice to the President, and would note further the opinion of 
the District of Columbia Circuit upholding the action of First 
Lady Hillary Clinton in declining to provide information to the 
inquiring parties, saying that they would avoid the issue as to 
whether she was or was not a Federal employee on the ground 
that Article II was implicated. The circuit there said, quote, 
``A statute interfering with the President's ability to seek 
advice directly from private citizens as a group, intermixed or 
not with government officials, therefore raises Article II 
concerns,'' and the court declined to order that information to 
be given.
    When I wrote to the Comptroller General raising the issues 
of executive privilege and inquiring as to his authority in the 
sense the Vice President is not an agency, certainly would have 
the standing of the President as interpreted by Franklin v. 
Massachusetts, Mr. Walker, the Comptroller General, responded 
in part to me, ``Importantly, the President has not invoked 
executive privilege in this case. Should he do so before we 
file suit, we will assess that development.''
    My question to you, Professor Lund, since a good bit of 
your statement deals with this issue, if the President did 
invoke executive privilege, and I might add to it, I have asked 
the Vice President about it and said that it has not been 
invoked because they feel the statute is not applicable, but if 
the President were to invoke executive privilege, would there 
be any doubt at all that that principle, to protect the 
deliberation and advice to the President, would resolve the 
matter with finality?
    Mr. Lund. Well, there would be very little doubt in my 
mind, but I have to say that these matters have not received 
judicial resolution and once something goes to court, I think 
there is no telling. The courts may agree with me, but they may 
not.
    Senator Specter. Well, is there any doubt under Espy or 
Nixon without a showing of some impropriety----
    Mr. Lund. The Espy court expressly noted that it was 
deciding this case in the context of the Judicial Department 
and noted that a conflict between the executive and the 
legislature would raise somewhat different issues, and that it 
did not explore those issues but it limited the decision to 
cases involving the Judicial Department.
    Senator Specter. But you think that would pretty much 
preclude it, subject to the vagaries of what the next court is 
going to decide on the next issue?
    Mr. Lund. I would certainly expect, but more forcefully, 
hope that if the courts are forced to decide the issue, as I 
understand the issues as they have arisen with the GAO, that 
they would favor the Vice President, but I cannot predict that 
with certainty.
    Senator Specter. You do not have to be a professor or a 
lawyer to understand that possibility. Even Senators understand 
that.
    Mr. Lund. Yes, sir, I understand.
    Senator Specter. Thank you very much.
    Chairman Leahy. Thank you, Senator Specter.
    Senator Kohl?
    Senator Kohl. Thank you, Mr. Chairman. We appreciate your 
calling this hearing today on lessons learned from Enron's 
failure. It would be wise to anticipate the next chapter in 
this story. Where corporations go bankrupt, people often 
follow.
    The next Enron scandal might be right around the corner. 
Texas and four other States allow people who declare bankruptcy 
to keep an unlimited amount of equity in their home. So the 
executives who may be at fault will be able to use the 
bankruptcy code to escape personal responsibility. They will 
continue to live in multi-million-dollar mansions, even as 
their former employees struggle to find a new paycheck or to 
cover their rent.
    Last week, we heard from the wife of Ken Lay, who said that 
they might need to declare personal bankruptcy and sell their 
homes in Aspen. However, Texas's homestead law will allow them 
to keep an unlimited amount of equity in their 13,000-square-
foot Houston penthouse, which is valued at over $7 million. 
Enron's former CFO, Andrew Fastow, has property and a house 
worth almost $3 million. Enron's former CEO, Jeffrey Skilling, 
has a house worth $2.5 million. Under Texas law, if they 
declare personal bankruptcy, they keep their multi-million-
dollar houses while, as you know, their creditors get nothing.
    While the Nation is focused on their misdeeds, real people, 
more than 4,000 of them fired from Enron and with 30 minutes' 
notice, are looking for jobs and trying to pay the bills. 
Millions more have seen their pension funds and personal 
investments disappear before their very eyes. There is no 
justice in a system that puts thousands of people on the street 
without a job, wondering about rent, but that helps 
perpetrators live in multi-million-dollar houses.
    The bankruptcy bill that we passed in the Senate and that 
is now in conference would fix this injustice. It would cap the 
homestead exemption at $125,000 in equity. It is a reasonable 
and common sense solution, and to those who have disagreed with 
this proposition before, I believe the Enron scandal should be 
enough to convince them.
    Mr. Chairman, let us put this in perspective. No Enron 
executive has declared personal bankruptcy yet. You can be sure 
their attorneys are counseling them on how to do it. We have 
seen this before. People like Burt Reynolds, Bowie Kuhn, Paul 
Bilzerian, and others too numerous to list all escaped their 
creditors and kept living like kings. So the question is, do we 
intend to let Enron executives add their names to this list?
    For those of you who are familiar with this homestead 
exemption which exists in five States right now, among which 
Texas is one, do you believe that it is imperative that we fix 
this bankruptcy law and the exception that it has for personal 
domiciles?
    General Gregoire. My answer to you, Senator, would be yes. 
The inequities are obvious and if we are going to protect the 
kind of people who lost their livelihood, lost their pension, 
and have nothing left while let corporate executives who have 
defrauded them, potentially to the tune of a criminal act, get 
by is just not fair in this country and I would implore you to 
do something about it.
    Mr. Raynor. Senator, I have, unfortunately, seen workers in 
bankruptcies lose their homes and there is no law that protects 
them when people take their homes away and throw their 
furniture and their families out on the street. The value of 
the Enron executives' homes are equal to the entire severance 
given to the 4,500 workers who got severance pay. They could 
have doubled the severance had they not had that exemption 
allowing these guys to keep those mansions.
    Senator Kohl. Thank you.
    Mr. Schatz. I would agree that the homestead exemption 
needs to be substantially revised.
    Mr. Lund. I am afraid I have to plead lack of expertise, 
Senator, on these complicated bankruptcy issues. I just do not 
know enough to comment. I am sorry.
    Chairman Leahy. Do not feel bad. Not too many people do.
    Ms. Koniak. I would like to say that, particularly because 
I know you are interested in class action abuse, that class 
actions now still provide a way in settlements for people to 
avoid the bankruptcy laws completely, and any priorities right 
into the bankruptcy laws can be avoided still--the Supreme 
Court has not closed the door on this--by using a class action 
settlement in lieu of bankruptcy under (1)(b)(i) of Rule 23 and 
I think the bankruptcy laws now can be avoided entirely. The 
creditors, any list of priorities you put in there can be 
avoided and you really have to look into that. Until you do 
that, anything you do in the bankruptcy bill is not going to be 
enough.
    Senator Kohl. Thank you. As I said in my statement, with 
the exception of five States now, what we are trying to do is 
to put in the bankruptcy bill an equity of $125,000 which you 
can maintain in a home, but beyond that, you cannot put 
anything into a home and have it exempted. Five States, of 
which Texas is one, have unlimited ability of individuals to 
sink money into a home and have it excepted from bankruptcy 
proceedings.
    Believe it or not, we are having a hard time getting it 
passed. We passed this in the Senate. The House has not passed 
such an exception, and the bankruptcy bill is now in conference 
where this exemption for these five States is attempted to be 
maintained and we are suggesting that we need to have a uniform 
50-State amount of money for domicile exception and we are 
suggesting that be at $125,000.
    I appreciate your comments, and Mr. Chairman, I turn it 
back to you.
    Chairman Leahy. Thank you very much.
    Next is Senator Feinstein. I understand the vote has been 
delayed somewhat. Senator Feinstein?

