[Senate Hearing 107-1140]
[From the U.S. Government Printing Office]



                                                       S. Hrg. 107-1140
 
  EXAMINING ENRON: THE CONSUMER IMPACT OF ENRON'S INFLUENCE ON STATE 
                             PENSION FUNDS

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

                                HEARING

                               before the

     SUBCOMMITTEE ON CONSUMER AFFAIRS, FOREIGN COMMERCE AND TOURISM

                                 OF THE

                         COMMITTEE ON COMMERCE,
                      SCIENCE, AND TRANSPORTATION
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 16, 2002

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation













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       SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

              ERNEST F. HOLLINGS, South Carolina, Chairman
DANIEL K. INOUYE, Hawaii             JOHN McCAIN, Arizona
JOHN D. ROCKEFELLER IV, West         TED STEVENS, Alaska
    Virginia                         CONRAD BURNS, Montana
JOHN F. KERRY, Massachusetts         TRENT LOTT, Mississippi
JOHN B. BREAUX, Louisiana            KAY BAILEY HUTCHISON, Texas
BYRON L. DORGAN, North Dakota        OLYMPIA J. SNOWE, Maine
RON WYDEN, Oregon                    SAM BROWNBACK, Kansas
MAX CLELAND, Georgia                 GORDON SMITH, Oregon
BARBARA BOXER, California            PETER G. FITZGERALD, Illinois
JOHN EDWARDS, North Carolina         JOHN ENSIGN, Nevada
JEAN CARNAHAN, Missouri              GEORGE ALLEN, Virginia
BILL NELSON, Florida
               Kevin D. Kayes, Democratic Staff Director
                  Moses Boyd, Democratic Chief Counsel
      Jeanne Bumpus, Republican Staff Director and General Counsel
                                 ------                                

          SUBCOMMITTEE ON CONSUMER AFFAIRS, FOREIGN COMMERCE 
                              AND TOURISM

                BYRON L. DORGAN, North Dakota, Chairman
JOHN D. ROCKEFELLER IV, West         PETER G. FITZGERALD, Illinois
    Virginia                         CONRAD BURNS, Montana
RON WYDEN, Oregon                    SAM BROWNBACK, Kansas
BARBARA BOXER, California            GORDON SMITH, Oregon
JOHN EDWARDS, North Carolina         JOHN ENSIGN, Nevada
JEAN CARNAHAN, Missouri              GEORGE ALLEN, Virginia
BILL NELSON, Florida
























                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on May 16, 2002.....................................     1
Statement of Senator Dorgan......................................     1
Statement of Senator Nelson......................................     2

                               Witnesses

Calvert, Bruce W., Chairman and CEO, Alliance Capital Management.     7
    Prepared statement...........................................    10
Glassman, James K., Resident Fellow, American Enterprise 
  Institute......................................................    21
    Prepared statement...........................................    24
Harrison, Alfred, Vice Chairman, Alliance Capital Management.....    13
    Prepared statement...........................................    15
Herndon, Tom, Executive Director, Florida State Board of 
  Administration; Accompanied by C. Coleman Stipanovich, Deputy 
  Executive Director, Florida State Board of Administration; and 
  Trent Webster, Portfolio Manager, Florida State Board of 
  Administration.................................................     3
    Prepared statement...........................................     6
Musuraca, Michael, Assistant Director, Department of Research and 
  Negotiations, District Council 37, American Federation of 
  State, County, and Municipal Employees (AFSCME)................    59
    Prepared statement...........................................    61
Plunkett, Travis, Legislative Director, Consumer Federation of 
  America........................................................    64
    Prepared statement...........................................    66
Teslik, Sarah Ball, Executive Director, Council of Institutional 
  Investors, prepared statement..................................    55


























  EXAMINING ENRON: THE CONSUMER IMPACT OF ENRON'S INFLUENCE ON STATE 
                             PENSION FUNDS

                              ----------                              


                        THURSDAY, MAY 16, 2002,

                                       U.S. Senate,
Subcommittee on Consumer Affairs, Foreign Commerce 
                                       and Tourism,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:30 p.m. in 
room SR-253, Russell Senate Office Building, Hon. Byron L. 
Dorgan, Chairman of the Subcommittee, presiding.

          OPENING STATEMENT OF HON. BYRON L. DORGAN, 
                 U.S. SENATOR FROM NORTH DAKOTA

    Senator Dorgan. This hearing will come to order. I'll be 
joined momentarily by my colleagues, Senator Nelson--I believe 
Senator Boxer will join us as well. But in light of the hour, I 
want to proceed.
    I will necessarily have to absent myself for a leadership 
meeting, at which time Senator Nelson will take the chair, in 
about 40 minutes, but--Senator Nelson has just joined us, as 
you see.
    This hearing is a continuation of a number of hearings that 
we have been holding discussing issues that surround the Enron 
Corporation. This hearing is at the request of my colleague 
from Florida, Senator Nelson, who, quite properly, wants an 
explanation about how the pension fund of Florida lost some 
$329 million in Enron's stock issues, more than any other 
public pension fund in the country, I understand.
    This is a long and tortured subject. We began hearings 
dealing with Enron matters in--last December, I believe it was, 
and we'll continue to hold some hearings into June. One of the 
issues that has arisen is the purchase of Enron stock, even as 
the Enron stock was collapsing, and the cost of those purchases 
to the Florida pension fund and other pension funds around the 
country, but the largest purchase, I think, and the biggest 
loss was to the Florida public employee's pension fund.
    Let me say that I don't have any preconceived notions or 
judgments about today's hearings. We're trying to understand 
and learn from the hearings. And I agree with my colleagues 
that Florida's public employees deserve to try to get some 
answers, and my hope is that this hearing will shed some light 
on some of these vexing and troubling issues.
    Let me call on my colleague, Senator Nelson.

                STATEMENT OF HON. BILL NELSON, 
                   U.S. SENATOR FROM FLORIDA

    Senator Nelson. Mr. Chairman, what we would like to 
accomplish here as we have responsibility for crafting 
legislation to try to protect the public for the future, and 
here we have--the public has been harmed in the course of this 
whole saga, because public servants in investing their funds in 
a public retirement fund, those funds having severely 
diminished under conditions that we're going to explore. In 
Florida's case, taxpayers were not harmed because the Florida 
retirement system was, in fact, fully funded. But it was only a 
few years ago that the retirement fund was not fully funded, 
and, had the same circumstances occurred, the losses would be 
being borne by taxpayers not by the pensioners of the state of 
Florida. So that adds another dimension that is considerably 
important for us as we are examining what is the legislative 
solution to this.
    So what we want to do is to get to the bottom of this and 
to prevent it from happening again by virtue of coming forth 
with legislation that would make it a lot less likely that this 
kind of scenario would occur again.
    Thank you, Mr. Chairman.
    Senator Dorgan. Senator Nelson, thank you. And the long-
term goal, of course, is for us to evaluate what we're learning 
form this scandal. And, yes, the Enron matter is a scandal 
involving, in my judgment, substantial dishonesty and grand 
theft, in some cases.
    Yesterday, for 4 hours, we heard of price fixing in 
California, which I expect will be the subject of a substantial 
criminal investigation. It appears to be not just the Enron 
Corporation, but they were neck deep in it. And so this issue 
has many tentacles, one of which deals with the losses to 
pension funds. And the question is: How do we legislate, or do 
we legislate, in ways that can provide some protection that 
this sort of thing will not happen again?
    We have a number of witnesses today. I indicated, Senator 
Nelson, that I will not be able to stay for the entire hearing, 
but you will be chairing when I have to depart.
    Mr. Glassman, welcome.
    Mr. Glassman. Thank you.
    Senator Dorgan. Is that Dow still going to hit $30,000? 
Didn't you have a book--all right, then one of these days I'm 
going to start buying again then. I don't have a lot of money 
to buy with, but we'll consult privately, I guess, about that. 
It's nice to see you again. I haven't seen you for some while.
    Others of you on the panel, thank you for being with us. I 
would like to begin by asking Mr. Tom Herndon, from the Florida 
State Board of Administrators, the executive director. He will 
give testimony. And I believe two of his colleagues are here, 
as well, to answer questions, Mr. Coleman Stipanovich and Mr. 
Trent Webster. Coleman Stipanovich is Florida State Board of 
Administrator's deputy executive director, and Trent Webster is 
portfolio manager of Florida State Board of Administrators.
    Following that, we will hear from Mr. Bruce Calvert, CEO of 
Alliance Capital Management, Alfred Harrison, account manager, 
Alliance Capital Management, and then we will have Mr. 
Glassman. And then we will have a second panel of three people: 
Michael Musuraca--I hope I've got that name right--American 
Federation of State, County, and Municipal Employees, AFSCME, 
Travis Plunkett, Consumer Federation of America, and Sarah 
Teslik, Council of Institutional Investors.
    So why don't we proceed, Mr. Herndon? Your entire statement 
will be made a part of the record, and you may summarize for 
us, if you would.

         STATEMENT OF TOM HERNDON, EXECUTIVE DIRECTOR, 
            FLORIDA STATE BOARD OF ADMINISTRATION; 
         ACCOMPANIED BY C. COLEMAN STIPANOVICH, DEPUTY 
          EXECUTIVE DIRECTOR, FLORIDA STATE BOARD OF 
         ADMINISTRATION; AND TRENT WEBSTER, PORTFOLIO 
         MANAGER, FLORIDA STATE BOARD OF ADMINISTRATION

    Mr. Herndon. Thank you, Mr. Chairman, Senator Nelson. It's 
nice to see you. With me this afternoon, as you pointed out is 
Coleman Stipanovich, the deputy director of the State Board of 
Administration, and Trent Webster, portfolio manager on the 
staff of the State Board of Administration in our Domestic 
Equities Division. I have a brief statement, and I'd like to 
work through that very quickly for all three of us.
    The opportunity to comment on the Enron disaster is not one 
that we really take any relish in. Unfortunately, Florida has 
the distinction of losing more money on Enron stock than any 
other known organization, but that is definitely not a 
distinction that we enjoy or we relish. Unfortunately, 
approximately 90 percent of the Enron losses were realized in 
an account managed by Alliance Capital Management. So for us at 
the State Board of Administration, the current situation could 
be more aptly called the ``Alliance Disaster.''
    Let me give you a brief background on who we are and how we 
operate. The Florida State Board of Administration is the 
investment arm of Florida State Government, with $125 billion 
under management. We are governed by three trustees: the 
Governor, the state comptroller, and the state treasurer. We 
invest funds on behalf of approximately 25 government clients, 
with the largest being the Florida retirement system at 
approximately $100 billion.
    We're a broadly diversified investment organization with 
assets in the U.S. stock market, the U.S. bond market, the 
international stock market, real estate, and private 
investments, and serve approximately 600,000 active members and 
approximately 200,000 retirees. Under our defined benefit plan, 
payments to retirees, as Senator Nelson has pointed out, are 
guaranteed by the employers regardless of the gains or losses 
in the investment portfolio.
    As a quick aside, Mr. Chairman, I might add that we're 
currently in the midst of transitioning to a defined 
contribution program, 401(a), for all of our members, and that 
might be of some interest to the Committee at a future date 
when you talk about social security.
    Now, back to the main issue, Alliance's Enron investments 
for the Florida Retirement System. Our Enron experience started 
in November of 2000 when Alliance first began to acquire a 
position in Enron. Our domestic equities unit has 14 outside 
managers who are charged with exercising their expertise to 
select sound investments for our portfolio. Alliance is one of 
those 14 managers. These investment firms are given full 
discretion by contract and are paid a handsome fee for the 
diligent deployment of their resources and expertise. In this 
case, the lion's share, by far, of our Enron position was 
acquired by Alliance Capital Management, and specifically their 
Minneapolis-based large-cap growth investment team headed by 
Mr. Harrison.
    Alliance's contract with the Florida SBA recognizes 
Alliance's fiduciary duties and committed it to certain 
investment protocols, including the obligation to perform 
rigorous company-specific research. In this case, however, Mr. 
Harrison and Alliance failed to meet their obligations under 
our investment advisory agreement. Alliance's Enron purchases 
ultimately caused a principal loss of $280 million to the 
Florida Retirement System, and we believe Alliance was 
negligent in its job performance. As a result, we have filed 
litigation against Alliance to recover our losses, and a copy 
of that complaint has been furnished to the Committee.
    We've all read stories about the inadequacy of Enron's 
financial disclosures and conflicts of interest at Enron as 
well as the conflicts that exist generally in the financial 
markets. While these subjects are worthy of your investigation, 
any investigative action you undertake should not allow 
financial professionals such as Alliance to shift the blame for 
their own negligence to the corporations in which they invest. 
As detailed in our complaint, sufficient Enron information as 
publicly available to inform a sophisticated investment manager 
such as Alliance of the extreme risks of Enron investments. 
Remember, before Alliance even invested in Enron, the footnotes 
of Enron's financial statement disclosed the supposedly, quote/
unquote, ``secret partnerships'' controlled by Andrew Fastow. 
Sadly, Mr. Harrison has admitted, quote, ``nobody ever really 
dug into the footnotes,'' unquote.
    Our concerns about Alliance's investments in Enron 
coincided with our broader concerns about Alliance's 
performance for the Florida Retirement System. Alliance had 
suffered a period of poor performance unrelated to and before 
Enron investments began. In calendar year 2000, we had put 
Alliance on a watch list where they stayed until terminated in 
December of 2001. Throughout this period, in spite of 
continuing red flags that were raised associated with Enron's 
death spiral, the Alliance investment team continued to buy 
Enron stock in an accelerated fashion. And all of this is 
detailed in the court complaint.
    You will note that Alliance kept buying, even though the 
Enron news was getting worse and worse. As we've observed the 
Enron investments being made, we assumed, to our detriment, 
that Alliance was conducting the, quote, ``rigorous company-
specific research'' they had promised. When we questioned 
Alliance about the Enron purchases, we were assured of this 
fact. It is now clear to us that Alliance was buying Enron on 
faith, not on research.
    However, this hearing is not the place to try the case. 
That'll be done later on in the court. Rather, the Committee's 
invitation to this hearing stated that the scope of your 
inquiry is focused on the practice of Enron officials 
contacting pension funds or institutional investors in order to 
tout Enron stock. We have no information to offer on that 
subject. We at the Florida State Board of Administration we 
were never contacted by Enron officials. We were informed by 
Mr. Harrison that he and members of the Alliance team met with 
high-ranking Enron officials, and we understand that such 
contacts are routine between money managers and corporate 
officials. They're certainly not unique to Enron or Alliance. 
However, we at the State Board of Administration have no direct 
knowledge about what was discussed between Enron and Alliance 
or if these discussions were in any way different than those 
which commonly take place in the industry.
    Much has been written about the conflicts of interest that 
surround Enron and Alliance, most notably, Mr. Frank Savage, 
who was an Enron board member and, in fact, on the finance 
committee that approved the off-balance-sheet partnerships and 
waived the conflicts of interest, and also served as a senior 
officer and board member of Alliance. We've been assured by 
Alliance that this was a conflict without consequences. Because 
the effects of Mr. Savage's conflicts are unclear to us at this 
time, our lawsuit against Alliance currently makes no claims 
relating to Mr. Savage's conflicts of interest.
    We understand that this committee or others in Congress are 
investigating conflicts in the investment industry. While we 
encourage a thorough review of this conflict practices, as a 
governmental body, the Florida SBA does not engage in the types 
of practices now under investigation. But clearly one lesson 
that needs to be learned from this experience is that conflicts 
of interest in the public financial marketplace should be at 
least fully and openly disclosed. And some conflicts of 
interest should be prohibited altogether. Investment firms 
should install and enforce policies that prohibit investment 
firm employees from serving on boards of directors of firms 
they analyze. Just as it is inappropriate for accounting firms 
to be auditors and consultants, or for investment bankers to 
not public analytical reports on firm clients, it is 
inappropriate that the board members of investment firms be on 
the boards of companies whose stock they are recommending and 
buying. There is simply too much opportunity for the wrong kind 
of alignment of interest.
    In closing, I've tried to highlight what happened to us as 
a pension fund as a result of the negligence on the part of 
Alliance Capital Management. As long as pension funds have 
active portfolio management, the pension industry must be able 
to rely on and fully trust expert outside financial advisors to 
exercise their fiduciary duty based upon independent research 
which is not compromised by conflicts of interest. Any actions 
you can take to ensure the integrity of the research and 
investment activities from Wall Street firms like Alliance 
Capital would be most worthwhile.
    Thank you for your attention, and we'll be happy to answer 
any questions.
    [The prepared statement of Mr. Herndon follows:]