  STATEMENT OF HON. DIANNE FEINSTEIN, A U.S. SENATOR FROM THE 
                      STATE OF CALIFORNIA

    Senator Feinstein. Thanks very much, Mr. Chairman.
    I just wanted to make a couple of remarks to the panel. In 
my judgment, this case is a real watershed. It points out so 
many things. It points out in the energy sector what has been a 
kind of unregulated, swashbuckling mentality. It points out 
that online futures trading is essentially nontransparent and 
unregulated. It points out the failure for employees, as 
Senator Kennedy mentioned. It is a double whammy. Here, the 
employees lose their job and their retirement. It points out, I 
think, the demise of financial reporting in our country, which, 
as Professor Coffey pointed out in House testimony, has 
deteriorated dramatically over the last 10 years. It points out 
the failure of all gatekeeper mechanisms, the failure of 
independent auditors, of financial analysts, the failure of 
virtually bond-rating agencies to be able to predict and deal 
with this. So all protective measures have essentially failed.
    I think it throws into renewed scrutiny our private 
securities reform litigation, Mr. Schatz. I voted for it. I 
voted to overturn the President's veto, and yet I do not know 
whether the safe harbor on forward reporting, those provisions 
which provide for no regulation really make any sense in this 
new environment.
    So as I see this, this is going to mean a lot of work. I 
mean, clearly, if it is an outside auditor, they should not be 
permitted to do what Arthur Andersen did, be both an outside 
auditor and also be a consultant. As Professor Coffey also 
points out, the consultant aspects of these auditors of big 
companies have now overwhelmed the fees for independent 
auditing. So it has become a whole new area that I think breeds 
a kind of familiarity with the company which is unhealthy in 
terms of its outside independent auditing role. So I see this 
particular bankruptcy as really needing major scrutiny from a 
number of different points of view.
    Let me just, in the time I have left, ask a couple of 
questions. The 1994 Supreme Court case, Central Bank of Denver 
v. First Interstate Bank of Denver, clarified that aiders and 
abetters were not subject to liability in private securities 
fraud cases, making it harder to recover against those entities 
in fraud cases. But it is my understanding that the Congress 
specifically addressed this issue by allowing the government to 
file suit against aiders and abetters. While private suits on 
this basis are not allowed, the government can proceed. Is that 
true?
    Mr. Schatz. That is correct. If that question was directed 
at me, that is correct.
    Senator Feinstein. Does anyone want to add anything on that 
particular question?
    Ms. Koniak. Well, they are allowed to proceed, but 
``knowingly'' is the standard that the SEC is supposed to 
proceed under when they bring an aiding and abetting action and 
that was a change from prior law and it makes it harder even 
for the SEC. Plus, the SEC does not have the resources to go 
after all these aiders and abetters. It always had the right 
beforehand. Private causes of action were there in addition.
    Senator Feinstein. And the SEC, I believe, has asked for 
additional staff and been denied by the Congress, so we are 
going to have to be alert to that, as well.
    Let me ask you this. In the Enron case, do you believe that 
Arthur Andersen was simply aiding and abetting, if the 
allegations are true, or were they direct participants in fraud 
and libel?
    Ms. Koniak. The courts have been struggling since Congress 
changed the Act in 1995 to define the line of when someone 
becomes a primary violator who we normally think of in regular 
parlance as a helper. Accountants are generally helpers. They 
also have liability potentially as primary violators, as do 
lawyers.
    But it is not true, as Senator Hatch said before, that it 
is as easy to get someone as a primary violator as it is as an 
aider and abetter and my testimony gives an example, at least 
one example, where it is very clear the wrongdoing is enormous, 
but whether it can be characterized--it happened to be a lawyer 
in that case, but if it had been an accountant, whether a court 
really could find that that was primary violator versus aiding 
and abetting is unclear. No decision on that matter exists.
    So there are still many situations that could be called 
aiding and abetting that offer substantial assistance, which is 
the standard for aiding and abetting--you have to have 
substantial assistance--that could not be called primary 
violations, and so there is a whole interconduct that is no 
longer available for anyone to go after except the SEC, and 
again, the SEC has a different mental standard than they had 
before to show.
    Mr. Schatz. Senator Feinstein, if I could briefly comment--
--
    Senator Feinstein. My time has expired. Would you allow Mr. 
Schatz to respond?
    Chairman Leahy. Of course.
    Mr. Schatz. First, assuming that the press reports are 
correct, I have little doubt that, given that there were 
audited financial statements here, that Arthur Andersen's 
conduct would be deemed to be a primary violation.
    Second, with respect to your opening comments, I wish to 
point out that the Reform Act's safe harbor provision 
explicitly does not relate to the company's financial 
statements. So that is not a concern and it is not an issue 
that arises from the safe harbor.
    And third, and I think this is something that certainly I 
see in my practice with respect to aiding and abetting, the 
problem that you have here is that, obviously, it is very 
tempting to do something in this case, but, for example, it is 
harder and harder to get conscientious people to serve on 
boards of directors, and when you have aiding and abetting 
liability and you employ joint and several liability when there 
is not knowing misconduct, it is going to become ever 
increasingly difficult to get conscientious people to serve on 
boards.
    Chairman Leahy. Thank you.
    Senator Feinstein. Mr. Raynor, I think, wanted to respond.
    Mr. Raynor. Mr. Chairman, may I comment?
    Chairman Leahy. Go ahead, Mr. Raynor.
    Mr. Raynor. On the last, on Mr. Schatz's comment, I think 
boards of directors in America are pretty much country clubs of 
a lot of wealthy and powerful people and I do not think that 
there is any labor shortage there.
    But in terms of your specific question, the 1995 
legislation protects companies and executives and law firms 
from private litigation. We have got to remember who that 
private litigation is. That is retirees. That is hospital 
workers and hotel workers and garment workers and electricians 
who now control litigation, no longer the lawyers. We are the 
plaintiffs, and so they are protected from us and I think that 
that needs to be repealed.
    Senator Feinstein. Thank you. Thank you, Mr. Chairman.
    Chairman Leahy. Senator Feingold?
    Senator Feingold. Mr. Chairman, thank you for scheduling 
the hearing. I do think that the Judiciary Committee has an 
important role to play in determining what changes in the law 
are necessary in the light of the horrible collapse of such a 
large and influential company. Like other members of the 
committee, I do think that the bankruptcy code is very 
implicated in the Enron failure.
    As we all know, and as the chairman said, the bankruptcy 
reform bills have been sent to a conference committee. The 
Enron situation calls for some hard thinking by that committee 
and I, for one, am very grateful that that bill is not already 
law in the form that it was passed so that we can perhaps 
correct some of these.
    For example, as the chairman said, and it certainly has 
been demonstrated through the tremendous leadership of my 
colleague, Senator Kohl, one provision of the bill that is 
squarely implicated by the debacle is the homestead exemption. 
Should some of Enron's executives be forced into bankruptcy by 
civil judgments that they defrauded investors or employees, we 
will perhaps see them, as Senator Kohl explained, sheltering as 
much of their ill-gotten gains as they can in multi-million-
dollar homes, which will then be protected under the State of 
Texas homestead exemption.
    I certainly want to point out that I think that the 
characterization by the ranking member of what the House bill 
would do in this regard is incorrect, that, in fact, those 
provisions in the House bill do not prevent the ability of 
these individuals to abuse this procedure. A bankruptcy reform 
bill that does not contain limits on the abuse of the homestead 
exemption is a fraud on the American people.
    Now, another provision of the bill in which Enron has shown 
a spotlight is Section 912, the asset securitization, which 
again the ranking member referred to in his remarks, and I have 
to respectfully disagree with him again. This section is a 
deeply misguided effort to shield from the scrutiny of the 
bankruptcy courts transactions that move certain assets off the 
books of a company so that they cannot be reached by other 
creditors. Now, if this provision is included in the final 
bill, whether Enron literally was engaged in this practice or 
not, it will encourage questionable transactions such as those 
that appear to have led to Enron's demise. So I believe that 
Section 912 simply must be deleted from the bankruptcy bill.
    Mr. Chairman, let me also describe a change to the 
bankruptcy code that I plan to introduce to try to address the 
calamities suffered by the employees and the retirees of Enron 
who saw their retirement savings evaporate as the stock value 
of the company plummeted. Under current law, claims that the 
company breached its fiduciary duty under ERISA in its 
management of retirement plans are only an unsecured debt in 
the Enron bankruptcy. What that means in practice is that the 
employees probably will not get anything from the company, even 
if the company broke the law, and that is not right.
    So I will introduce legislation to give the employees' 
claims for breach of fiduciary duties equal status in the 
bankruptcy and equal claims to the assets of the company with 
the secured lenders. If this rule is enacted, Enron's employees 
will have a seat at the creditors' table in the bankruptcy and 
perhaps they will get some satisfaction.
    Just as important, in the future, the market will monitor 
companies to determine whether they are meeting their fiduciary 
obligations in administering their retirement plans. I think it 
would be logical for prospective lenders to require, then, as a 
condition of lending some certification or assurance that the 
company's retirement plans actually pass legal muster. In 
effect, the credit market will then help provide effective 
enforcement of the borrowing company's fiduciary obligations to 
its employees and retirees.
    I look forward to discussing this proposal with my 
colleagues and I hope that we might consider it in the 
committee promptly.
    Now, I was interested in the testimony from Mr. Schatz that 
can be summarized, I think, by saying that the Private 
Securities Litigation Reform Act played no role whatsoever in 
creating the climate in which the Enron scandal occurred and 
will not inhibit those injured by Enron or its accomplices from 
being fairly compensated. I am not sure, but I thought I 
perceived Professor Koniak squirming a bit when she heard that 
and I would like to give her an opportunity to respond.
    Ms. Koniak. The biggest problem with the Private Securities 
Reform Act is not that it makes it difficult, which it does, 
for some defrauded investors to recover. The biggest problem is 
that it takes away the deterrents, particularly from 
professionals who understand how to avoid direct knowledge and 
can put themselves in a situation of plausible deniability, 
which makes it very difficult to show direct knowledge, and, 
therefore, have a license to act recklessly. When you have 
professionals with a license to act recklessly, you will get 
this situation.
    If I might just comment on Mr. Schatz's remark in answering 
Senator Feinstein about how the Andersen lawyers were 
definitely primary violators here, I could not agree more, but 
they will not have enough money to pay everybody and there are 
many other actors who have skirted the line between primary 
violator and aiding and abetting who did substantial help in 
allowing this to happen and were also not just--you should not 
just be legislating with this crisis in mind but with the next 
one in mind.
    And so I disagree in that sense with the importance of 
changing back to the rule we had for 30 or 40 years, so this 
argument about unintended consequences, we know that lawyers 
lived, law firms prospered.
    Senator Feingold. Thank you, Professor. Thank you, Mr. 
Chairman.
    Chairman Leahy. Thank you.
    Senator Cantwell?
    Senator Cantwell. Thank you, Mr. Chairman, and in the 
interest of time, if I could enter a longer statement into the 
record, I would appreciate that.
    Chairman Leahy. Of course.
    Senator Cantwell. Clearly, the State of Washington has been 
greatly impacted by this Enron crisis and we have heard today 
from our Attorney General, who has talked about ratepayers who 
have suffered from perhaps price manipulation and ongoing 
investigation, as well as individual shareholders in our 
pension fund and how that pension fund has been impacted.
    I would like to followup on a question in regard to the 
pension suit. Laws that were passed in the 1990's have limited 
the statute of limitations in this type of suit to 3 years, and 
yet almost half of the losses suffered by our pension fund are 
due to investments in Enron that are outside the statute of 
limitations. This obviously restricts our pension holders and 
what we will be able to recoup.
    General Gregoire. Yes. In fact, for Washington State, our 
claim in the case is for approximately $50 million when, in 
fact, our losses are in excess of $100 million. But because of 
the statute of limitations, we are not able to make that claim.
    Second, when they made their restatement, they went back as 
far as 1997, but because of the statute of limitations, that is 
not included, despite the fact they admit that they were wrong 
in what they said to the public. They misinformed the public in 
1997 and the years subsequent to it. So I think the statute of 
limitations is a real concern to all of us.
    Senator Cantwell. So how do you think we should best 
address that?
    General Gregoire. I think the statute of limitations 
actually ought to occur from when it is known or should have 
been known. I think that is a much more accurate reflection of 
what the statute of limitations ought to be, as opposed to 
starting when they actually began their defrauding.
    The other statute of limitations problem that we have as a 
result of the PSLRA is with respect to those who aid and abet, 
in my opinion. That is the 1-year statute of limitations. If 
you have a stay of discovery that lasts beyond a year, then the 
plaintiffs are unable to get any information that could lead to 
a filing against a lawyer or against an accountant, despite the 
fact they were incapable because of the stay of discovery of 
getting access to that information. That, too, should be told 
once that lawsuit is brought. That is a very troubling aspect 
of the PSLRA.
    Senator Cantwell. Following up on that discovery of 
documents, does the 1995 Act deal with accountants' 
preservation of documents?
    General Gregoire. Well, what happens as a practical matter 
is when accountants do their signature on the financial 
document for the company, they then destroy within 1 year all 
underlying documents that they used in the preparation of that 
statement. That, in this case, with respect to Enron, means 
that all documents held in the possession of Arthur Andersen 
have more likely than not been destroyed, and I mean destroyed 
in the normal course, not just in shredding, from 1997, 1998, 
and 1999. Again, they need to retain those documents, 
particularly when you have a stay of discovery and the statute 
of limitations that you do under the PSLRA. Plaintiffs' counsel 
are put at a tremendous disadvantage, like us in our bringing 
our lawsuit.
    Senator Cantwell. Mr. Chairman, as somebody who has been an 
executive officer of a company, I think that these are very 
important issues to address, as well as how they relate to 
those reforms that we have implemented. I know Mr. Schatz in 
his testimony spoke highly of these provisions, and yet we 
cannot just simply say that they had nothing to do with Enron 
or that Enron was not affected by it. Clearly, our Attorney 
General is having a challenge getting the documents and 
information that we need.
    Madam Attorney General, I would like to point out, as well, 
that in your FERC investigation, which is in addition to the 
pension fund suit that we have the same challenges of getting 
our hands on documents and information. In fact, I think one of 
our utilities has been slapped with a restraining order to 
prevent it from disclosing the terms of their Enron contract. 
This is a critically important issue for us.
    I had to leave the hearing, Mr. Chairman, to attend the 
Energy Committee, where the FERC general counsel was 
testifying, and where he reiterated FERC's commitment to 
investigate and said that they were in the process of 
determining what documents needed to be collected before the 
Commission could make a final decision that the investigation 
could move forward. Attorney General Gregoire, do you want to 
comment on what kind of documents in that case we need?
    General Gregoire. Well, just last June, I testified here in 
the Senate, and at that point, Enron indicated that they would 
fully cooperate. We ended up in document discovery taking that 
issue to the State Supreme Court in California, which said that 
the State attorneys general were entitled to document 
discovery. Despite that, on January 16, we brought a motion in 
California court against Enron specifically to be held in 
contempt for failure to comply with that order. And finally, on 
January 31, they gave us our first document discovery, a year 
after we made our first request.
    Again, that kind of failure to disclose, failure to 
cooperate with a law enforcement investigation, I think 
probably could have unveiled some of this some time ago, not 
just with regard to the energy crisis but the collapse of Enron 
that we see that has led to the shareholders' suit, as well.
    Senator Cantwell. Thank you, Mr. Chairman. I see my time 
has expired.
    Chairman Leahy. Thank you, Senator.
    We will put statements in the record for all members. We 
will leave the record open until the end of the day for that.
    I am going to recess for a few minutes. We obviously have a 
roll call vote on. Senator Edwards will be recognized next. If 
he comes back from his vote, he can take the gavel.
    This has been a fascinating panel and I will state more of 
my thanks to all of you, but thank you very much.
    [Recess from 12:03 p.m. to 12:37 p.m.]
    On the basis that many are called, et cetera, et cetera, I 
understand from staff that the Senators who had to go over to 
vote are now double-teamed into other schedules and will not be 
coming back. As a result, we will wrap up this hearing.
    Could I suggest this to each of the witnesses. If you go 
back over your testimony and you find that you want to 
elaborate on a point, feel free to do so. This is not a game of 
``gotcha'' in this committee. At least, that is not the way I 
run committees. We want to educate the Judiciary Committee and 
the staff. So if you see things that you wish you had said, 
note that as an addendum for the record and it will be included 
in the record. If you find that you stated a fact or a citation 
wrong and want to change that--I doubt if anybody on this panel 
would, but, in fact, sometimes we get some that would--you are 
allowed to do that.
    I will also hold the record open for 24 hours for Senators 
to add any further statements, including if Senators from other 
committees wish to.
    Some of you have been here before and you know how chaotic 
it can get. We in the Senate are trying to build a record here, 
and I am in the Judiciary Committee, for some of the issues 
that come before us, whether it is securities legislation, to 
the extent that we are involved, criminal matters, for which we 
are always involved, or the bankruptcy conference which is now 
underway. The things you have said will be involved in that.
    I think all Americans--again, this is not a partisan 
issue--all Americans are distressed by what has happened with 
Enron. As I said earlier, you cannot legislate away greed. 
Unfortunately, greed is always there. You can, however, take 
legislative steps to punish those whose greed tramples on 
others and make others suffer. It is one thing when Michael 
Douglas gets a well-deserved Oscar for his role as Gordon 
Gekko, where he spoke of ``greed is good.'' That was a movie. 
There are no Oscars being given out to the people at Enron or 
at Arthur Andersen nor should they get one.
    I thank you very much and we stand in recess.
    [Whereupon, at 12:40 p.m., the committee was adjourned.]
    [Submissions for the record follow.]
    [Additional material is being retained in the Committee 
files.]
                       SUBMISSIONS FOR THE RECORD