 Prepared Statement of Tom Herndon, Executive Director, Florida State 
Board of Administration; Accompanied by C. Coleman Stipanovich, Deputy 
 Executive Director, Florida State Board of Administration; and Trent 
   Webster, Portfolio Manager, Florida State Board of Administration
    Thank you for this opportunity to comment on the ``Enron disaster'' 
and its implications for Florida State Board of Administration 
(``Florida SBA'') and other pension funds. The Florida SBA has a unique 
distinction in this situation, namely, that we lost more money on Enron 
stock than any other known organization. I can assure you that this is 
not a distinction that we relish. Approximately 90 percent of our Enron 
losses were realized in an account managed by Alliance Capital 
Management. So, for us at the Florida SBA, the current situation could 
more aptly be called ``the Alliance disaster.''
    Let me give you a brief background on who we are and how we 
operate. Briefly, the Florida SBA is the investment arm of Florida 
State government, with $125 billion under management. The Florida SBA 
is governed by three members of the Florida Cabinet--the Governor, the 
Comptroller and the Treasurer. We invest the funds of approximately 25 
government clients, with the largest being the Florida Retirement 
System at approximately $100 billion. We are a broadly diversified 
investment organization with assets in the U.S. stock market, U.S. bond 
market, international stock market, real estate and private 
investments. The Florida Retirement System serves approximately 600,000 
active members and 200,000 retirees. Under our defined benefits plan, 
payments due to retirees are guaranteed regardless of the gains or 
losses in the investment portfolio.
    As a quick aside, I might add that we are currently in the midst of 
transitioning to a new Defined Contribution program, which might be of 
interest to the Committee members at the point in time that you discuss 
privatizing Social Security.
    Now, back to the main issue at hand--Alliance's Enron investments 
for the Florida Retirement System. Our Enron experience in Florida 
started in November, 2000 when Alliance first began to acquire a 
position in Enron. Our Domestic Equities unit has 14 outside money 
managers who are charged with exercising their expertise to select 
sound investments for our portfolio. Alliance was one of those 14 
managers. These investment firms are given full discretion by contract, 
and are paid a handsome fee for the diligent deployment of their 
resources and expertise. In this case, the lion's share, by far, of our 
Enron position was acquired by Alliance Capital Management, and 
specifically their Minneapolis based large cap growth investment team 
headed by Al Harrison. Alliance's contract with the Florida SBA 
recognized Alliance's fiduciary duties and committed it to certain 
investment protocols, including the obligation to perform ``rigorous 
company-specific research.''
    In this case, however, Mr. Harrison and Alliance failed to meet 
their obligations under our investment advisory agreement. Alliance's 
Enron purchases ultimately caused a principal loss of over $280,000,000 
to the Florida Retirement System. We believe Alliance was negligent in 
its job performance. As a result, we have filed litigation against 
Alliance to recover our losses. A copy of our Complaint has been 
furnished to this Committee as an attachment to a copy of this 
statement.
    We have all read stories about the inadequacy of Enron's financial 
disclosures, conflicts of interest at Enron as well as conflicts, which 
exist generally in the financial markets. While these subjects are 
worthy of your investigation, any investigative action you undertake 
should not allow financial professionals such as Alliance to shift the 
blame for their own negligence to the corporations in which they 
invest. As detailed in our Complaint, sufficient Enron information was 
publicly available to inform a sophisticated investment manager such as 
Alliance of the extreme risks of Enron investments. Remember, before 
Alliance even invested in Enron, the footnotes of Enron's financial 
statements disclosed the supposedly ``secret'' partnerships controlled 
by Andrew Fastow. Sadly, Mr. Harrison has admitted, ``nobody ever 
really dug into the footnotes.''
    Our concerns about Alliance's investments in Enron coincided with 
our broader concern about Alliance's performance for the Florida 
Retirement System. Alliance had suffered a period of poor performance 
unrelated to and before the Enron investments began. In 2000, we had 
put Alliance on a ``watch list'' where they stayed until terminated in 
December 2001. Throughout this period, in spite of continuing ``red 
flags'' that were raised associated with Enron's death spiral, the 
Alliance investment team continued to buy Enron stock in an accelerated 
fashion. All of this is detailed in the Court Complaint, which we have 
furnished to you. You will note that Alliance kept buying, even though 
the Enron news was getting worse each day.
    As we observed the Enron investments being made, we assumed, to our 
detriment, that Alliance was conducting the ``rigorous company specific 
research'' they had promised. When we questioned Alliance about the 
Enron purchases, we were assured of this fact. It is now clear to us 
that Alliance was buying Enron on ``faith''--not on research. However, 
this hearing is not the place to try our case; that will be done later 
in court.
    Rather, the Committee's invitation to this hearing stated that the 
scope of your inquiry is focused on the practice of Enron officials 
contacting pension funds or institutional investors in order to tout 
Enron's stock. We have no information to offer on this subject. We at 
the Florida SBA were never contacted by Enron officials. We were 
informed by Mr. Harrison that he and members of his Alliance team met 
with high-ranking Enron officials. We understand such contacts between 
corporate officials and large money managers are common and not unique 
to Enron nor Alliance. However, we at the Florida SBA have no direct 
knowledge about what was discussed between Enron and Alliance, or if 
these discussions were in any way different than those which commonly 
take place in the investment industry.
    Much has been written about the conflicts of interest that surround 
Enron and Alliance, most notably, Mr. Frank Savage, who was an Enron 
Board Member (in fact on the Finance Committee) while also serving as a 
senior officer and board member of Alliance. We have been assured by 
Alliance that this was a conflict without consequences. Because the 
effects of Mr. Savage's conflicts are unclear to us at this time, our 
lawsuit against Alliance currently makes no claims relating to Mr. 
Savage's conflicts of interest. We understand that this Committee, or 
others in Congress, are investigating conflicts in the investment 
industry. While we encourage a thorough review of these conflict 
practices, as a governmental body, the Florida SBA does not engage in 
the types of practices now under investigation.
    One lesson that needs to be learned from this experience is that 
conflicts of interest in the public financial marketplace should at 
least be fully and openly disclosed, and some conflicts of interest 
should be prohibited altogether. Investment firms should install and 
enforce policies that prohibit investment firm employees from serving 
on boards of directors of firms they analyze. Just as it is 
inappropriate for accounting firms to be both auditor and consultant, 
or for investment bankers to not publish analytical reports on firm 
clients, it is inappropriate that board members of investment firms be 
on the boards of companies whose stock they are recommending and 
buying. There is simply too much opportunity for the wrong kind of 
alignment of interest.
    In closing, I've tried to highlight what happened to us as a 
pension fund as a result of negligence on the part of Alliance Capital 
Management. As long as pension funds have active portfolio management, 
the pension industry must be able to rely on and fully trust expert 
outside financial advisors to exercise their fiduciary duties based 
upon independent research which is not compromised by conflicts of 
interest. Any actions you can take to ensure the integrity of the 
research and investment activities from Wall Street firms like Alliance 
Capital would be most worthwhile. Thank you for your attention, and I 
am happy to answer any questions.

    Senator Dorgan. Mr. Herndon, thank you very much. I 
understand Mr. Stipanovich and Mr. Webster are here to answer 
questions, but you do not have a statement.
    Let me ask to have the testimony from Alliance next, and 
then we will ask some questions and then have the testimony of 
Mr. Glassman from this panel.
    Mr. Calvert, how would you like to proceed? Do you and Mr. 
Harrison both have a statement, or do you have a statement on--
--
    Mr. Calvert. Yes, Mr. Chairman, we do.
    Senator Dorgan. All right. Why don't you proceed, and your 
entire statement will be made a part of the permanent record.

   STATEMENT OF BRUCE W. CALVERT, CHAIRMAN AND CEO, ALLIANCE 
                       CAPITAL MANAGEMENT

    Mr. Calvert. Thank you, Mr. Chairman, Senator Nelson. Would 
it be all right if we just switched chairs here for----
    Senator Dorgan. Let me note that the Ranking Member of the 
full Committee has just joined us, Senator McCain, and I've 
asked if he has an opening statement. He does not. So we will 
proceed, Mr. Harrison, with your testimony.
    Mr. Calvert. Good morning. My name is Bruce Calvert, and 
I'm the chairman and chief executive officer of Alliance 
Capital Management, which is an investment management company. 
With me today is Al Harrison, vice chairman of Alliance Capital 
Management.
    Mr. Harrison is among the most highly regarded and well-
respected managers in the industry. Over the last 30 years, he 
has developed a superb investment record and also a well-
deserved reputation for honesty and integrity. As many of you 
know, Mr. Harrison purchased Enron stock on behalf of a number 
of Alliance clients. He will address some of the reasons why he 
made these investments, including his reliance on the 
statements made to him by Enron's management, statements that 
we now know to be untrue. But first, some background.
    Alliance is one of the world's largest investment managers. 
Investment management and research is our only business. We 
manage approximately $450 billion for a global clientele: 
institutions and individuals directly and through a family of 
mutual funds. For example, we manage money for 45 of the 
Fortune 100 companies, and we manage money for public 
retirement systems in 43 of the 50 states.
    Our interests are directly tied to the interests of our 
clients. Alliance is paid advisory fees based on the assets it 
manages for each account. Simply stated, when we buy securities 
or make investments that appreciate in value, our revenues 
increase. Conversely, if we make investments that decline or 
depreciate in value, our revenues decline proportionately. We 
do not earn investment banking fees, nor do we trade for our 
own account. We prosper when our clients prosper.
    Alliance offers a broad range of investment services to 
meet the diverse needs of our clients. Today I'm going to focus 
on our large-cap growth product, Al Harrison's team, which 
consists of 25 portfolio managers, each of whom manages 
accounts in accordance with the team's philosophy and 
investment process. Each of these managers is also involved in 
researching potential investment candidates. The team is 
supported by Alliance's investment research organization. Some 
320 analysts cover companies throughout the world. Each analyst 
is assigned a limited number of companies in the same or 
related industries so that they can develop a focused 
expertise.
    I would now like to turn to our investment in Enron. The 
decision to invest in Enron was based on extensive research 
into Enron's business, its growth prospects, and the company's 
fundamentals, importantly, always in relationship to the price 
of the shares. I believe the judgment of Alliance's investment 
professionals with respect to Enron was entirely reasonable 
based on the information available to them at the time. Of 
course, we would have acted differently based on the 
information that we have today, but this information was hidden 
from us.
    While we deeply regret having invested in Enron, the root 
problem rests not with the judgment of our portfolio managers, 
but with Enron itself. I believe that the blame for the 
collapse of Enron and the resulting loss to countless investors 
lay with Enron's management and its officers who we now--and I 
emphasize ``now''--know were on a course to deliberately 
mislead the investors, analysts, rating agencies, and others.
    I believe that meetings with management are a crucial part 
of the investment decisionmaking process. At Alliance, these 
meetings are serious and substantive. Our researchers and 
portfolio managers had many such meetings with Enron. During 
these meetings, senior members of Enron management 
misrepresented numerous material facts. Mr. Harrison can 
elaborate on some of these misrepresentations, and I will leave 
that subject matter to him.
    But we also know that others were misled. For example, a 
representative from Standard and Poor's testified that far from 
providing anything like complete, timely, and reliable 
information, Enron committed multiple acts of deceit and fraud, 
just as it did to many others with whom Enron dealt. 
Significantly, under federal securities laws, Standard and 
Poor's enjoys preferred access to Enron's books, access that 
investment advisors, such as Alliance, do not enjoy. Despite 
this preferred access, Standard and Poor's were still unaware 
of Enron's fraud and continued to rate Enron's credit 
investment grade until November 28th, 2001, more than 2 weeks 
after Alliance's last purchase of Enron.
    Many other investors were similarly deceived. Press reports 
have confirmed that a number of money managers invested in 
Enron in October and November. Moreover, hundreds of millions 
of shares--hundreds of millions of shares--traded in October 
and November. As Alliance's purchases represented only a very 
tiny fraction of these trades, it is clear that many others 
were buying Enron at what they perceived to be very attractive 
prices.
    It has been reported in the press that, excluding Florida, 
at least 5 state pension funds lost more than $100 million in 
Enron stock. Alliance did not make the Enron investments for 
these funds. Other investment managers had been similarly 
misled.
    The truth is this. If a management of a corporation is bent 
on deceiving the investment public, and if they are vetted by a 
major auditing firm in that enterprise, it is very difficult 
for investment professionals to discern the truth. This is the 
case even where those investment professionals performed 
extensive research, as Alliance did with Enron.
    If I may, I'd like to just address one final issue relating 
to Frank Savage, a director of Alliance Capital. Until July, 
Mr. Savage was also an employee of Alliance with responsibility 
for sales and marketing in the Middle East and Africa. He did 
not have investment responsibilities. Mr. Savage also served on 
the board of directors of Enron, beginning in mid October 1999.
    Mr. Savage joined the Enron board at Enron's request and 
his service was personal to him. Alliance did not ask Mr. 
Savage to serve on the Enron board, nor did he so as a 
representative of Alliance. Alliance permitted him to join the 
board only after he had agreed to comply with our policies 
governing employee service on unaffiliated boards which, among 
other things, required that he be walled off from any 
discussion with Alliance personnel concerning investments in 
Enron. Mr. Savage re-certified his compliance with these 
policies annually thereafter.
    To be perfectly clear, Mr. Savage never participated 
directly or indirectly in any decisions by Alliance to buy, 
hold, or sell Enron stock, and his membership on the Enron 
board had nothing to do with those investments. There was, in 
fact, no conflict.
    Thank you.
    [The prepared statement of Mr. Calvert follows:]

  Prepared Statement of Bruce W. Calvert, Chairman and CEO, Alliance 
                           Capital Management
    Good morning Mr. Chairman and Members of the Subcommittee. My name 
is Bruce Calvert and I am the Chairman and Chief Executive Officer of 
the investment management firm Alliance Capital Management (``Alliance 
Capital''). I have been with the firm for nearly thirty years, during 
which time I served as Chief Investment Officer, Director of Equity 
Research and an active equity portfolio manager. I would like to thank 
the Subcommittee for the opportunity to appear before you to discuss 
Alliance Capital's investments in Enron Corporation (``Enron'').
    I am appearing with Alfred Harrison, a Vice Chairman of Alliance 
Capital and its most senior portfolio manager. Mr. Harrison is not only 
one of Alliance Capital's best managers, he is among the most highly 
regarded and well-respected managers in the entire industry. Over the 
last thirty years, he has developed one of the most successful 
investment track records, and also a well-deserved reputation for 
honesty and integrity. As many of you know, Mr. Harrison purchased 
Enron stock on behalf of a number of Alliance Capital's clients, and he 
can address some of the reasons why he made those investments, 
including his reliance on the statements made to him by Enron's 
management--statements that we now know to have been untrue.
    Alliance Capital is one of the world's largest investment managers. 
Investment management and research is our only business. Alliance 
Capital provides a wide range of investment management services to a 
diverse group of investors worldwide, including U.S. pension plans, 
institutional investors and high-net-worth individuals. For example, 
Alliance Capital has been selected to manage money for 45 of the 
Fortune 100 companies, public retirement systems in 43 of the 50 
states, as well as by foundations, endowments, central banks and other 
global institutions. Alliance Capital is also one of the largest mutual 
fund sponsors, with a diverse family of globally distributed mutual 
fund portfolios. As of March 31, 2001, Alliance Capital's total assets 
under management were approximately $452 billion.
    Significantly, Alliance Capital's revenue is directly tied to 
achieving positive performance for its clients. For its investment 
management services, Alliance Capital is paid advisory fees based on a 
percentage of the net assets it manages for each account. This fee 
structure is important in looking at Alliance Capital's incentives with 
respect to the investments it made in Enron on behalf of its clients. 
Because its investment management revenue is based on a percentage of 
assets under management, if Alliance Capital invests in a company whose 
stock drops in value, its advisory fees will drop proportionately.
    You should also know that Alliance Capital offers its clients 
multiple products. Our clients have greatly varying needs, and in 
response to those needs, we offer a full range of investment 
disciplines. In broad terms, we offer growth equities, value equities 
and fixed income. Within these broad categories, we offer more specific 
services. In growth equity, we offer such products as large-cap growth, 
mid and small-cap growth, international growth and others. A product 
wheel identifying these many offerings is attached to my statement as 
Exhibit A.
    Of the broad spectrum of investment disciplines Alliance Capital 
offers, I am going to talk today about our Large Capitalization Growth 
product. Alliance Capital's large cap growth team is headed by Alfred 
Harrison. The team consists of portfolio managers and investment 
professionals based in Minneapolis, Chicago and Cleveland, all of whom 
are responsible for managing accounts pursuant to a large 
capitalization growth investment strategy. Collectively, these managers 
use their independent knowledge and experience to research potential 
investment candidates. These portfolio managers work as a team, and 
very often, but by no means always, invest in the same securities. 
Although there will typically be a broad degree of overlap in the 
holdings of the large cap growth portfolio managers, each portfolio 
manager does have a meaningful degree of individual discretion with 
respect to portfolio composition, and it would be unusual to see two 
portfolio managers have identical holdings in their portfolios.
    It is critically important to understand that Alliance Capital is a 
research-driven organization. We have more than 320 analysts covering a 
broad universe of companies throughout the world organized into growth, 
value and fixed income teams. The number of analysts is important 
because it permits us to assign each analyst to a specific industry 
sector with a limited number of companies to follow so that the 
analysts can develop a depth of knowledge about the companies they 
follow. We often assign multiple analysts to cover a single company 
from different viewpoints, such as equity and fixed income. The sole 
purpose of these analysts is to assist in improving performance of 
client accounts. That is how we grow our revenues. We do not earn 
investment banking fees, nor do we engage in trading for our own 
account.
    With that background, I would like to turn to Alliance Capital's 
investments in Enron. The decision to invest in Enron was based on 
extensive research by the Alliance Capital research and portfolio 
management team into Enron's business, its growth prospects, and the 
company's fundamentals in relation to the price of its shares. Without 
question, I believe that the judgment of Alliance Capital's investment 
professionals with respect to Enron was entirely reasonable based on 
the information available to them at the time. We at Alliance Capital 
deeply regret having invested in Enron, but the root of the problem 
rests not with the judgment of our portfolio managers, but with Enron 
itself. That is, I believe the blame for the collapse of Enron and the 
resulting loss to countless investors lay with Enron's management and 
its auditors, who now appear to have been on a course to deliberately 
mislead investors, analysts, rating agencies and others.
    I understand that Alliance Capital's research and portfolio 
management team had many meetings and conversations with Enron 
management to discuss Enron's business. Based on my years of 
experience, I believe that meetings with management are a very 
important part of the investment decision-making process. These 
meetings tend to be serious and substantive.
    In the course of Alliance Capital's meetings with Enron, senior 
members of Enron management misrepresented numerous material facts. Mr. 
Harrison can elaborate on some of those misrepresentations, and I will 
leave that subject matter to him. But we do know, based at least in 
part on the testimony before this Subcommittee and other Senate 
Committees, that many others were similarly deceived by Enron and its 
management.
    For example, a representative from Standard & Poor's testified that 
Enron failed to disclose that certain Enron insiders had a financial 
stake in Enron's off-balance-sheet partnerships and failed to disclose 
the nature of compensation that was paid to Enron's CFO in connection 
with these partnerships. Specifically, he testified that ``far from 
providing anything like complete, timely and reliable information to 
Standard & Poor's, [Enron] committed multiple acts of deceit and fraud 
on Standard & Poor's, just as it did to many others with whom Enron 
dealt.'' Significantly, under federal securities laws, Standard & 
Poor's enjoyed preferred access to Enron's books, records and financial 
condition--access that investment advisors such as Alliance Capital do 
not enjoy. Despite this preferred access, Standard & Poor's was still 
unaware of Enron's fraud and continued to rate Enron's credit as 
investment grade until November 28, 2001, almost two weeks after 
Alliance Capital's last purchase of Enron stock.
    Similarly, an analyst for Credit Suisse First Boston stated that 
the ``inaccuracies and lack of information in Enron's financial 
reporting affected [his] conclusions and ratings on Enron.'' He 
explained that ``[i]f the information a company provides is incomplete, 
incorrect or misleading, [his] analysis will be undermined.'' 
Obviously, we concur with this statement.
    As I have said, it is plain that many institutions and private 
investors relied on the statements of Enron management and the 
company's audited financials. At this point, it is not clear which 
institutions were investing in Enron in the fourth quarter of 2001, but 
certainly many firms bought Enron stock during this time. Press reports 
have confirmed that a number of money managers invested in Enron in 
October and November on behalf of public pension funds. Moreover, there 
were many millions of shares being traded each day in October and 
November, and in some cases, hundreds of millions of shares. As 
Alliance Capital's purchases represented only a minor fraction of these 
trades, it is clear that many others were buying Enron in large 
quantities at what they believed to be bargain prices. And many 
investors who did not buy Enron during this time period still owned 
substantial quantities they previously purchased, but did not sell. It 
has been reported in the press that, excluding Florida, at least 5 
state pension funds each lost more than $100 million in Enron stock. 
(Alliance Capital did not make the Enron investments for those funds.)
    These large and widespread losses underscore one unfortunate fact--
that as a general matter, if management of a corporation is bent on 
deceiving the investing public, and they are abetted by a major 
auditing firm, it is very difficult for investment professionals to 
discern the truth. This is the case even where those investment 
professionals perform extensive research into the company's business, 
as Alliance Capital did with Enron.
    I would also like to take the opportunity to address one final 
issue relating to Frank Savage, a director of Alliance Capital 
Management Corporation, the general partner of Alliance Capital. Until 
the end of July of 2001, Mr. Savage was an employee of Alliance 
Capital, with responsibility for sales and marketing in the Middle East 
and Africa.
    Mr. Savage also served on the board of directors of Enron beginning 
in mid-October 1999. Mr. Savage joined the Enron board at Enron's 
request, and his service was personal to him. Alliance Capital did not 
ask Mr. Savage to serve on the Enron board, nor did he do so as a 
representative of Alliance Capital. Alliance Capital permitted him to 
join the Enron board only after he had agreed in writing to comply with 
Alliance's policies governing employee service on unaffiliated boards, 
which among things required that he be ``walled off'' from any 
discussion with Alliance Capital personnel concerning investments in 
Enron. Mr. Savage re-certified his compliance with those policies 
annually thereafter. To be perfectly clear, Mr. Savage never 
participated directly or indirectly in any decisions by Alliance to 
buy, hold or sell Enron stock, and his membership on the Enron board 
had nothing to do with those investments.
    Thank you, Mr. Chairman. I appreciate the opportunity to answer any 
questions the Subcommittee might have.
Exhibit A





    Senator Dorgan. Mr. Calvert, thank you very much.
    Mr. Harrison, you may proceed.

 STATEMENT OF ALFRED HARRISON, VICE CHAIRMAN, ALLIANCE CAPITAL 
                           MANAGEMENT

    Mr. Harrison. Good afternoon, Mr. Chairman and Members of 
the Subcommittee, and thank you for the opportunity to appear 
here today to discuss events related to Enron. My name is 
Alfred Harrison, and I'm a vice chairman of Alliance Capital 
Management. I also lead the large capitalization growth team, 
which has over $50 billion in assets under management.
    For 17 years, I have been responsible for managing the 
Florida State Board of Administration account. During that 
time, the account grew from an initial funding of $50 million 
in 1984 and subsequent contributions of $294 million to more 
than $3.6 billion in assets, a total return of over 1500 
percent, versus comparative returns for the S&P 500 of 978 
percent, the Russell 1000 growth index of 863 percent, and 843 
percent for a benchmark unique to Florida. Even allowing for 
the $280 million loss on Enron and all fees paid to Alliance 
Capital by the SBA, this means that we added more than $1 
billion to the account than would have been achieved by 
indexing in any benchmark. I believe the pensioners of Florida 
would be very pleased with this result.
    Our investment philosophy centers on using intensive 
research to find the correct balance between a company's 
fundamentals, on the one hand, and using judgment to assess its 
price. We call this the ``V factor.'' It sometimes means buying 
a stock into a price period of weakness if we believe it 
underprices a company's long-term core earnings power. We've 
followed this buy-low/sell-high methodology on many successful 
occasions benefiting the fund by several hundreds millions of 
dollars.
    If I could just interject here, painful though it is, I 
bought the airlines stocks immediately--the market opened after 
September the 11th and made a very strong recovery in price as 
a result of that.
    My original investment in Enron was in November 2000. Its 
reported annual earnings were growing at 25 to 35 percent at a 
time when technology stocks were beginning to collapse. Enron's 
reported growth stood out by comparison.
    I have been asked how I viewed Jeff Skilling's departure on 
August the 14th. My colleagues and I considered the return of 
Ken Lay and the promise of openness and a commitment to get rid 
of non-core assets as a positive. We met with Ken Lay and 
colleagues in Minneapolis on August the 21st and intensively 
questioned them all. On October the 16th, the company took a 
one-time charge in writing off its investment in failed 
entities such as broadband, but noted that its quarterly 
recurring earnings increased by 26 percent on the core 
business. They also took a $1.2 billion equity writeoff for 
losses incurred in a partnership, but took back from Enron 
shares that had been pledged as collateral to that partnership. 
The next day, I and six members of Alliance Capital from 
Minneapolis and New York on both the equity and fixed income 
sides met with the entire Enron team in New York. We concluded 
that Enron's core business was still intact.
    Senator Dorgan. Excuse me. What date was that?
    Mr. Harrison. That was October the 17th, sir.
    We concluded that Enron's core business was still intact 
and that Ken Lay was doing what he had promised in terms of 
acknowledging past investment mistakes and clearing the decks.
    Senator Dorgan. Mr. Harrison, excuse me for interrupting 
again. Did that include Mr. Lay and Mr. Fastow?
    Mr. Harrison. No. Mr. Fastow was not there at that meeting. 
Just Mr. Lay, CEO Greg Whalley, Executive Vice President Mark 
Koenig, Jeff McMahon, the treasurer, and Paula Rieker, investor 
relations.
    Senator Dorgan. Thank you.
    Mr. Harrison. Enron's management insisted that it had 
completely unwound its relationship with the partnership and 
that everything was now out in the open. He insisted that no 
further negatives would be revealed. Based in part on the false 
reassurances directly from the most senior levels of Enron 
management, we continued to add to our Enron positions in the 
ensuing price weakness.
    On November the 9th, Dynegy made a bid for Enron, which 
seemed to validate our confidence in its core operations. The 
bid was backed by $1.5 billion from Chevron Texaco, who owned 
27 percent of Dynegy. This was like Avis making a bid for 
Hertz.
    We met with Dynegy management, who had seen Enron's book. 
We met them in New York, Chicago, and Minneapolis in the next 
few days and were convinced that the resulting company could be 
a powerhouse, assuming regulatory approval. We bought more 
Enron stock, around $9 a share. Since the SBA gets daily 
electronic transmission of all of our trades, they are aware of 
these purchases. Unfortunately, Dynegy withdrew their offer in 
late November when the rating agencies downgraded Enron's debt 
two notches to junk status and bankruptcy was imminent, as we 
sold our shares.
    Let me stress that only a little over 10 percent of my 
dollar investments in Enron took place in October and November 
before this bankruptcy. Throughout our ownership of Enron, our 
analysts on my team researched the company extensively, met 
with management over a several-year period. We talked with Wall 
Street energy traders, suppliers, and the rating agencies, 
amongst many others. Unfortunately, we know now that Enron was 
a massive fraud. Its audited financial statements were 
misleading and grossly incomplete. We, along with other 
investors, suffered greatly as a consequence.
    Before closing, let me also address the subject of Frank 
Savage, who served on the board of Alliance Capital's general 
partners and who, until the end of July 2001, was an Alliance 
Capital employee. Let me say emphatically that I did not 
discuss Enron with Mr. Savage, and he played no part in my 
decisions on Enron.
    I would be happy to answer your questions.
    [The prepared statement of Mr. Harrison follows:]