  Statement of Hon. Maria Cantwell, a U.S. Senator from the State of 
                               Washington

    Thank you, Chairman Leahy for holding this hearing and for inviting 
my home state's Attorney General, Christine Gregoire, to testify before 
the committee today on behalf of the people of Washington state.
    Mr. Chairman, working people in Washington state--including our 
teachers, police, and firefighters--lost over $100 million dollars as 
their pension fund's investment in Enron collapsed.
    Attomey General Christine Gregoire has taken a leadership role in 
filing a class-action lawsuit on behalf of investors defrauded by 
Enron.
    In addition to her work on behalf of investors, she has played a 
key role in defending ratepayers and consumers against unfair market 
manipulation by Enron.
    We are fortunate to have her with us today to give us the 
perspective of state Attorneys General.
    At its core, Enron was a make-believe company more worthy of a 
paperback novel than a business school textbook.
    But even as the details of how Enron defrauded its shareholders 
emerge, we are now learning of a new scheme to bilk ratepayers and line 
Enron's pockets.
    Some of the very same people who have lost money in my state's 
pension fund are now hit with a double whammy.
    Why? Because despite its collapse, Enron continues to earn hundreds 
of millions of dollars from over- inflated energy contracts which have 
resulted in massive rate hikes for consumers--including the very same 
people who lost money in my state's pension fund.
    I was visited by a representative of a utility in rural Washington 
state recently. This utility has been forced to raise its rates by 
about 40 percent in the last year. Customers visit its office daily--in 
tears--because they simply can't pay their power bills.
    What is shocking is that even after its bankruptcy, Enron has 
charges this utility and others like it energy prices more than triple 
today's market.
    Mr. Chairman, where there's smoke there is usually fire, and when I 
hear that Enron has charged utilities triple current market rates, I 
naturally become extremely suspicious.
    And in yet another blatant attempt to conceal its activities, Enron 
has actually slapped a restraining order on one Northwest utility, to 
prevent it from disclosing just how absurd the terms of its contract 
are.
    Last week the Energy Committee--on which I serve with Sen. 
Feinstein and others here today--heard testimony that Enron is only 
able to charge such high-prices for long-term contracts because it was 
able to manipulate prices in forward energy markets.
    The Federal government has an obligation to right this wrong for 
energy consumers in the West.
    That is why I called upon FERC Chairman Pat Wood to open an 
investigation into whether power prices in the West have been unjust 
and unreasonable as a result of alleged manipulation by Enron.
    Thank You.

                                

            Statement of Lauren Pfeifle, Justice Department

    The Justice Department today released the following statement on 
the Enron investigation:
    ``The Justice Department sees no reason to appoint a special 
counsel to investigate the Enron matter. Our investigators have a duty 
and responsibility to enforce the criminal laws in this matter. 
Regulations call for the appointment of a special counsel when 
prosecution by the Department would both present a conflict of interest 
and serve the public interest.
    ``Neither of these criteria exist for the Department of Justice in 
this case. No conflict of interest exists. No person involved in 
pursuing this investigation has any conflict, or any ties that would 
require a recusal. Failing to carry out our duties and responsibilities 
in investigating this matter would not serve the public interest.''
    On background, the regulation on ``Grounds for Appointing a Special 
Counsel'' states: ``The Attorney General, or in cases in which the 
Attorney General is recused, the Acting Attorney General, with appoint 
a Special Counsel when he or she determines that criminal investigation 
of a person or matter is warranted and (a) that investigation or 
prosecution of that person or matter by a United States Attorney's 
Office or Justice litigating Division of the Department of would 
present a conflict of interest for the Department or other 
extraordinary circumstances, and (b) that under the circumstances, it 
would be in the public interest to appoint an outside Special Counsel 
to assume responsibility for the matter.''

                                

Statement of Hon. Russell D. Feingold, a U.S. Senator from the State of 
                               Wisconsin

    Mr. Chairman, I want to thank you for scheduling this hearing. It 
may seem like every committee in the Congress wants to get into the 
Enron act, but I do think that the Judiciary Committee has an important 
role to play in determining what changes in the law are necessary in 
light of this horrible collapse of such a large and influential 
company.
    I want to talk first about an area of the law that has not been 
addressed by the testimony today, but that I think is squarely 
implicated by the Enron failure--the bankruptcy code. As we all know, 
bankruptcy reform bills have been sent to a conference committee. The 
Enron situation calls for some hard thinking by that committee.
    One provision of the bill that is squarely implicated by the Enron 
debacle is Senator Kohl's amendment dealing with the homestead 
exemption. Should some of Enron's executives be forced into bankruptcy 
by civil judgments that they defrauded investors or employees, we will 
undoubtedly see hem sheltering as much of their ill-gotten gains as 
then can in multi-million dollar homes, which will then be protected 
under the State of Texas's homestead exemption. As I have said before, 
a bankruptcy reform bill that does not contain limits on abuse of the 
homestead exemption is a fraud on the American people.
    Another provision of the bill on which Enron has shone a spotlight 
is Section 912, asset securitization. This section is a deeply 
misguided effort to shield from the scrutiny of the bankruptcy courts 
transactions that move certain assets off the books of a company so 
that they cannot be reached by other creditors. If this provision is 
included in the final bill, it will encourage questionable transactions 
such as those that appear to have led to Enron's demise. Section 912 
simply must be deleted from the bankruptcy bill.
    Mr. Chairman, let me also describe an change to the bankruptcy code 
that I plan to introduce to try to address the calamity suffered by the 
employees and retirees of Enron who saw their retirement savings 
evaporate as the stock value of the company plummeted. Under current 
law, claims that the company breached its fiduciary duty under ERISA in 
its management of the retirement plans are only an unsecured debt in 
the Enron bankruptcy. What that means in practice is that the employees 
probably won't get anything from the company, even if the company broke 
the law. That's not right.
    I plan to introduce legislation to give the employees' claims for 
breach of fiduciary duties equal status in the bankruptcy. and equal 
claim to the assets of the company with the secured lenders.
    If this rule is enacted. Enron's employees will have a seat at the 
creditor's table in the bankruptcy and perhaps get some satisfaction. 
Just as important in the future, the market will monitor companies to 
determine whether they are meeting their fiduciary obligations in 
administering their retirement plans. I think it would be logical for 
prospective lenders to require, as a condition of lending, some 
certification or assurance that the company retirement plans pass legal 
muster. In effect, the credit market will help provide effective 
enforcement of the borrowing company's fiduciary obligations to its 
employees and retirees.
    I look forward to discussing this proposal with my colleagues and I 
hope, Mr. Chairman, that we might consider this in the committee 
promptly, either as part of the bankruptcy conference or as separate 
legislation.