Prepared Statement of Alfred Harrison, Vice Chairman, Alliance Capital 
                               Management
    Good morning Mr. Chairman and Members of the Subcommittee, and 
thank you for the opportunity to appear here today to discuss events 
related to Enron Corporation (``Enron'').
    My name is Alfred Harrison and I am the Vice Chairman of Alliance 
Capital Management (``Alliance Capital''). I also lead the large 
capitalization growth team at Alliance Capital with over $50 billion in 
total assets under management.
    For seventeen years, I have been the portfolio manager with 
ultimate responsibility for managing the account of the Florida State 
Board of Administration (``SBA''), the state agency charged with 
responsibility for managing Florida's public pension fund. During the 
17 years that I managed the SBA portfolio, we grew the account from 
$344 million in contributions to more than $3.6 billion in assets--a 
total return of approximately 1,500 percent versus comparative returns 
for the S&P 500 Index of 978 percent, the Russell 1000 Growth Index of 
863 percent and the benchmark selected by Florida itself of 843 
percent--even allowing for the approximately $280 million loss on Enron 
and all fees paid to Alliance Capital by the SBA.
    This means that Alliance Capital achieved a return for the SBA 
account of more than $1 billion more than would have been achieved by 
investing in any index benchmark during that period. I believe the 
pensioners of Florida should be very pleased with this result.
    Our investment philosophy, which has been consistently applied, 
involves finding the correct marriage between Fundamentals as they 
relate to each company--which is a product of intensive research--and 
then applying a Price judgment in relation to the facts we ascertain. 
We call this the ``V factor''.
    Enron appeared to have many of the qualities we look for in a 
growth stock. For example, when I originally invested in Enron in 
November 2000, it was the seventh largest U.S. company, with a dominant 
market position in the newly deregulated area of gas and electricity 
distribution and trading. It had reported annual earnings growth of 25 
percent-35 percent. Enron's management had been widely heralded as 
among the brightest and most visionary management teams in the world.
    Although market opinion is never unanimous about a company's 
business and prospects, Enron, because of its dominant position, was 
widely held by institutional investors, including many of the largest 
fund managers in the country. That notwithstanding, some have 
criticized my additional purchases of Enron stock in the months before 
Enron's bankruptcy. Overall, a little over 10 percent of my dollar 
investment in Enron on behalf of the SBA took place in October and 
November of 2001 before Enron declared bankruptcy.
    A key element of our ``V'' factor'' investment philosophy is to 
opportunistically add to a position in a stock that is declining in 
price if the company's core earnings power is projected to remain 
intact. This philosophy is clearly stated in the investment advisory 
agreement between Alliance Capital and the SBA, and has worked with 
enormous success for the SBA and many other clients over the years.
    When Enron's stock came under price pressure but its fundamental 
business appeared to remain intact, the stock appeared to be attractive 
consistent with the ``V'' philosophy. That is, Alliance Capital's 
purchases were based on the belief that the magnitude of the adverse 
developments was more than discounted in the stock price and that 
Enron's assets and long-term earnings power were undervalued. Again, 
this is a time-tested investment strategy that Alliance has applied 
consistently over the last two decades to achieve the outstanding 
results it has for the SBA and its other clients.
    I have been asked how I viewed the August 14, 2001 resignation of 
Enron's then-CEO Jeffrey Skilling. At the time, we viewed Kenneth Lay's 
return as CEO to be a positive development given his promise of 
openness and a commitment that Enron would shed non-core assets and 
focus upon its core business lines. Upon learning of Skilling's 
departure, I and my colleagues immediately arranged for a meeting with 
Lay, which was held in Alliance Capital's Minneapolis offices on August 
21, 2001. At that meeting, we had a very detailed discussion about 
Enron's business, and our questions appeared to have been answered in a 
complete and satisfactory manner.
    On October 16, 2001 Enron reported its third-quarter results and a 
surprising $1.2 billion reduction in shareholder equity. The very next 
day, I and my colleagues, including a number of portfolio managers, our 
equity analyst, our fixed income analysts and our oil analyst, met in 
New York with Ken Lay, COO Greg Whalley, Treasurer Jeff McMahon, 
Executive Vice President Mark Koenig and Paula Rieker, from Investor 
Relations. The Enron group represented to us that the reduction of 
shareholder equity was offset by Enron's buyback of stock pledged to a 
partnership, and that the write-off was equivalent to the company's 
repurchasing the shares in the open market. Enron's management insisted 
it had completely unwound its relationship with the partnership and 
that everything was now out in the open. As we now know, these and 
other representations were patently false. Even with the few special 
purpose entities that did come to light, crucial facts were withheld 
about the structure and insider relationships with Enron management.
    Based in part on the false reassurances directly from the most 
senior levels of Enron management, in the four weeks following October 
16, Alliance Capital added to the SBA's Enron position.
    Some of these additional purchases were made shortly after November 
9, when Dynegy, with a $1.5 billion dollars cash commitment from 
ChevronTexaco, announced its intention to merge with Enron. Based on 
the fixed exchange rate stipulated in the proposed merger agreement 
between Dynegy and Enron, Enron was trading at a large discount to its 
indicated exchange value. Moreover, we saw the new combined entity as 
offering strong appreciation potential. Before investing, Alliance 
Capital discussed the proposed deal with Dynegy management in the week 
following the merger announcement. We met with Dynegy management in New 
York, Chicago and Minneapolis. Dynegy stated that it was confident that 
the merger would be completed. Specifically, Dynegy's management stated 
that, based on their due diligence and their extensive experience in 
the business, Enron's books appeared to be in order and confirmed that 
Enron's core energy business was very strong. Market analysts around 
the country also generally believed that the deal would close, and that 
the deal presented a strong upside for Enron shareholders. Again, 
consistent with the ``V'' philosophy, I added to the Enron position 
around $9 per share.
    Alliance Capital's research was critical to all these decisions. 
Typically, I select stocks for investment using judgment, experience, 
and research by our analysts and my team of portfolio managers. In the 
case of Enron, that research included many meetings and calls with 
Enron's senior management. It included a review of Enron's public 
filings, audited financial statements and press releases. It included 
detailed discussions with Enron's suppliers, customers and competitors. 
It included following Enron's credit ratings, discussing Enron with the 
credit rating agencies, following energy industry developments, 
attending major industry conferences, utilizing the expertise of sell-
side analysts that followed Enron, and analyzing Enron's apparent debt 
load.
    In my experience, one of the most crucial aspects of Alliance 
Capital's research and evaluation process is speaking with a company's 
management team. The last year's events notwithstanding, I have found 
that management almost invariably provides an accurate picture of the 
company's business. They are of course obligated by law to do so. 
Unfortunately with Enron, this was not the case. As I have said, I and 
other portfolio managers and analysts on the Alliance Capital team met 
and spoke with Enron management repeatedly throughout 2001, and their 
answers to our questions were false and misleading in significant 
respects.
    We now know, of course, that Alliance Capital was not the only 
investment advisor or investor misled by Enron. Based upon published 
reports, it appears that the SBA lost as much as $50 million as a 
result of other investment advisers' investments in Enron, or in index 
funds managed by the SBA itself. Many thousands of other investors 
suffered losses in Enron, ranging from a few dollars to well over $150 
million dollars. Indeed, it has been reported that apart from the SBA, 
5 state pension funds each lost at least $100 million in Enron. 
(Alliance Capital did not make those Enron investments).
    And while we never rely uncritically on the opinions of sell-side 
analysts affiliated with other firms, often the substance of the 
information they convey, as well as their opinions, are helpful to our 
analysis. It is interesting to note that throughout October and 
November 2001, many sell-side analysts continued to rate Enron a buy or 
strong buy. Goldman Sachs, J.P. Morgan, Lehman Brothers, Salomon Smith 
Barney, UBS Warburg, Merrill Lynch, CIBC Oppenheimer and CS First 
Boston were among the major firms that continued to recommend Enron as 
an attractive stock. We consulted a number of these institutions whose 
analysis of Enron appears to have been wrong-footed by Enron's 
misinformation.
    Alliance Capital also consulted Standard & Poor's regarding its 
credit ratings of Enron. Credit rating agencies can serve as a 
significant source of information about a company, as the agencies 
enjoy unrivalled access to a company's books and records under the 
securities laws that investment advisers such as Alliance Capital do 
not have. Unfortunately, Standard & Poor's has publicly confirmed that, 
despite its privileged position, it too was deliberately misled by 
Enron.
    I have managed money for institutional and private investors for 
forty years, and I have always taken my responsibilities very 
seriously. Part of this responsibility involves exercising judgment in 
selecting stocks for my clients. In the case of Enron, that judgment 
was impaired by false and misleading information from Enron and its 
auditors Arthur Andersen. The truth is, Enron may be the single 
largest, most far-reaching episode of corporate fraud of this century, 
and a great number of portfolio managers around the country were likely 
misled, just as Alliance Capital was.
    Finally, I want to address a question that has been raised 
concerning Frank Savage, who served on the board of Alliance Capital's 
general partner and who, until the end of July 2001, was an Alliance 
Capital employee. Let me say emphatically that I have never discussed 
Enron with Mr. Savage, and he played no part with my Enron decisions.
    I welcome any questions the Subcommittee may have regarding these 
matters.

    Senator Dorgan. Mr. Harrison, thank you very much.
    I'm not quite sure where to start here, except that the 
public employees pension fund in Florida lost $300-and-some 
million, and I think, Mr. Herndon, you say it really wasn't 
your fault. Mr. Calvert and Mr. Harrison, you say it wasn't 
yours. And I think what you're saying is that you were lied to 
and misled by the Enron Corporation. You did due--you say you 
did due diligence, but the deception by the Enron Corporation 
caused you to do things. The result is that caused the Florida 
pension fund to experience a rather substantial loss.
    Senator McCain, I indicated I was going to ask a couple of 
questions of Alliance and then call on Mr. Glassman, if that's 
all right with you.
    Senator McCain. I see. All right.
    Senator Dorgan. Let me try to understand this just a bit 
more, if I can. Does the Florida pension management know of the 
general positions that are taken and the purchases made when 
they are made? Did you know, for example, that as Enron stock 
was collapsing and pancaking, that additional purchases were 
being made by Alliance, in your behalf, of Enron stock?
    Mr. Herndon. Yes, sir, Senator. We knew that those 
activities were taking place and, in response to our queries of 
Alliance, were reassured that the rigorous company-specific 
research they promised us was also being undertaken by 
Alliance, so we continued to place our trust in them and may 
have been misguided, in retrospect.
    Senator Dorgan. But you trusted them. Was there internal 
difficulties? Did you have discussions amongst yourselves, 
amongst the three-member board, of whether this was a good 
decision or whether you should continue to allow this to 
happen?
    Mr. Herndon. We discussed it at some length. Remember, it's 
important to put in perspective the fact that we had put 
Alliance on our watch list almost a year before, because their 
performance had been deteriorating overall. So the Enron 
situation was a specific example of concern that we had in that 
broader context.
    We did discuss it. We discussed it with Alliance. They 
reassured us that everything was OK, that they knew what they 
were doing. We don't second guess our managers' stock 
decisions. We make decisions about whether to hire or fire 
managers. We don't have the resources or the capabilities--nor 
does any other pension fund, for the most part, in this 
country--have the capability to do individual stock research. 
That's what we hire the experts for.
    Senator Dorgan. I understand that. But if you don't second 
guess those who purchase your stocks, then why do you put them 
on a watch list?
    Mr. Herndon. Well, we asked them questions to try and 
discern whether or not they are confident in their view that 
they are, in fact, in possession of the facts, that they can 
express their discipline and their professional opinion in a 
sound fashion. And we were hearing comforting noises from 
Alliance that were intended, at least, to reassure us that they 
were doing the homework. We don't know that.
    Senator Dorgan. And my question, I guess, is that the 
entire country was selling Enron--that's why its stock was 
collapsing--and you were discovering that you were buying more 
of it through your relationship with Alliance, and I was trying 
to understand if, internally, you were having second thoughts 
about that and having a discussion about whether you ought not 
to see that that's discontinued.
    Mr. Herndon. We did have those discussions.
    Senator Dorgan. Mr. Stipanovich, can you describe those 
discussions for me?
    Mr. Stipanovich. What we look at with a manager, and as Mr. 
Herndon related, when we put a manager on a watch list, it's 
really performance based. It's not really their--it's a 
byproduct of their stock selection. But because we don't have 
the expertise, nor do we exercise the discretion to get into 
individual stock selection, we really look at overall 
performance over periods of time, and that period of time is 
typically 1-, 3-, and 5-year periods and then since inception 
and that kind of thing, but the--more of the emphasis on the 3- 
and 5-year period. So it was for overall performance that 
really was the overriding problem. Enron was really the straw 
that broke the camel's back.
    Senator Dorgan. Let me just--an initial question about 
Enron and your meetings with them. Mr. Calvert, you and Mr. 
Harrison both indicated that the top officials from Enron just 
lied to you, misrepresented the company. You used the word 
``fraud'' a good many times in your presentation. We had Mr. 
Lay sitting at the table that you're now sitting at, and he 
took the Fifth Amendment. And we had Mr. Skilling, and he 
talked from here to Europe, but we really didn't understand 
much of what he was saying, at least he never admitted to very 
much. And Mr. Fastow is nowhere to be found. And so we're 
struggling to try to determine what Enron represented to people 
like you.
    Tell me again, if you can, with more specifics, how do you 
believe Enron lied to or deceived Alliance Capital, and who did 
that?
    Mr. Harrison. In retrospect, I think we can see that we not 
only had misleading information that came out in a very 
parsimonious fashion, but it was grossly incomplete. What has 
come out subsequently, in terms of literally hundreds, maybe 
thousands, of partnerships would have given a totally different 
picture, both as it relates to the gains and losses, and 
particularly the debt position of Enron.
    So I think that the key thing here is that, notwithstanding 
face-to-face meetings, looking them in the eye, asking all of 
the questions that we have done over the years that have led to 
our successful performance, the answers that were given, in 
retrospect, were just not adequate.
    Senator Dorgan. Mr. Harrison, were you aware of an SPE 
called ``Braveheart''?
    Mr. Harrison. Was I aware at the time? No.
    Senator Dorgan. You are now?
    Mr. Harrison. No. I am now, yes.
    Senator Dorgan. Would an analyst or someone in your 
position expect to be knowledgeable about Braveheart? I mean, 
would you expect the corporation to have disclosed sufficient 
footnotes and information on their financial statements to 
allow one to understand what a Braveheart is and how they use 
the money?
    Mr. Harrison. If the auditors had considered something to 
be material, it very definitely should have been right out 
there in front of investors, rating agencies, and everybody 
else.
    Senator Dorgan. So do you believe you were lied to by the 
auditors with respect to this company, as well?
    Mr. Harrison. Clearly, the failure to provide information 
on something such as this would point to at least inadequacy on 
their party.
    Senator Dorgan. Senator McCain?
    Senator McCain. Mr. Herndon, in March of 2002, the Tampa 
Tribune quotes you as saying, ``I can probably give as many 
examples on the upside as I can on the downside of investment 
managers of ours who have taken relatively large positions on 
companies on bad news, where the price got driven down only to 
have it rebound.'' It continued, ``I'm not sure we would do 
anything different today than we did last fall.''
    Mr. Herndon, given those statements, why do you now believe 
Mr. Harrison was negligent by investing in Enron?
    Mr. Herndon. My view hasn't changed much, Senator, since 
last fall, and that is that the process by which Alliance makes 
its investments, we believe is sound if its rigorously applied 
and done in the utmost of fiducially responsible fashion. We 
don't believe that occurred in this case.
    Senator McCain. You wouldn't have done anything different 
than you did last fall?
    Mr. Herndon. If we had been able to rest confidently that 
Alliance had, in fact, done the homework, Senator, I don't 
believe we would have done anything different, but we don't 
believe Alliance did the homework. They've never been willing 
to share that with us. So, consequently, we have no other 
position to take except that they didn't do it.
    Senator McCain. In the summer of 2001, SBA personnel 
visited Harrison's group in Minneapolis. After the meeting, Mr. 
Webster wrote in a memo to the SBA, ``My opinion of Alliance as 
a first-class organization is only enhanced by our visit. The 
depth and breadth of the knowledge within Alliance is 
impressive.'' It continued, ``We discussed a wide range of 
operational market issues with Al Harrison. He gives me no 
reason to believe we should be at all concerned about Al's 
ability. I continue to believe that Al is one of the best money 
managers employed by the state board.''
    Mr. Webster, how does the SBA reconcile the statements with 
their claim now that Alliance was negligent?
    Mr. Webster. Our trip up to Minneapolis was to better 
understand the process by which Alliance picked stocks. Our 
observations made us believe that the process was sound.
    Senator McCain. Well, were you fooled, Mr. Webster?
    Mr. Webster. Well, I would probably think so, yes, in this 
case.
    Senator McCain. And, Mr. Herndon, you were not deceived?
    Mr. Herndon. Senator, we have no quarrel with the fact that 
Alliance has been an outstanding investment manager on behalf 
of the state board for many years. But just as I have a clean 
driving record for 17 years, and then if I plow into a 
crosswalk and kill a bunch of children, the fact remains that I 
have been negligent in that specific instance. And that's 
exactly what we think happened in this case. And Alliance has 
made no effort to help us understand why, in fact, that didn't 
occur.
    The process is sound. We don't have any quarrel with that, 
if it's diligently applied. In this case, we believe there was 
negligence afoot on the part of Alliance, and we'll ultimately 
let a court of law make that determination.
    Senator McCain. Mr. Calvert, there have been suspicions 
raised regarding a possible conflict of interest by Mr. Savage, 
who sits simultaneously on the Alliance and the Enron boards of 
directors. Do you believe that Mr. Savage's dual roles give, at 
a minimum, an appearance of impropriety? And I'd ask you to 
take the microphone, if you don't mind.
    Mr. Calvert. We don't believe that there was, in fact, a 
conflict. We believe it was well covered by our policies. And, 
on the other hand, we do understand that perception is a 
different issue, and we think people have been entirely 
entitled to question at great length, and to question that 
relationship to see if there was impropriety, and I believe we 
have said there was not, and I believe people have concluded--
--
    Senator McCain. Do you believe there was an appearance of 
impropriety?
    Mr. Calvert. I do not believe that, no.
    Senator McCain. Should corporate board members be required 
to disclose potential conflicts, in your view, Mr. Calvert?
    Mr. Calvert. Yes, they should. And our 10-K discloses that 
Mr. Savage was on the Enron board.
    Senator McCain. Don't you think average citizens, when 
seeing the very large amounts of money Mr. Savage directed 
toward investments in Enron would say, ``Wait a minute. He's a 
member of the board of directors of this company. Wouldn't that 
give him some bias?''
    Mr. Calvert. Mr. Savage didn't direct any investments for 
Enron. He was not involved in any way, shape, or form at any 
time, in any discussions, or any decisions that were made about 
our investments in Enron.
    Senator McCain. He had no involvement in the decisions made 
by Mr. Harrison's team in Florida.
    Mr. Calvert. Absolutely not.
    Senator McCain. I thank you. I thank the witnesses, and I 
thank you, Mr. Chairman. I thank the witnesses. Mr. Glassman, 
welcome.
    Senator Nelson [presiding]: Mr. Glassman, we'll take your 
testimony, and then we'll continue the questioning.

   STATEMENT OF JAMES K. GLASSMAN, RESIDENT FELLOW, AMERICAN 
                      ENTERPRISE INSTITUTE

    Mr. Glassman. Thank you, Senator Nelson and Senator McCain. 
My name is James K. Glassman. I'm a resident fellow at the 
American Enterprise Institute and host of the Web site 
texcentralstation.com. I'm also a syndicated financial 
columnist for the Washington Post and author of two books on 
investing. I devoted much of my professional career to 
educating small investors. I am deeply concerned about the 
effects of the Enron scandal on these investors, and I 
congratulate you for holding this hearing today.
    Currently, more than half of U.S. families own stock, 
compared with just 15 percent in the mid 1960's and 20 percent 
in the early 1990's. This is an enormously beneficial 
development. The Enron disaster has been costly and shameful, 
but it provides a valuable educational opportunity for these 
investors. It is important that Members of Congress help them 
draw the right lessons.
    But I worry that, in hearings like this one, investors can 
get a dangerous message, that they are not personally 
responsible for their investments. For example, many Florida 
officials have, unwittingly or not, given the public the 
impression that the way the stock market works is that you keep 
your gains and sue to recover your losses since they must be 
someone else's fault. Indeed, the most important lesson of the 
Enron collapse should be that investors assume risks when they 
invest in stocks, and that they need to protect themselves.
    A smart investment strategy, then, is one that harnesses 
risk, dampens it, tries to control it. But eliminating risk in 
the stock market is impossible. The best way to harness risk is 
through diversification. That is owning lots of stocks in 
different sectors so the inevitable losers will be offset by 
winners. Well-run pension funds typically hire several managers 
with different, often uncorrelating investment styles. Each of 
the managers is responsible for a portion of the fund's assets. 
And one thing tell my readers is that stock investing is a 
long-term endeavor. There will be rotten years and great ones. 
The only way judge a portfolio manager is over the long-term.
    As someone who follows investment managers, I can only say 
that Mr. Harrison's long-term record has been exceptionally 
good. Mr. Harrison can defend his own record, and he has, 
although if I were Mr. Harrison, I would certainly respond to 
the comments about his investment style being equated to a 
drunk driver who kills children.
    But let me just emphasize what I think is the relevant 
information about his long-term record--his record. Long-term 
records are what count. And from 1984 to 2001, according to 
published reports, even with the Enron losses, he increased his 
share of the Florida account from $345 million to $3.7 billion, 
beating the S&P and other benchmarks. His investing style was 
well known to Florida officials, or it should have been. He 
buys, in an often very risky way, beaten-up stocks that are 
solid but he believes are underpriced. For example, according 
to the New York Times, he made a, quote, ``quick large gain,'' 
end quote, by buying Continental Airlines stock after the 
tragedy of the terrorist attacks of September 11th, which went 
down and then went back up.
    Overall--and I think this is a point that has not been made 
and should be--Enron represented, according to my calculations, 
0.3 percent of the total Florida pension fund. If the Florida 
pension fund had been invested in the Standard & Poor's 500 
stock index, which is generally perceived as a good way and not 
overly risky way to invest in stocks, it would have represented 
0.5 percent. So, in a sense, Florida was actually under-
invested in Enron.
    Let me just address a couple of specifics. Mr. Harrison was 
faulted for buying Enron as the price fell. The New York Times 
quoted Tom Gallaher, the Florida State Treasurer and one of the 
state pension fund's trustees, as saying, quote, ``Only fools 
buy on the way down,'' end quote. In fact, good investors, who 
believe in the companies in which they put their money, prefer 
to buy stocks at low prices rather than high.
    Second, Enron's value in the stock market fell sharply 
when, on October 16th, 2001, it announced a reduction of 
shareholder equity of $1.2 billion because of partnership 
losses. Then came the further shocks of October 22nd and 
November 8th, the overstatement of profits.
    Between October 22nd and November 16th, Mr. Harrison 
bought, according to published reports, $35 million worth of 
Enron at prices ranging from $9 to $23 a share. The question is 
whether this investment was reckless. A little math is in 
order. This investment represented less than 1 percent of his 
total Florida portfolio under management and less than four-
one-hundredths-of-one-percent of the entire Florida pension 
fund. Specifically, the New York Times cited the $12 million he 
invested between November 13th and November 16th and called it, 
quote, ``a huge bet that the company's prospects would turn 
around,'' end quote. In fact, it was not a huge bet. It 
represented one-three-hundredths of Mr. Harrison's Florida 
portfolio, and about one-ten-thousandth of the entire pension 
fund. Clearly, in hindsight, Mr. Harrison did make a mistake, 
but it appears to me that he didn't do anything that was 
reckless.
    Were Mr. Harrison's investing practices bizarre, as Senator 
Nelson, you, yourself are quoted as saying? Not in my opinion. 
It is important to remember humility in viewing the workings of 
markets. The price of a stock is the considered judgment of 
thousands of investors. For every seller, there is a buyer. 
After the adverse revelations, the fact that Enron stock was 
plummeting, for example, doesn't mean that it's a bad 
investment. For example, by definition, $10 a share was the 
best--that is to say, the most informed--price for Enron on 
November 14th, one of the days on which Mr. Harrison made his 
purchases. Yes, it was a mistake. It was a bad purchase, in 
hindsight. But Mr. Harrison has also made many good ones.
    The Enron collapse has unfortunately generated a kind of 
hysteria. In fact, what is bizarre is not so much the behavior 
of portfolio manages like Mr. Harrison, but the behavior of 
many journalists and public officials. Enron was a costly 
episode, but I fear that the search for scapegoats will end up 
not merely smearing the reputations of talented and dedicated 
professionals, but will send small investors--that is, your 
constituents--a disastrously wrong message.
    We should not frighten people away from investing. Whether 
we like it or not, for most Americans, stock market investing 
represents not just the best, but, in fact, the only way to 
build a large enough nest egg for a comfortable retirement. 
Yes, we need to protect and nurture investors, but we should 
not treat them like fools or children. We need to give them the 
tools, including accurate reporting and good financial 
education, which is an important role for Congress to play, to 
make their responsible choices.
    I thank you.
    [The prepared statement of Mr. Glassman follows:]