                                

Statement of Hon. Charles E. Grassley, a U.S. Senator from the State of 
                                  Iowa

    Thank you Senator Leahy for calling this hearing. I agree there are 
lessons that we can learn from Enron's collapse, particularly with 
respect to accountability issues. I share in my colleagues' outrage 
over these events, and truly feel for the workers and innocent 
investors who lost their jobs and life savings
    Government and Congressional investigators, as well as the media 
and legal prosecutors, are still hard at work trying to get at all the 
facts surrounding this case. But from what I read in the papers and 
from my staff's own investigative work, the facts don't look good. As 
efforts to uncover all the facts surrounding the Enron debacle proceed, 
there are legislative actions that we in Congress can take to ensure 
that similar corporate missteps, including fiduciary mismanagement, 
aren't allowed to fester elsewhere
    There may be other cases of misconduct that we'll need to learn 
more about. For example, what about the Global Crossing bankruptcy? 
Obviously something smells when you have the Democratic National 
Committee Chairman - who just happens to be a buddy of the Chairman of 
Global Crossing - ten a $100,000 stock investment into what's been 
reported to be an $18 million mega-profit, while employees and 
shareholders are left holding the bag when the company goes bankrupt. 
Who knows, there may be more than one Enron out there ready to happen. 
Let me be loud and clear, corporations must get their shop and books in 
order even before we in Congress make changes to the laws. You know 
what the problems are, so fix them. Common sense needs to rule. If not, 
the integrity of our financial markets is in big trouble
    As the senior Republican member on the Finance Committee, I've 
focused on doing something about a number of tax and pension related 
problems that have been exposed by the Enron collapse. In fact, I've 
been working on legislation to tighten pension protections for working 
and retired Americans. The failure of Enron has been such a devastating 
blow to the shareholders, workers and retirees who invested in Enron 
stock
    Furthermore, it's a real issue when the top dogs can cash out their 
stock options, but employees are prohibited from doing so. According to 
news reports, top Enron officials were allowed to sell their shares 
before the stock value bottomed out, while rank-and-file employees were 
left out to dry. This behavior smacks of mismanagement and moral 
disregard for the loyal workforce and retired employees. This cannot 
happen again.
    I'm also drafting a legislative proposal that would help the IRS 
prevent tax cheats from shielding tax liabilities with the use of 
corporate tax shelters and other vehicles often used as tax-free 
havens. Enron may have used as many as 900 tax-haven subsidiaries to 
avoid taxes and mask financial debts. That's disturbing, and 
underscores the need for full disclosure of tax shelters so the IRS can 
better police their use. My investigative staff is getting to the 
bottom of this.
    Moreover, the Enron crash raises serious ethical questions about 
the roles of auditors and consultants, as well as inside and outside 
legal counsel who make representations about a company' s finances. In 
order for markets to work, there must be transparency and accuracy in a 
company's books so that investors and shareholders can get the whole 
picture and make informed decisions. Complete and accurate information 
is the foundation for a fair system, a system that Americans can have 
confidence in. People invest in stocks because they think they've 
gotten honest, open and full disclosure of a company's financial 
condition. We need to reevaluate the rules eliminating conflict of 
interests in the work of auditors, consultants, analysts and lawyers, 
so that any report they produce is honest, accurate and transparent, 
and so the work is independent and hasn't been tainted by inside 
interests. In addition, we should make sure that the government 
regulators are not asleep at the switch. They need to be ready to crack 
down on those who cook the books and abuse the system. Ultimately, we 
need to preserve the integrity of the market system by safeguarding the 
integrity of information given to the public.

                                

 Statement of Hon. Herb Kohl, a U.S. Senator of the State of Wisconsin

    Thank you for calling this hearing on the lessons learned from 
Enron's failure. It would be wise to anticipate the next chapter in 
this story. Where corporations go bankrupt, people follow. And the next 
Enron scandal might be right around the corner. Texas and four other 
states allow people who declare bankruptcy to keep an unlimited amount 
of equity in their home. So the executives who may be at fault will be 
able to use the bankruptcy code to escape personal responsibility. They 
will continue to live in multimillion-dollar mansions--even as their 
former employees struggle to find a new pay check or to cover the rent.
    Last week, we heard from the wife of Ken Lay who said that they 
might need to declare personal bankruptcy and sell their homes in 
Aspen. But Texas' homestead law will allow them to keep an unlimited 
amount of equity in their 1 3,000-square-foot Houston penthouse--valued 
at $7.1 million. Enron's former CFO, Andrew Fastow, has property and a 
house worth almost $3 million. Enron's former CEO, Jeffrey Skilling, 
has a house worth $2.5 million. Under Texas law, if they declare 
personal bankruptcy, they keep their multimillion-dollar houses. Their 
creditors get nothing.
    While the nation is focused on their misdeeds, real people--more 
than 4,000 of them fired from Enron with 30 minutes notice--are looking 
for jobs and trying to pay the bills. Millions more have seen their 
pension funds and personal investments disappear before their very 
eyes. There is no justice in a system that puts thousands of people on 
the street without a job and wondering about the rent, but that helps 
perpetrators live in multimillion-dollar houses. That's just wrong.
    The bankruptcy bill that the Senate passed and that is now in 
conference would fix this injustice. It would cap the homestead 
exemption at $125,000 in equity. It is a reasonable and common-sense 
solution. And to those who have disagreed with this proposition before, 
the Enron scandal should be enough to convince you.
    Mr. Chairman, let's put this in perspective. No Enron executive has 
declared personal bankruptcyyet. But you can be sure their attorneys 
are counseling them on how to do it. We've seen this before: Burt 
Reynolds, Bowie Kuhn, Paul Bilzerian and others too numerous to list 
all escaped their creditors and kept living like kings. Do we intend to 
let Enron executives add their names to this list?

                                

  Statement of Hon. Jon Kyl, a U.S. Senator from the State of Arizona

    Thank you, Mr. Chairman.
    On December 2, 2001, Enron Corporation filed the largest corporate 
bankruptcy in the history of America. Many thousands of investors 
across the country have seen their stock become worthless, and 
thousands of employees have lost both their jobs and their lifetime 
401(k) retirement savings.
    In one way, Enron's collapse demonstrates that no company can 
consider itself ``too big to fail'' in our free-market system; schemes 
like the ones we've been reading about simply won't be sustainable 
forever. Yet the sudden bankruptcy of the seventh largest U.S. 
corporation raises questions about the federal government's role and 
responsibilities in a free market.
    Both Houses of Congress and the Departments of Justice, Labor, 
Commerce, as well as the Securities and Exchange Commission, and the 
Commodities and Futures Trading Commission, have begun investigations 
to determine whether the company violated federal accounting standards, 
securities laws, and pension laws.
    Specifically, these investigations will seek to establish whether 
or not, through the use of accounting gimmickry and artifice, the 
company defrauded its investors by systematically failing to disclose 
financial liabilities that degraded the real value of company stock; 
and whether or not it harmed its employees by violating the federal 
pension statute, the Employee Retirement Income Security Act (ERISA), 
which requires employers to act as fiduciaries by managing employee 
retirement funds ``exclusively for the benefit of plan participants and 
beneficiaries.''
    To address the pension issues highlighted by Enron's implosion, 
President Bush in his State of the Union Address called upon Congress 
to enact new protections so that 46 million American workers will have 
confidence that the collective $4 trillion they have invested for their 
retirement--a tremendous source of capital for the national economy--is 
available when they need it.
    The President has proposed to: 1) afford workers greater freedom to 
diversify and manage their own retirement funds; 2) require that senior 
corporate executives are held to the same restrictions as average 
American workers during trading ``lockdown'' periods; 3) ensure that 
workers see quarterly information about their investments and their 
right to diversify, and 4) expand workers' access to independent 
investment advice for which the employer would not be liable. (One of 
the major problems in the Enron case is employees who did not diversify 
their investments, but instead chose to put most or all of their 401 
(k) contributions into Enron stock. Social Security presents a similar 
undiversified system, except that there is no choice.
    Since Enron's failure, many who have defined retirement security in 
terms of Social Security, a single plan headed for bankruptcy which 
forces workers to invest in one financial instrument, U.S. Treasuries, 
have concluded that mandatory diversification is a wise investment 
strategy.) The Congress will also consider whether to implement a rule 
that I have supported which would bar accounting firms--such as Arthur 
Andersen, Enron's accountant--from providing both auditing and 
consulting work for the same client. I believe such an arrangement 
creates an inherent conflict of interest. It is important to remember 
that a Certified Public Accountant's first obligation is to the public, 
not the payor.
    These comments are offered in my capacity as a U.S. Senator and as 
a member of the legislative branch of government, a government in which 
the constitutional separation of legislative, executive, and judicial 
powers is scrupulously maintained. My purpose is not to influence the 
ongoing DOJ, Commerce, Labor, SEC or CFTC regulatory processes, or to 
anticipate the conclusions of any future judicial proceedings.
    Rather, it is merely to offer my view on why Congress must take 
care to gather the facts and make whatever statutory changes are 
necessary to restore employee confidence in our retirement system and 
investor confidence in our capital markets. Because these 
investigations have just begun and may ultimately be resolved in 
criminal and civil courts, it is very important that Congress not 
prejudge the outcome.
    The congressional role of patient finder of fact is especially 
critical here. We may well end up legislating new protections, but we 
should not act in such a way that employers will be discouraged from 
offering 401(k) plans, an important benefit they voluntarily offer.
    Mr. Chairman, based on initial press accounts, I believe I am safe 
in saying that no employee or investor, no matter how sophisticated, 
could have known the full extent of Enron's obligations. Until firms 
are required to disclose completely information about their obligations 
and liabilities, employees and stockholders will not know which firms 
are burdened by debts that don't appear on balance sheets--debts that 
reduce the true value of the stock.
    We can assume that, if stockholders can't reliably know the extent 
of corporate obligations, they will stop buying stock. If this happens, 
our capital markets will forfeit the public trust that allows them to 
function. Our economy will stagnate, our standard of living will 
decline, and the personal and business tax revenues necessary for vital 
government functions such as defense and law enforcement will be 
depleted.
    Those of us with an appreciation for free markets have a special 
burden to police capitalists who abuse their freedom; we must do all we 
can to restore confidence in the system that we advocate as the best in 
the world. Those who are convicted of wrongdoing must be punished to 
the full extent of the law.
    All Americans have a special interest in the healthy function of 
the markets. I agree with George Will that a properly functioning free-
market system ``is a complex creation of laws and mores that guarantee, 
among much else, transparency, meaning a sufficient stream--a torrent, 
really--of reliable information about the condition and conduct of 
corporations. By casting a cool eye on Enron's debris and those who 
made it, government can strengthen an economic system that depends on 
it.''
    Mr. Chairman, I could not have said it better. I look forward to 
working with the Chairman, the Ranking Member of the Judiciary 
Committee, and all of my colleagues in the Senate to take the steps 
needed to restore trust in a framework--namely, democratic capitalism--
that has undeniably brought the most benefits to the largest numbers of 
people of any system ever devised.

                                

                          The Retirement Systems of Alabama
                             Montgomery, Alabama 36104-2150
                                                   February 1, 2002

The Hon. Jeff Sessions
United States Senate
495 Russell Senate Office Building
Washington, DC 20510

    Re: Enron

    Dear Senator Sessions:

    As I am sure you know, the Retirement Systems of Alabama (RSA) 
manages and administers the retirement plans and funds for all public 
education employees and most state, county and city employees in the 
State of Alabama. RSA manages and invests approximately 26 billion 
dollars which is held in trust for the payment of Retirement benefits 
for approximately 280,000 active and retired public Employees.
    As prudent investment standards require, these funds are diversely 
invested in stocks, bonds, real estate and cash, Approximately 44% of 
our retirement fund assets are invested in stocks and approximately 85% 
of that is indexed to the S&P 500, Midcap and Smallcap indexes and 
approximately 15% is actively managed Consequently, when the Enron 
``crash'' occurred RSA suffered a $14 million loss on the sale of Enron 
stock, although RSA earlier realized trading gains amounting to $48 
million, and RSA is left with bonds for which we paid approximately $44 
million and which are currently valued at approximately $9 million.
    Fortunately, because of the size of our investment trust, our 
conservative investment strategy and the diversification of our 
investments, the Enron loss has not endangered our ability to pay 
benefits which our retirees have earned. Furthermore, because our 
Retirement plans are defined benefit plans, rather than defined 
contribution plans benefits are guaranteed as obligations of the RSA, 
as a stockholder and a bond holder, is a member of the classes in the 
numerous class action securities fraud lawsuits which have been filed 
in Houston, Texas, against Enron, its officers and Arthur Andersen. We 
have joined with the states of Georgia, Ohio and Washington in their 
effort to seek lead plaintiff status in that litigation. Unfortunately, 
it is generally believed that available assets of Enron and its 
officers and auditor will not be enough to provide meaningful relief to 
Enron's many creditors and defrauded stockholders.
    It is my hope that: (1) those responsible for this fraud on 
investorsEnron officers, auditors, and any others who participated and 
contributed to this fraudwill be held accountable and sill be required 
to disgorge any personal wealth acquired in this nefarious enterprise 
as a strong deterrent to others, and (2) federal and state regulatory 
actions will be taken to diminish the chances of something like this 
ever happening again.
    It is probably too late to help those who were defrauded by Enron 
and its officers but we should make every attempt to see that innocent 
investors are not defrauded in this manner and on this scale in the 
future.
            Sincerely,

                                           David G. Bronner
                                            Chief Executive Officer

                                

                              Duke University School of Law
                          Durham, North Carolina 27708-0360
                                                   January 24, 2002

Senator Patrick Leahy
433 Russell Senate Office Bldg
United States Senate
Washington, D.C. 20510

Congressman F. James Sensenbrenner
2332 Rayburn House Office Building,
Washington, D.C. 20515-4909

    Dear Chairman Leahy and Chairman Sensenbrermer:
    I am very troubled by the January 23 letter delivered to you by a 
group of law professors opposed to section 912 of S.420/H.R. 333. The 
suggestion that section 912 would encourage the types of off-balance 
sheet financing that Enron abused is misleading for two reasons. First, 
Section 912 addresses only securitization transactions, which are not 
the types of off-balance sheet financing that caused the problems in 
Enron. Second, the problems in Enron do not appear to have been caused 
the problems in Enron. Second, the problems in Enron do not appear to 
have been caused by the creation and use of special purpose entities, 
per se, but rather by the off-balance sheet accounting treatment of 
such entities and their specially lobbied exemptions from the 
investment company act. Accounting treatment is governed exclusively by 
generally accepted accounting principles, promulgated by the Financial 
Accounting Standards Board and having nothing whatsoever to do with 
section 912. And the specially lobbied exemptions from the investment 
company act appear to apply only to Enron, so there well be no further 
similar abuses.
    Using the Enron debacle to oppose section 912 threrefore relies on 
a false analogy. I have taken the liberty of attaching a forthcoming 
law review article that analyzes section 912 in some detail. The 
article concludes that section 912 represents a public good and, if 
enacted, would foster significant economic benefits.
    Thank you for your consideration.
            Sincerely,

                                         Steven L. Schwarcz
            Professor of Law & Professor of Business Administration

                                

Statement of Steven L. Schwarcz, Duke University School of Law, Durham, 
                             North Carolina