  Prepared Statement of James K. Glassman, Resident Fellow, American 
                          Enterprise Institute
Bizarre Behavior? The Story of Enron Stock Losses in the Florida State 
        Employee Retirement Fund
    Mr. Chairman and Members of the Subcommittee:
    My name is James K. Glassman. I am a resident fellow at the 
American Enterprise Institute and host of the website 
TechCentralStation.com. I am also a syndicated financial columnist for 
the Washington Post and author of two books on investing. I have 
devoted much of my professional career to educating and advising small 
investors. I am deeply concerned about the effects of the Enron scandal 
on these investors and congratulate you for holding this hearing today.
    Currently, more than half of all U.S. families own stock, compared 
with just 15 percent in the mid-1960s and 20 percent in the early 
1990s. This is an enormously beneficial development. Americans 
primarily own shares of individual companies, mutual funds run by 
professionals, or index portfolios, which are baskets of stocks, 
maintained by computer programs, that reflect broader markets. The 
Enron disaster has been costly and shameful, but it provides a valuable 
educational opportunity for investors. It is important that members of 
Congress help them draw the right lessons.
    I worry that in hearings like this one, investors get a dangerous 
message--that they are not personally responsible for their 
investments. For example, many Florida officials have, unwittingly or 
not, given the public the impression that the way the stock market 
works is that you keep your gains and sue to recover your losses--since 
they must be someone else's fault. In this view, investing is an 
endeavor that always produces winners, so, if there are losers, they 
someone must have cheated.
    Instead, the most important lesson of the Enron collapse should be 
that investors assume risks when they invest in stocks, and they need 
to protect themselves. This hearing asks witnesses to comment on how 
losses such as those in the Enron case could be ``avoided in the 
future.'' They cannot. Some stocks will always fall in value. The 
market as a whole has fallen in 22 of the past 76 years. Investors need 
to know that short-term losses are part of investing. Stocks are risky.
    However, the risk that a company will use deceptive or illegal 
accounting practices is a highly unusual one. Share prices of America's 
very best companies, with good managers, good products, good employees 
and good ideas, will fall from time to time--with no chicanery or 
lawbreaking involved.
    In early 2000, for example, the stock-market value of Procter & 
Gamble, a sound corporation with great brand names like Tide and Crest, 
dropped by 54 percent in just two months. Volatility is inherent in 
stock investing. And volatility means that some stocks can rise by 7800 
percent in a decade (as Dell Computer has done) while others, like 
Enron can go from $80 to a few cents in a year.
Stocks Are Risky, But Rewards Are High
    In fact, the way to understand why stocks have been such a great 
investment over the past two centuries in the United States is to 
recognize that investors get compensated for taking risks. Since 1926, 
a portfolio the 500 stocks of the Standard & Poor's benchmark index (or 
its predecessor) has returned an annual average of 7.6 percent after 
inflation, compared with an annual average of just 2.2 percent, also 
after inflation, for medium- and long-term U.S. Treasury bonds. In 
other words, over 30 years, an investment of $1,000 in stocks rose, on 
average, to $8,000, while a similar investment in bonds rose to less 
than $2,000.
    A smart investment strategy, then, is one that harnesses risk, 
dampens it, tries to control it. But eliminating risk in the stock 
market is impossible.
    The best way to harness risk is through diversification--that is, 
owning lots of stocks in different sectors, so that the inevitable 
losers are offset by winners. Well-run pension funds typically hire 
several managers with different, often uncorrelated investing styles; 
each of the managers is responsible for a portion of the fund's assets. 
Small investors can get the same effect by owning different kinds of 
mutual funds: a growth and income fund, for example, that concentrates 
on large-company stocks that pay dividends, might be balanced by a 
small-cap aggressive-growth fund, whose manager looks for smaller firms 
that are often ignored by the public and by analysts, or by a fund that 
concentrates in Asian-based companies.
    One thing I tell my readers is that stock investing is a long-term 
endeavor. There will be rotten years and great ones. Bonds are short- 
or medium-term investments; stocks are not. The only way to judge a 
portfolio manager is over the long term.
The Alliance Losses
    It is with this approach that I have analyzed the events I first 
saw described in an article that appeared on March 3, 2002, in the New 
York Times. It reported that Alfred Harrison, a money manager for 
Alliance Capital, had lost $328 million through his investments in 
Enron Corp. on behalf of the Florida State Pension Fund.
    The article asked why Mr. Harrison had bought Enron at the ``11th 
hour''--that is, as late as two weeks before Enron filed for 
bankruptcy. The clear implication was that Mr. Harrison had done 
something terribly wrong, unprofessional, even corrupt.
    I had heard of Mr. Harrison since I write about mutual funds, and 
knew he had an excellent reputation for his management of Alliance 
Premier Growth, a fund that had consistently beaten its peers. As I 
read the entire article and did some research on my own, a different 
picture emerged. It became clear that Mr. Harrison's critics lacked a 
basic understanding of how markets work and that they were making him a 
kind of scapegoat for some reason, perhaps political. But, more 
important, I worried that the way the story was treated might lead 
small investors--the people for whom I write--to draw the wrong 
conclusions about their own investment strategies.
    Let me be specific . . .

        1. The loss of $328 million in Enron stock came in a pension 
        fund portfolio of $95 billion. In January 2001, Enron 
        represented about 0.53 percent of the S&P 500 index, a good 
        proxy for the market as a whole. A quick calculation finds that 
        Mr. Harrison's peak holding of Enron represented about 0.3 
        percent of the Florida pension fund. In other words, if 
        anything, Enron appeared to be underweighted in the Florida 
        portfolio.

        2. Mr. Harrison had been managing a piece of the Florida 
        pension fund since 1984, presumably with annual reviews. Why 
        hadn't Florida fired him earlier? Very simply because Mr. 
        Harrison had increased his initial stake from $345 million to 
        as much as $6 billion in about 15 years, according to published 
        reports. When his contract was terminated, the stake had fallen 
        to $3.7 billion--but that was still a 10-fold increase in 17 
        years, for an average annual return of 16 percent, considerably 
        above the returns of the market as a whole.

        3. Mr. Harrison is well-known for a particular style of 
        investing. He takes extra risks and generally achieves extra 
        rewards. Morningstar Mutual Funds, a research firm, calculates 
        that, for the public fund he has managed since 1992, his 
        investments have been about one-third riskier than the market 
        as a whole. It is hard to believe that the Florida authorities 
        were unaware of that style. Money managers operate in public; 
        their records and strategies are well-known. Mr. Harrison, in 
        fact, has a reputation for trying to find undervalued companies 
        whose price, he believes, will rise. A well-run pension plan 
        balances a manager like Mr. Harrison with other managers who 
        might specialize in income-producing stocks or mid-caps or bank 
        stocks.

        4. Mr. Harrison was faulted for buying Enron as the price fell. 
        The New York Times quoted Tom Gallagher, the Florida State 
        Treasurer and one of the state pension fund's three trustees, 
        as saying, ``Only fools buy on the way down.'' In fact, good 
        investors, who believe in the companies in which they put their 
        money, prefer to buy stocks at lower, rather than higher 
        prices. Most smart investment analysts would generalize the 
        opposite way: ``Only fools sell on the way down--and buy on the 
        way up.'' If you have found a good company in which to invest, 
        and have bought its shares at $50 each, then it makes sense to 
        buy more of those shares at $10 each. The question with Enron 
        was its soundness as an investment, not the fact that its price 
        had dropped. Indeed, Mr. Harrison frequently invested in stocks 
        that had dropped in price, and, if Mr. Gallagher thought this 
        something ``only fools'' do, then it is hard to understand why 
        Mr. Harrison was retained for 17 years. In the right hands, Mr. 
        Harrison's approach is a very effective strategy. For example, 
        according to published reports, Mr. Harrison made a profit in 
        the Florida fund by investing in Continental Airlines last 
        year. He bought the stock after it fell shortly after the 
        terrorist attacks in New York and Washington in September. Not 
        long afterwards, it rose strongly, and Mr. Harrison made what 
        the Times called ``a quick large gain.''

        5. Enron's value in the stock market fell sharply when, on Oct. 
        16, 2001, it announced a reduction of shareholder equity of 
        $1.2 billion because of partnership losses. Then came further 
        shocks: the announcement on Oct. 22 of an SEC inquiry and the 
        announcement on Nov. 8 of an overstatement of profits over the 
        previous 5 years. Between Oct. 22 and Nov. 16, Harrison bought 
        $35 million worth of Enron at prices ranging from $9 to $23 a 
        share. The question is whether this investment was reckless. A 
        little math is in order. This investment represented less than 
        1 percent of his total Florida portfolio under management and 
        less than four-one-hundredths of one percent of the entire 
        Florida pension fund. Specifically, the New York Times cited 
        the $12 million he invested between Nov. 13 and 16 and called 
        it ``a huge bet that the company's prospects would turn 
        around.'' In fact, it was not a huge bet--it represented one-
        three-hundredth of Mr. Harrison's Florida portfolio and about 
        one-ten-thousandth of the entire pension fund. Clearly, in 
        hindsight, Mr. Harrison made a mistake. He evidently believed 
        that Enron's assets remained substantial and that the company 
        would be bought out by Dynegy, a competitor. The Dynegy deal 
        fell through on Nov. 30, and Harrison liquidated his Enron 
        holdings that day. Two days later, Enron filed for bankruptcy 
        protection.
A ``Bizarre'' Decision?
    Let me be clear. I certainly would not have invested in Enron in 
October, nor would I have advised my readers to do so (and many of them 
asked). The reason, very simply, is that for small investors I advocate 
a strategy of buying companies with solid long-term (meaning 20 years 
and more) prospects. But was Mr. Harrison's decision ``bizarre,'' as 
Sen. Bill Nelson is quoted as saying? Not in my opinion. It is 
important to remember humility in viewing the workings of markets. The 
price of a stock is the considered judgment of thousands of investors--
for every seller, there is a buyer. After the adverse revelations, the 
fact that Enron stock ``was plummeting,'' in Sen. Nelson's words, did 
not make it an imprudent investment. For example, by definition, $10 a 
share was the best (that is, the most informed) price for Enron Nov. 
14, one of the dates on which Mr. Harrison made one of his purchases. 
Yes, it turned out to be a bad investment, but Harrison also had many 
good ones, including, according to press reports, MBNA, Motorola and 
Cisco Systems. These stocks were bought according to the strategy that 
had produced good results for his clients--a strategy that his 
promotional literature calls ``V investing''--that is, buying companies 
whose shares had fallen beyond what he believed to be reasonable levels 
and then selling them when they recovered, as many did.
    Overall, Mr. Harrison not only beat the S&P with his Florida-fund 
portfolio but, with his public mutual fund, also beat the large-cap 
growth group and the Russell 100 Growth index, according to 
Morningstar. In addition, from 1994 to 1999, his fund beat the S&P in 
four out of five years. It returned 46 percent in 1995, 23 percent in 
1996, 32 percent in 1997, 48 percent in 1998, and 28 percent in 1999.
A Kind of Hysteria
    The Enron collapse has, unfortunately, generated a kind of 
hysteria. In fact, what is bizarre is not so much the behavior of 
portfolio managers like Mr. Harrison but the behavior of many 
journalists and public officials. Enron was a costly episode, but I 
fear that the search for scapegoats will end up, not merely smearing 
the reputations of talented and dedicated professions, but will send 
small investors--that is, your constituents--a disastrously wrong 
message.
    Mr. Harrison was not the only money manager or analyst who was 
impressed by Enron's historic results, its business strategy, its 
management and its story. The company was lauded by Fortune magazine 
for many years as America's most innovative. In late September 2001, 
after Enron's stock price had fallen by two-thirds, the Value Line 
Investment Survey, an independent research firm with an excellent 
reputation, gave the company an ``A'' rating for financial strength and 
a ``2'' (above-average) rating for ``timeliness.'' The Value Line 
analyst wrote, ``We think fears are overdone . . . and . . . markets 
for both wholesale and retails services are still growing strongly.'' 
After all, revenues had risen from $14 billion to $100 billion in 10 
years, and earnings had gone from 9 cents a share in 1989 to $1.47 a 
share in 2000.
    Janus, one of the biggest mutual fund houses in the country, owned 
5.6 percent of the company's shares by itself, and the Fidelity sector 
fund that specializes in energy made Enron its largest holding. 
Alliance and Mr. Harrison were not alone in their admiration of the 
company. Like the entire business press and the entire investment 
establishment, they were duped by what we have learned were aggressive 
misrepresentations of the company's financial condition.
    The bulk of Mr. Harrison's investment in Enron--approximately 90 
percent by my calculation from published reports--occurred before the 
company's restatements of assets and earnings. The relevant issue is 
not his investment in a particular stock that lost money; it is, 
instead, the structure of his portfolio. Was he dangerously 
overweighted in Enron? In other words, did he have too much stock in 
that one company in relationship to his other holdings? Not at all. Did 
his losses in Enron seriously impair his overall performance? Again, 
no. An average annual return of 16 percent over 17 years is 
exceptional. Imagine one of your constituents at age 31 turning over 
$10,000 to Mr. Harrison to invest for retirement at age 64. At a 16 
percent rate of return, the constituent would have a nest egg of well 
over $1 million.
    Does Congress have a legislative role here? Again, no. The Florida 
state pension fund and similar funds should select and oversee their 
own managers without federal interference. They are fully capable of 
deciding who should manage their money. It is a shame, however, that 
the trustees have handled this matter in the politically and 
emotionally charged way they have. If they don't like the way 
particular managers perform, then they can fire them. If laws are 
broken, they can ask for prosecution.
    So what are we doing here?
Promote Financial Education
    Congress can serve a constructive function in the aftermath of the 
Enron scandal. That function is educational. It is a fact and a 
blessing that the majority of Americans now own stock. Many of them, 
however, do not understand the basics, let along the intricacies, of 
investing. Teaching them is what I try to do in my columns and books, 
but government leaders can also play an important role. Let me close by 
listing what I believe are the lessons to small investors from the 
Enron collapse:

    Diversify. If a stock like Enron is among only five or 10 stocks 
you own, then you're in big trouble, but if Enron is part of a widely 
diversified portfolio--as it should be--then you can pick yourself up, 
take your tax loss and move on.