    I have been asked to testify on section 912 of S.420/H.R.333. My 
testimony is intended to supplement the letter and attached article 
that I sent to Senator Patrick Leahy and Congressman F. James 
Sensenbrenner on January 24, 2002, expressing concern over a January 23 
letter delivered to them by a group of law professors opposed to 
section 912.
    Section 912, as you know, would create a ``safe harbor'' under 
bankruptcy law for true sales of eligible assets in securitization 
transactions. My background includes both scholarly expertise and 
extensive practical experience in the fields of securitization and 
bankruptcy. Prior to joining the Duke faculty, I was a partner at two 
leading law firms, where I was principally engaged in representing 
creditors and debtors in bankruptcy cases and in structuring 
securitization transactions. I also taught courses in bankruptcy and 
securitization at Yale Law School and Columbia Law School. In 1996 I 
became Professor of Law at Duke University, where my areas of 
scholarship include bankruptcy and securitization. Among numerous works 
in these fields, I have authored the widely used Structured Finance, A 
Guide to the Principles of Asset Securitization (3d edition Jan. 2002).
    I believe that section 912 represents a public good and, if 
enacted, would foster significant economic benefits. Securitization is 
believed to be the most rapidly growing segment of the U.S. credit 
markets. The Securities and Exchange Commission has characterized it as 
one of our country's dominant means of capital formation. The most 
critical issue in a securitization is whether the transfer of eligible 
assets from a company to a special purpose vehicle (SPV) constitutes a 
sale under bankruptcy law, usually referred to as a ``true sale.'' True 
sale characterization is usually necessary for the securitization 
transaction to successfully attract outside investors.
    The law governing true sale characterization, however, is muddled 
and ambiguous. As a result, many otherwise viable securitization 
transactions cannot be done. Furthermore, even viable securitization 
transactions generate excessive transaction costs, mostly involving 
lengthy legal opinions on the issue of true sale characterization. 
Section 912 recognizes that these transaction costs are wasteful. It 
would minimize these costs by permitting true sale issues to be 
promptly resolved by examining the transactional documentation. 
Moreover, section 912 should provide a basis to do away with the 
present need in many securitization transactions for a two-tier 
structure. This would allow the benefits of securitization to be 
extended to middle-market companies.
    There are no overriding policy reasons that would favor the current 
state of legal ambiguity on true sale characterization. Opponents of 
section 912 essentially argue that its safe harbor would provide 
participants in securitization with an ordinate degree of protection 
and immunity from the normal operation of the bankruptcy system at the 
expense of other creditors and debtors that seek to reorganize under 
the shelter of the bankruptcy laws. Those arguments, however, raise the 
larger question of whether securitization is efficient and fair. I 
believe, and have argued at length, that it is. Securitization merely 
replaces financial assets with cash. Unsecured creditors have the same 
amount of unencumbered assets to levy against after the securitization 
as they did before the securitization.
    Some may argue that securitization nonetheless could hurt creditors 
where the cash received is wasted by the company originating the 
securitization. But one cannot assume wasteful behavior simply because 
a company sells assets for cash. In fact, given the scrutiny imposed by 
rating agencies--section 912 requires that at least one nationally 
recognized, Securities and Exchange Commission-approved rating agency, 
such as Standard & Poor's or Moody's, has rated at least one class of 
the SPV's securities to be investment grade--securitization may present 
fewer opportunities for wasteful behavior than other financing methods.
    Nonetheless, securitization, just like any other sale of assets by 
a company, may become suspect if implemented when the company is on the 
brink of bankruptcy. The potential for such suspect actions, however, 
is not unique to securitization transactions. The same issues would 
arise, for example, if on the eve of bankruptcy a company sold, or 
borrowed money by encumbering, a factory or equipment and similarly 
sought to dissipate the sale or loan proceeds. Such questionable uses 
of proceeds are more appropriately addressed by the existing network of 
preference and fraudulent conveyance laws.
    Moreover, securitization increases overall value by providing a new 
source of financing, the capital markets, whose rates are 
systematically lower than the rates at which many companies commonly 
borrow. So long as the added transaction costs are less than the 
interest saved by using securitization instead of secured financing, 
there is a net gain.
    This begs the question, however, why the capital markets should be 
prepared to fund securitization transactions at a lower rate than 
secured financing. It's because a securitization based on a ``true 
sale'' effectively can separate the source of payment of the SPV's 
securities from the risks associated with the company originating the 
transaction, largely eliminating the need for investors to monitor the 
original company's financial condition. Although the risks associated 
with servicing and collecting the eligible assets still necessitate 
some monitoring, these risks are borne by specialists who are in the 
business of precisely assessing and absorbing such risks.
    I acknowledge that--all other things being equal--the safe harbor 
for securitization proposed in section 912 to some extent would act 
counter to the bankruptcy goal of debtor rehabilitation. That's because 
the safe harbor would prevent a court from re-characterizing a 
securitization ``sale'' as a secured loan even though, in a bankruptcy 
reorganization case, eligible assets consisting of a business's 
receivables are often a prime source of collateral for debtor-in-
possession financing. But other things are not equal. For example, the 
proceeds of the securitization may have provided liquidity to help a 
debtor stave off an earlier bankruptcy filing or could allow sufficient 
liquidity to help the company avoid bankruptcy altogether. The safe 
harbor also would help to preserve reasonable commercial expectations 
that insure efficiency and predictability in the marketplace. 
Furthermore, this all must be viewed in perspective: most companies 
that engage in securitization transactions do not end up in bankruptcy; 
in contrast, the possibility that these transactions could be undone in 
bankruptcy casts a shadow over all securitization deals. On balance, I 
therefore favor the safe harbor of section 912.
    This result is sensible and, indeed, parallels the regulatory safe 
harbor similarly instituted by the Securities and Exchange Commission, 
after extensive study, in its Rule 3a-7 in order to promote 
securitization transactions.
    Finally, section 912, which is limited to securitization 
transactions, would not encourage the kinds of abuses that occurred in 
Enron. Those problems were caused by Enron's manipulative use of 
special purpose entities, capitalized by Enron stock, in order to (a) 
sell assets, at inflated profits, enabling Enron to recognize the 
inflated profit for financial statement purposes, and (b) sell assets 
that would be falling in value, in order to book the sale proceeds and 
avoid having to later write-down asset value. These are accounting, not 
bankruptcy law, failures. Moreover, a company originating a 
securitization transaction would be prevented by federal securities law 
from capitalizing the SPV with company stock. Section 912 therefore 
would not cause Enron-style abuses.

                                

   Statement of Hon. Jeff Sessions, a U.S. Senator from the State of 
                                Alabama

    Every director and officer of a corporation owes his corporation 
and its shareholders a very high legal duty--a duty of loyalty.\1\ This 
duty of loyalty is owed to all of the stockholders of the corporation 
and is of paramount importance if there is to be a true open and 
transparent capital market.
---------------------------------------------------------------------------
    \1\ See Marciano v. Nakash, 535 A.2d 400,403 (Del.1987) (citing 
Guth v. Loft, Inc., 5 A.2d 503 (Del.1939)). See also WILLIAM A. KLEIN 
AND JOHN C. COFFEE, JR., BUSINESS ORGANIZATION AND FINANCE: LEGAL AND 
ECONOMIC PRINCIPLES, 162-65 (6th ed.1996).
---------------------------------------------------------------------------
    The duty of loyalty requires that officers or directors not engage 
in self-dealing transactions. Enron's own report released this past 
week, indicated that directors and officers of Enron may have engaged 
in such self-dealing transactions, thereby breaching their duty of 
loyalty. These officers breached their duty by setting up partnerships 
where Enron invested 97% of the capital needed (some of it in debt) for 
the partnership while the other partners--who were Enron officers--only 
invested 3%. This type of arrangement is allowable under Generally 
Accepted Accounting Principles.
    It appears these partnerships worked to the direct advantage of the 
minority partners--the Enron officers. While Enron was able to hide the 
debt incurred to start the partnerships off its corporate balance 
sheet, yet still being liable for the debt, the other partners were 
making millions. Enron's own report states ``[m]any of the most 
significant transactions apparently were designed to accomplish 
favorable financial statement results, not to achieve bona fide 
economic objectives or to transfer risk.'' Engaging in these types of 
transactions by corporate officers is a breach of the duty of loyalty 
that the officers owed to Enron and it stockholders. If these 
allegations are true, the officers and directors must be held 
responsible.
    Furthermore, it appears that Enron insiders made millions by 
unloading their stock in the months leading up the collapse of this 
Fortune 100 company. The insiders apparently used their knowledge of 
inside material information to make their money while others held on to 
their Enron stock and lost millions. A corporate insider has a duty 
under Federal securities law to not trade on material non-public 
information. The insider has a duty to ``abstain or disclose.'' This 
means the insider must either disclose the information or abstain from 
trading.
    If Enron insiders have engaged in these transactions, they should 
and will be held accountable and liable to the public for their illegal 
actions. It is a shame that many Americans trusted this company to be 
honest in its accounting practices only to discover that Enron's books 
were a financial ``house of cards.''
    Even the State of Alabama has felt the effects Enron's fall. The 
Retirement System of Alabama, which held investments in Enron, has lost 
approximately $50 million in stocks and bonds on Enron. This retirement 
fund is for teachers and other state employees of Alabama. 
Additionally, there are several other state retirement funds that have 
lost millions as a result of Enron's bankruptcy--not to mention the 
countless others who held investments in Enron, including Enron's own 
employees. If these losses were due to fraud, those responsible must be 
held accountable.
    The key to American economic progress has been a confidence on the 
part of investors that the financial data they receive is honest. This 
confidence should and can be restored. I believe there are problems 
with our accounting system that must be corrected.
    I also believe that the retirement funds of individuals employees 
are of immense importance and great care must be taken to avoid huge 
financial disasters that could place in poverty an entire family. I 
will support reforms to make these plans more secure.
    It is important that the investigators and investors get to the 
bottom of what transpired at Enron over the past several years. There 
should be a full investigation that will be fair and equitable to the 
innocent investors. If innocent investors have been defrauded by this 
company or its executives then they should and will recover under our 
system of justice. Congress must carefully examine Enron's fall and 
decide if the rules need to be changed.

                                

  Statement of Hon. Strom Thurmond, a U.S. Senator from the State of 
                             South Carolina

    Mr. Chairman:
    Thank you for holding this timely hearing on the collapse of Enron 
Corporation. I hope that today's witnesses will give us a clearer 
understanding of what happened at Enron and how we can protect American 
investors from future business calamities. The bankruptcy of this giant 
corporation has serious implications for our economy, and we should 
examine closely the business and regulatory culture that led to its 
downfall.
    I am particularly troubled by the devastating losses that many 
Enron employees suffered because their retirement savings were heavily 
invested in the company's stock. These unfortunate events have shown us 
the importance of pension reform, and I applaud President Bush's plan 
to protect the hard-earned retirement savings of our Nation's 
workforce. We should follow the President's lead and develop policies 
that would provide employees with more freedom in determining how to 
invest money in their 401(k) plans. Congress should also pass 
legislation that makes it unlawful for corporations to prohibit their 
employees from selling company stock while at the same time allowing 
senior executives to do so. As we have seen from recent press reports, 
it appears that Enron's upper-level management sold their stocks when 
it became apparent that the company was in trouble. However, the 
company's lower-level employees did not have the same opportunities or 
even enough information to know that their retirement savings were in 
jeopardy.
    Our economic system thrives on the full disclosure of information 
to investors. Clearly, Enron succeeded for some time in hiding the true 
state of the company from investors, including its own employees. 
According to press reports, Enron was able to hide millions of dollars 
of debt in supposedly independent businesses that were in reality 
controlled by Enron executives. Not only were millions of dollars in 
debts hidden by these ``outside'' businesses, but the profits 
attributed to them were inflated. According to the Wall Street Journal, 
Enron acknowledged in November that it had erroneously reported $600 
million in earnings since 1997. Soon after this revelation, when 
investors became aware that the company indeed troubled, the company 
went bankrupt.
    There appear to be many factors that contributed to this investor 
deception. We should examine them thoroughly. While Congress should not 
react in a knee-jerk fashion, we must review several aspects of our 
current financial system
    that may have been factors in the Enron collapse. First of all, I 
am concerned about the conflicts of interest that arise for analysts 
employed by Wall Street firms. While they offer advice to clients on 
whether to buy or sell a particular company's stock, their firms may 
also provide lending services to the same company. While the lending 
side of the business is supposed to be walled off from the brokerage 
side, there have been allegations leveled that analysts are often 
discouraged from offering honest assessments of a corporation's 
performance.
    Second, Congress should also examine the practice that consulting 
firms, such as Arthur Anderson, have of providing consulting and 
auditing services to the same client. The potential for abuse is 
readily apparent. This is particularly so because the consulting side 
of the business is more lucrative than the auditing side. Several 
consulting firms and businesses have already made public their 
intentions to separate auditing and consulting services, and I find 
this to be an encouraging development.
    Moreover, I hope that our witnesses today will discuss accounting 
reform in general. While some of Enron's practices appear to have 
violated accounting standards, others may have been set up in 
conformance with current standards. I believe that Congress should 
prohibit accounting gimmicks from hiding the true state of a 
corporation's financial standing. Investors should not be deceived by 
trickery. Rather, they should have an abundance of accurate information 
available to them.
    While regulation of the markets should be limited, we must ensure 
that basic protections exist to protect shareholders and retirement 
savings. We should allow the market to operate unhindered, but in order 
to do so we must not sanction unethical and deceptive behavior. The 
market should not encourage immoral behavior, and it is our 
responsibility to take steps to help root it out. Ethical standards 
should be no different on Wall Street than on the Main Streets of towns 
and cities across this Nation.
    In addition to the concerns that I have discussed, legislative 
proposals have been advanced that would amend our laws on securities 
fraud. I will gladly consider making reasonable changes to current 
laws, but I do not want Congress to react unwisely in the face of 
political pressure. It is important to keep in mind that those who may 
have committed wrongdoing in this case can be prosecuted under current 
law. Additionally, shareholders who have been injured may bring civil 
suits to recover their losses. Our current system does not allow those 
who break the law to go unpunished or to reap the benefits of their 
fraudulent activities. However, that being said, we should examine all 
proposals that may discourage future Enron-type debacles.
    Some Wall Street observers have called for the repeal of certain 
provisions of the Private Securities Litigation Reform Act of 1995. We 
should be very careful regard. The PSLRA was the result of a bipartisan 
effort and was intended to place reasonable limitations on liability 
exposure in securities litigation. For example, under the PSLRA, an 
individual cannot bring a civil action against someone who has aided 
and abetted a securities fraud. Aiders and abettors would typically 
include professionals who were not direct violators of the law but who 
facilitated the commission of the fraud, such as attorneys and 
accountants. Although an injured person may not sue the aider or 
abettor, the Securities and Exchange Commission may bring a civil 
action against the wrongdoer. This system prevents the filing of 
multiple, harassing lawsuits meant to go after the deep pockets of 
professionals but allows for the government to sue those who have truly 
aided and abetted I do not think that we should repeal this section of 
the Act and open the floodgates to unlimited lawsuits. However, there 
are some minor changes that could offer a great benefit. We should make 
the SEC a more meaningful enforcer. Currently, the SEC can bring civil 
actions against aiders and abettors if the person knowingly helped in 
the fraudulent activity. However, the ``knowingly'' standard provides 
incentives for lawyers and accountants to look the other way while 
inappropriate behavior is occurring. We should consider adding a 
``recklessness'' standard, thereby eliminating any safe harbors for 
those who intentionally ignore fraudulent behavior.
    Another suggested change to the PSLRA that concerns me is the 
elimination of the securities exemption under the racketeering laws. As 
part of the PSLRA, Congress prevented civil RICO claims from being 
brought in securities fraud cases. This reform was enacted because 
Congress understood that the broad language of the RICO statute 
permitted actions to be brought in circumstances that did not involve 
organized crime. Because of this broad language, RICO claims were 
commonly made in securities fraud cases and commercial litigation. 
These claims provided major incentives for defendants to settle because 
of the possibilities of treble damages under the RICO statute. We 
should be careful about re-opening the doors to abuse of RICO claims. 
If minor changes in the law would be adequate, we should not undo 
important reforms just for the sake of appearances.
    Mr. Chairman, thank you for holding this important hearing. I hope 
that this committee will conduct a reasonable inquiry into the 
activities that led to Enron's all. We should develop sensible policies 
that encourage corporate responsibility and ethical behavior. At the 
same time, Congress should not rush to make unnecessary and harmful 
changes in the law. We should pursue a course that will discourage 
corporate dishonesty and punish those who violate the trust of 
investors. Yet we must not overreact and hamper the market's ability to 
deliver strong economic growth. I look forward to hearing the testimony 
of our witnesses today.

                               
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