    Be skeptical of the experts. Wall Street has a herd mentality. Not 
only do analysts have a bullish bias, but, worse, they have a sheepish 
bias. They don't want to stand out from the flock. So if a few top 
analysts start buying a story, then practically every analyst buys the 
story. In the case of Enron, it was a famous short-seller, James 
Chanos, who started asking questions about the company's financial 
statements. Chanos, of course, had an ax to grind himself because, by 
selling short, he made money if the stock fell. But he proved an 
important point for small investors: Often, in the market, as in life 
in general, it is better to listen to non-conforming argument than to 
the conventional wisdom.

    Recognize that bad things happen to good investors. Events such as 
the Enron debacle are part of the risk inherent in investing. They'll 
always occur. Mr. Harrison said of Enron, ``On the surface it had 
always seemed to be a fairly good growth stock.'' It did, but it 
wasn't. However, investment professionals who bought the stock for 
their clients' portfolios were not venal or corrupt. They simply took 
at face value what the company reported in its official filings, and 
they were deceived. Mr. Harrison and others bought Enron stock after 
adverse revelations, but they too believed that the company still had 
valuable assets. This was a mistake but not an outrageous one. Through 
diversification, he protected the bulk of his account. That's a key 
lesson for small investors.

    Take Personal Responsibility. Finally, all investors need to 
understand that their choices in financial investing are their own 
responsibility, just as their choices in home-buying are their own 
responsibility. They should not expect to be bailed out by lawyers or 
politicians. Thanks to the incredible financial democracy and diversity 
that has developed in the United States, small investors can take 
advantage of professional management and analysis at low cost, or, at 
even lower cost, they can simply own index funds that reflect the 
entire market. Investors who have proceeded in this way, with clear-
headed, long-term strategies, have done very well. Over the past 20 
years, an investment in the 30 stocks of the Dow Jones Industrial 
Average, with dividends re-invested, has increased about 20-fold.
    We should not frighten people away from investing. Whether we like 
it not, for most Americans, stock-market investing represents not just 
the best way, but the only way, to build a large enough nest egg for a 
comfortable retirement. Yes, we need to protect and nurture investors, 
but we should not treat them like fools or babies. We need them to give 
them the tools--including accurate reporting and good financial 
education--to make their own responsible choices.
    Thank you.

    Senator Nelson. Thank you, Mr. Glassman, and thanks to all 
of you for your testimony. I think the chairman will be coming 
back after he finishes this interview that he's doing. In the 
meantime, I've got a few questions. First, for Mr. Herndon.
    Mr. Herndon. Yes, sir.
    Senator Nelson. In your experience with Florida and the 
knowledge of public funds across the country--and by the way, I 
think we ought to state that you've headed this Florida 
retirement system, otherwise known as the State Board of 
Administration, for, what, about 5 or 6 years?
    Mr. Herndon. 5\1/2\ years.
    Senator Nelson. And is it true that you've been--that you 
have decided to retire?
    Mr. Herndon. Yes, sir.
    Senator Nelson. And who is to be your replacement?
    Mr. Herndon. The board has not made that decision yet. I 
hope it's my colleague, Mr. Stipanovich, but that remains to be 
seen. The trustees will make that decision.
    Senator Nelson. Well, in your experience with Florida and 
your knowledge of the public funds--and I might point out here 
that, as I understand it, this Florida pension fund is the 
fourth-largest pension fund in the country.
    Mr. Herndon. Yes, sir.
    Senator Nelson. Then with that kind of knowledge, give me 
an estimate of the percentage of funds invested in index funds 
versus fixed investments like bond funds and versus a 
percentage of actively invested through money managers.
    Mr. Herndon. I'd be happy to, Senator. And maybe Mr. 
Glassman might want to pay attention to this as well since over 
60 percent of our equity investments are in index funds, we 
hire 14 different outside managers, all of whom possess 
different styles so that we are a very diversified fund. It's 
never been our intention to try and send a message to the 
public or anyone else that they're not responsible for their 
losses, provided the investment manager that they hire conducts 
themselves in a responsible fashion and does the homework that 
they contract for.
    In this case, we don't believe that happened. In this case, 
we believe Alliance was negligent. And in that case, it's 
incumbent on institutional investors like us and any investor 
to hold them responsible for the misdeeds that they conduct. 
And in this case, that's what we're trying to do.
    Senator Nelson. All right. Now, what I'm trying to find out 
is a relative amount of the fund that's in the index funds and 
other kinds of investments and then what percentage of your 
stock portfolio is handled by outside money managers. You have 
some internal managers, as well.
    Mr. Herndon. About 40 percent, approximately, of the stock 
portfolio is handled by outside money managers. About 60 is 
indexed by both internal and external money managers. And 
overall, about 60 percent of the entire pension fund is in 
indexed products, both bonds, international, and U.S. equity. 
And I'm setting aside, for the moment, real estate and private 
investments since they're really quite a bit different 
investment.
    Senator Nelson. All right. Let me see if I understand. So 
40 percent of your stock portfolio is handled by outside money 
investors----
    Mr. Herndon. Right.
    Senator Nelson.--money managers. And 60 percent is handled 
internally or by----
    Mr. Herndon. Or by external index funds.
    Senator Nelson.--by the index funds.
    Mr. Herndon. Correct.
    Senator Nelson. All right. You state in your testimony that 
Alliance was put on an internal watch list for poor 
performance.
    Mr. Herndon. Yes, sir.
    Senator Nelson. Tell me when that occurred, and describe to 
our Committee the nature of a watch list.
    Mr. Herndon. It occurred in the fall of 2000, late in the 
fall of 2000, as we saw Alliance's performance for the overall 
portfolio deteriorate. And I might add--Mr. Glassman has made 
this comment, as well--that, at its peak, Mr. Harrison's 
portfolio on behalf of the State Board of Administration was 
close to $6 billion. When he was terminated, it was $3.7 
billion. So they lost $2.3 billion for the State Board of 
Administration, of which $280 million was Enron investments. So 
it's not exactly as if we were acting in a capricious fashion. 
We were very cognizant of his long track record with us.
    But to the point, we tried to accelerate our monitoring of 
Alliance from the quarterly process that we currently do to a 
monthly review, where our analysts and our staff talk to the 
staff in Minneapolis, or vice versa, every single month so that 
we keep a close eye on what's going on. And we ask them, ``Why 
are you doing some of the things that you're doing? We want to 
be assured that you're doing it in full possession of the 
facts.'' And they kept assuring us that they were. I'm not so 
sure about that, but----
    Senator Nelson. And you said that they were put on this so-
called watch list, which is the terminology that you've 
described----
    Mr. Herndon. Yes, sir.
    Senator Nelson.--from the fall of 2000.
    Mr. Herndon. That's correct. November or so of 2000.
    Senator Nelson. Now, is--you talked about the frequency of 
the meetings as a result of being on a watch list. Does this, 
then, suggest--for example, in a New York Times article of 
March the 3rd, they make reference to the fact that Mr. 
Harrison was meeting with representatives of the Florida fund 
some 31 times last year. Would that have caused the increased 
frequency of these meetings?
    Mr. Herndon. I'm not sure about that story, Senator. We 
certainly didn't meet with Mr. Harrison 31 times. We did talk 
with his office or his staff or Mr. Harrison on a number of 
occasions. I don't have the count in front of me, but it was a 
couple of dozen times over the course of 2001. I don't know 
about 31, but----
    Senator Nelson. All right. Once I get to Mr. Harrison, I'll 
ask him these kinds of questions, and I'd like the Committee to 
have an understanding of this. We wanted to understand what 
watch lists are. Do other funds have watch lists?
    Mr. Herndon. Yes, sir. It's a fairly common practice in the 
industry. When an investment manager's performance 
deteriorates, all of us increase our scrutiny, we increase the 
attention that we're giving to the investment manager to try 
and understand what's going wrong, what do we attribute the 
poor performance to. In this case, that's exactly what we were 
trying to do. We were trying to understand what was accounting 
for the poor performance on the part of Alliance.
    Senator Nelson. And so if other funds have this--do they 
have that same kind of criteria as you do for putting them on 
watch lists?
    Mr. Herndon. Essentially they do. I mean, we're all 
watching manager performance. That's what we do is hire and 
fire managers, not invest in individual stocks. And most all of 
the large pension funds follow a similar pattern. They may use 
a slightly different screen, but they all follow a similar 
pattern.
    Senator Nelson. Since we're talking about the time from the 
fall of 2000 until the winter of 2001, how many other money 
managers were on that watch list for the State of Florida?
    Mr. Herndon. As I recall, during that period of time--I 
don't recall that there was anybody else that was on that watch 
list at that particular time. I could stand corrected, and I'd 
be happy to get that information for you, Senator.
    Senator Nelson. So Mr. Harrison was on the watch list for--
somewhere I've picked out the time--it was approximately 17 
months.
    Mr. Herndon. That sounds about right.
    Senator Nelson. What kind of action--with him being on a 
watch list for that long and him being--as you have just 
testified, being the only one on the watch list for the state 
of Florida, what kind of specific action, other than the 
meetings being accelerated from quarterly to monthly, would 
occur--did occur?
    Mr. Herndon. Increased communication, visits to 
Minneapolis, bringing the Alliance staff down to Florida to 
visit with us, watching their purchases with a closer degree of 
scrutiny than we did prior to that time, trying to get more of 
an explanation of just exactly what was underlying their 
investment decisions.
    Senator Nelson. Well, maybe you can help me understand 
this, then. You know, one of the sources, as I've prepared for 
this hearing, was this New York Times article of March the 3rd, 
and it says, ``As Enron edged toward bankruptcy, Mr. Herndon 
said communication from Alliance ground to a halt. `There was 
an abysmal lack of communication,' he said.'' Given the fact of 
this increased communication, how does that square with this?
    Mr. Herndon. What I was referring to in that particular 
quote was the decisionmaking process that Alliance went through 
to sell the stock that we owned. They, without notice to us, 
blind-sided us, in spite of repeated discussions, visits in our 
office. A day after we received an e-mail from them 
highlighting the value of the Enron stock, they sold the entire 
position out in a sale in a private placement overseas without 
telling a sole and never did tell us even til after the fact. 
We found out about it on our own volition. Alliance never did 
tell us until several days later that they had, you know, 
bailed out and left us holding the empty sack.
    Senator Nelson. Well, with this particular scenario, what 
corrective action was taken in the course of the watch list, 
and what was not taken, that led to the present situation?
    Mr. Herndon. Well, we fired Alliance, first and foremost, 
for a variety of reasons, many of which we've discussed here 
this afternoon. We've also made an effort to implement a 
variety of screening tools to more closely monitor the 
investment decisions of our managers. But bear in mind, 
Senator, as you heard the Alliance officials represent, they 
had 25 analysts on their team in Minneapolis, 300 research 
folks around the world. The State Board of Administration and 
no pension fund in this country has that kind of resources. We 
don't have the capability to monitor individual stock decisions 
on the part of our managers when they're managing a $50 billion 
stock portfolio.
    So what we are doing is trying to understand and trying to 
develop screens that help us understand exactly how focused and 
disciplined that investment process on the part of the 
managers, and reassure us that the reason we hired them is 
still a valid one.
    Senator Nelson. As I said at the outset, what--the purpose 
of this hearing is for us to get to the bottom of this so we 
can understand what happened and why it happened and what we 
should do about it from the standpoint of reforms at the 
federal legislative level. How long would you suggest to us 
that we should consider, as we consider this whole matter, that 
someone should stay on a watch list before corrective action 
should be taken?
    Mr. Herndon. Our general rule of thumb is approximately 3 
years, assuming that there are not consequential events, 
material events, that are at play that shorten that watch list, 
as is the case with Enron. We didn't originally put Alliance on 
the watch list because of Enron. It became a more profound 
problem as we moved further and further into the watch list 
period. But, generally speaking, I think 3 years is the 
industry benchmark. That's a sufficient time to determine 
whether the individual manager is skillful or not, and that is 
the practice that the board generally applies, is 3 years.
    Senator Nelson. Is that the practice that other states use, 
as well?
    Mr. Herndon. Well, that's my impression, Senator. I can't 
speak for all of them, obviously, but my impression certainly 
is that 3 years is a pretty common benchmark for watch list 
activity.
    Senator Nelson. In light of this activity, are you still 
comfortable with 3 years?
    Mr. Herndon. I think we're comfortable with 3 years, again, 
recognizing that there are critical events that could happen. 
Had we known, for example, that Mr. Savage was on the board of 
Enron, we might very well have done something different, but 
that was never disclosed to us. And, in fact, I think--I could 
certainly stand to be corrected--but I think it's even against 
Alliance's own corporate policy, but they made an exception in 
this case for Mr. Savage. That's the kind of material event 
that we might very well have dealt with differently had we 
known that, but we didn't know that. And those kind of events 
can shorten a watch list cycle.
    Senator Nelson. You know, someone would know that if they 
just read the annual report of the company.
    Mr. Herndon. Well, that's perhaps the case, Senator. I'm 
not at all sure that it's always the case, but we would hope 
that that's the case.
    Senator Nelson. Let me ask you about a reform. The Florida 
State Board of Administration had a standard beyond which an 
outside money manager was not to go, and that was that, of that 
outside money manager's total portfolio, they were not to 
invest in more than 6 percent of that portfolio in a single 
stock. It's my understanding that that was exceeded in this 
case. Is that accurate?
    Mr. Herndon. It may have been, on limited occasions. I 
don't know that they were consistently above that standard 
throughout the period of time that they were investing in 
Enron, but there may have been some instances where they 
pierced that level.
    Senator Nelson. Would that have been a matter of discussion 
as a benchmark that would trigger certain actions in the course 
of being on this watch list?
    Mr. Herndon. Yes, sir.
    Senator Nelson. And should that be, as part of the reforms 
that we're looking at?
    Mr. Herndon. It should be something that you take into 
consideration, Senator, no question about it.
    Senator Nelson. And in looking at reforms, what could you 
suggest to us might give some signals with regard to someone on 
a watch list with regard to index funds, as compared to the 
performance of an outside money manager? Is there something in 
the lingo of the trade that would be helpful to us there?
    Mr. Herndon. Well, in most cases, outside money managers or 
active managers have a benchmark against which they're 
measured. It may be an index-style benchmark, like an S&P 500, 
or it may be a custom benchmark that was in place, for example, 
for Alliance. Anybody should be gauging the performance of the 
investment manager against that benchmark. And if they 
consistently underperform that benchmark over a long enough 
period of time, going back to our 3 years, then they should be 
dealt with. Whether they are de-funded to some degree or 
terminated is up to the individual investment firm--investment 
fund.
    Senator Nelson. Tell me your recommendation with regard to 
reforms that--in many states, I understand that the governing 
board--in this case, as you have described it, the State Board 
of Administration board of trustees are the Governor, the 
treasurer, and the comptroller--in many states, I understand 
that there is a representative of the participants in the fund, 
such as a retiree who is drawing from the fund or a state 
worker that is paying into the fund, instead of just elected 
officials. What is your observation there?
    Mr. Herndon. I count ourselves as one of the fortunate 
organizations, in that we have a board of, as you say, 
statewide elected officials that are ultimately accountable to 
not only the members of the pension fund, but to the taxpayers, 
ultimately. And, as you observed early on in the testimony in 
the hearing today, ultimately the taxpayers are the ones that 
are responsible for the pension fund in some respects.
    So I think the form that we currently have is a good one. 
It's very effective. It is a well-managed organization, from 
the standpoint of the trustees. We have an advisory council. In 
fact, we have two advisory councils that have representatives 
of the various labor unions and so forth on them, and I think 
that gives everybody a very rational way to communicate their 
interests and concerns.
    Senator Nelson. Has there been any concern for you, as we 
consider this legislation, that you could advise us about 
potential conflicts of those elected officials? For example, 
either by law or rule, I don't know which, anyone participating 
as a member of the Florida cabinet in the capacity as the 
Division of Bond Finance cannot receive contributions from any 
bond company. Do you think that there should be similar kinds 
of prohibitions with regard to elected officials being the 
trustees on any kind of the investments that are in that state 
retirement fund and/or the money managers and the principals of 
those money managers? What is your advice to us there?
    Mr. Herndon. This issue was considered, I believe, two or 3 
years ago by the SEC. At the time, there was discussion about 
prohibiting investment managers, investment companies like 
Alliance, from making campaign contributions to trustees of 
various pension funds. For whatever reason, that idea didn't 
ever quite get implemented, to the best of my knowledge, but I 
think it's one that is worth considering, Senator.
    Senator Nelson. Well, thank you for your testimony. I may 
come back, so thank you. What we're trying to do is to see if 
we can put things in place here to get to the heart of the 
issue.
    Mr. Stipanovich, let me ask a couple of questions of you. 
And thank all of you for your time and your patience. We'll 
take as long as we need to get this whole issue aired, and then 
we'll be looking forward to going on to the second panel, as 
well.
    The statement was made, and I don't remember who--it may 
have been you, Mr. Calvert; it may have been you, Mr. Herndon, 
I don't know--but, for the record, have any of the three of you 
had any conversations with anyone from Enron?
    Mr. Stipanovich. I'll answer for myself, Senator. I have 
not had any conversations with anyone from Enron. And----
    Senator Nelson. We're talking basically in this 2-year 
period.
    Mr. Stipanovich. Right.
    Senator Nelson. We're talking about 2000 and 2001.
    Mr. Stipanovich. That's correct.
    Senator Nelson. Or representatives of people from Enron 
specifically about the Enron stock.
    Mr. Stipanovich. I have not. We did learn this morning that 
our--Trent Webster had a marketer call on him in mid 1999 from 
Enron, and that was before--well before we owned Enron or even 
knew what Enron was. And he had a fairly brief meeting with 
her. And that's--it's fairly standard for them to go out around 
the country and talk up their stock. And we just learned about 
that this morning from Trent, who said that he had never had 
any conversations subsequently, with Alliance or otherwise, 
about this meeting or making any kind of recommendations about 
Enron.
    But we did learn for the first time--we had actually 
thought no one had ever had any contact with Enron at the 
board, and we really went to great lengths to try to ascertain 
that, if there was anybody that possibly had contact with 
Enron, and we learned of this development this morning, which 
we think is inconsequential. It's not an official. It's a 
marketer that basically promotes their stock, and this was, 
like, in mid 1999, and we did nothing with the information or 
made no recommendations or did not buy the stock, internally or 
otherwise, except in certain portfolios which we have no 
control over.
    Senator Nelson. Mr. Stipanovich, who would have made the 
decision to put Enron on--correction.
    Who would have made the decision to put Alliance on the 
watch list?
    Mr. Stipanovich. That would have been the chief of domestic 
equities, Senator.
    Senator Nelson. And is that someone that reports to you?
    Mr. Stipanovich. That's correct, Senator.
    Senator Nelson. And is that someone that Mr. Webster works 
for?
    Mr. Stipanovich. Yes, it is.
    Senator Nelson. And what is that person's name?
    Mr. Stipanovich. That would be Susan Schueren. Susan 
Schueren.
    Senator Nelson. Susan Schueren.
    Mr. Stipanovich. Yes, sir.
    Senator Nelson. And when that decision to make a particular 
company put on the watch list, then is that reported to you 
from Mrs. Schueren, and how does it go through the pecking 
order?
    Mr. Stipanovich. At that point in time, Senator, it was not 
a formal, formal process. It was more of an informal process. 
We now are implementing, as you were talking about earlier, 
these watch list monitoring guidelines, which there will be 
protocol as to how that's reported, but there was no process in 
place that necessarily there was a list, an authentic list, 
produced of managers on this watch list that they would 
actually produce in hard copy and distribute to Tom or myself. 
It was an informal kind of watch list. This came about with 
deterioration in Alliance's performance that began late August. 
And unofficially they went on this watch list, as Tom said--it 
was late December 2000 or early 2001.
    And to kind of digress here a moment in this context of 
answering your question, Senator, this watch list--we spent 
considerable time, post-Enron, trying to refine how we 
developed a watch list and better monitoring procedures for the 
managers. And these major consultants around the country have a 
lot of expertise in the industry counseling with all of the 
major funds in the country, and we have come up with and 
adopted a monitoring list that has actually been adopted and 
been implemented that we are now formally using. And so there's 
very specific criteria that we look at that would then produce 
managers on the watch list.
    We went back and back-tested that watch list against 
Alliance, and actually did this as an afterthought. This 
monitoring watch list was not developed around Enron--you know, 
around Alliance; it was really developed based on consultants', 
you know, expert advice in what the industry is doing and what 
we might best do to better monitor managers and increase 
communications. And in that back-test thing, they actually 
would have gone on the watch list officially about the same 
time that they did unofficially, but in stone there's some very 
specific criteria, Senator, and it's not quite so--note quite 
as simple as, like, a 3-year period. It's a combination of 
things where the three kind of standards that we look at are 
extraordinary events, which would deal with organizational 
issues, and that was part of what Trent's objective was in 
going up there, where you would look at changes in the 
ownership or control of the manager or revisions of the 
business plan of the manager, or a key decisionmaker in the 
organization leaves, like the portfolio manager to my right, or 
a rapid increase or decrease in assets and that kind of thing.
    The other thing would be a short-term performance in 
relation to an appropriate index or peer group, and there's two 
ways that we look at that. We look at that versus an index, and 
that's the benchmark that you've heard us talk about here 
today. And in addition, we are now using a universe peer 
analysis called TUCS, Trust Universe Comparative Service, is 
the major type of service like that in the country. And because 
we're such a big firm, as you know, the fourth largest in the 
country, we are in this universe where it's large funds. So in 
this universe, you would be looking for a fund manager that 
significantly underperforms the appropriate peer group over 
four consecutive quarters--and this is on a short-term basis, 
and you're just looking at a 1-year snapshot. And then on a 
longer-term basis, you would be looking at under performance 
for 3- and 5-year periods, and we get into so much of that time 
being under median or so much of that time being in bottom 
quartile. And so the three kind of variables begin to kind of 
interrelate.
    And this is not a science, Senator. This is an art, and it 
will always be an art. And so it's those kind of factors that 
would come into play, but it is at least quantifiable enough 
now that it would trigger an official watch list. And at that 
point, it's really up to our discretion for about a 6-month 
period whether or not we would terminate that manager 
immediately or maybe keep him on another 6 months or so.
    Senator Nelson. Since Mrs. Schueren would report to you, 
what role did you play as the deputy director to oversee the 
watch list?
    Mr. Stipanovich. Let me qualify that, if I may, Senator. I 
serve Mr. Herndon as a full deputy executive director. In our 
organization, we do not have a, quote/unquote, ``chief 
investment officer.'' When I was moved into this position in 
June of 2001, it was to--my primary responsibilities were to 
assist the executive director, who was the closest thing to a 
CIO that we have, but we, in fact, do not have a CIO, with the 
asset classes. And in addition to that, I do do some other 
things in terms of initiatives and projects and some 
operational things.
    So, to answer your question, Senator, she actually reports 
to both of us.
    Senator Nelson. I see. And what was the role that you would 
play, back then, up until the end of 2001 with regard to the 
watch list? Is that part of your responsibility to see that the 
watch list is watched?
    Mr. Stipanovich. At this point in time, over the last few 
months, I have been very directly involved in the development 
of an official performance monitoring watch list. Earlier on, 
because it was such an earlier period, with me not coming 
onboard until June, I was not as involved in the, you know, 
watch list and what it might look like at that point in time, 
but I was certainly aware that there was a watch list, and that 
the Alliance was put on this watch list. They would discuss it 
with me, in terms of what, you know, my thoughts were and was I 
in agreement or disagreement. And so I was certainly involved, 
Senator.
    Senator Nelson. And did you say earlier that there was no 
written procedure for monitoring companies on the watch list?
    Mr. Stipanovich. Not in terms of something that literally 
had gone before the board and been approved and been adopted 
and become part of the contract for the investment manager. 
This now is part of contracts for the investment managers where 
they have these performance monitoring guidelines, but there 
was certainly something in writing internally in terms of just 
kind of--you know, loose kind of common practices that took 
place.
    Senator Nelson. And there is now a--written procedures?
    Mr. Stipanovich. That's correct, Senator.
    Senator Nelson. As Mr. Herndon had referred to a series of 
meetings and teleconferences concerning Alliance, I have some 
notes from a teleconference that occurred on September the 
17th, 2001, and also October the 30th, 2001. And the 
participants were Stipanovich, Menke, Hurdle, Campbell, 
McKnight, Davis, Robinson, Webster, Lathum, and Al Harrison and 
Elizabeth Smith, from Alliance. On this teleconference, what 
did you go over? And how did that work into the decisions that 
you all made to allow Alliance to continue to keep purchasing 
shares?
    Mr. Stipanovich. Yes, sir. The way that normally occurs, in 
terms of Mr. Herndon's role and my role, the--as you know, we 
have probably in excess of 40 active managers and, with 
quarterly meetings, there is literally numerous meetings that 
take place throughout the year. And it's my practice that when 
there are issues or a manager is on a watch list--and even as 
informal as it was, it was a watch list--I then began--I would 
attend meetings and participate. Mr. Herndon would do that on a 
much more limited basis, less so than myself.
    At this particular meeting, I was attending because of 
performance. It really was more--had more to do with Alliance's 
performance. As you can see in the memo, there is some mention 
of Enron, but we did not spend a great deal of time talking 
about Enron at that point in time, but we certainly were 
concerned about Enron. We did talk about Enron, and it was 
literally the--following the interim and next--the following 
meeting that took place on October 30th and thereafter, but 
certainly September, that we really began to zone in on Enron.
    Because, Senator, even with everything that we're doing now 
in creating these screens and trying to identify early warnings 
for stocks that we can heighten communications with managers 
about these stocks, at the end of the day, we give these 
managers full discretion, and we pay them well--and some would 
disagree with that--but we pay them well to exercise their 
discretion. We are not stock pickers. And right now, with Enron 
and everything that's behind us, we still do not plan to be 
stock pickers. That's what we hire them for.
    So we're going to do a better in getting this information, 
but there's still, you know, a challenge as to what we're going 
to do with this information, because we're not going to tell 
them what to buy and sell.
    Senator Nelson. Well, we're trying to figure out how to 
protect the public through legislation in the future to avoid 
this kind of thing. Would you bring that up here and put it on 
the easel? Bring it up over here, please, close to me where I 
can point to it.
    Now, this--have you got a pointer? See if you've got a 
longer pointer. But this is a graphic that depicts the price 
and the date starting at October the 17th, when the stock price 
was at about $32. And here's the first signal, right here, SEC 
investigation is announced when the price is at $22, 311,000 
shares are bought. And then as the stock goes on down, you see 
the picture, prices keep coming down, the stock keeps being 
bought. And here's the date that we're talking about right now. 
October the 30th is when you have this telephone conference 
call with Alliance on the watch list. And so the stock now has 
come down to $12.23.
    And this is what the notes say of the teleconference, 
``Enron was a big part of the recent under-performance. 
Alliance had a couple of face-to-face meetings with the company 
last week. The reality is that the core trading business is in 
fine operational shape.'' Now, that's the notes that you all 
have of this teleconference.
    And can you comment about that since--and I'll ask Mr. 
Webster, too, when we get to him. They just called a vote, so 
I'm going to have to call a recess in a minute, but go ahead, 
please, Mr. Stipanovich.
    Mr. Stipanovich. Yes, Senator. As you--if you look at the 
longer time line, there are many, many flags such as this on 
the time line that, again, heightened us and we began to ask 
these questions. But there's probably no one sitting at this 
table that can answer that question, hopefully, better than 
Alliance, because we don't--we didn't understand it. As much as 
we tried, we did not understand why they were still buying it 
after all of the--everything that even my mother was reading in 
the paper about Enron, and they were continuing to purchase the 
stocks. We were at the point that we felt they were on the 
wings of a prayer and wish in this thing either stabilizing or 
going back up, but we--it was incumbent upon us, as 
fiduciaries, to continue to ask these questions, knowing that 
we were not going to give them--tell them to sell or buy, and 
they're the people that need to answer that question, Senator.
    Senator Nelson. And, as a matter of fact, you just used the 
word ``flags.'' I noticed that that was the statement that you 
had made in a New York Times article on January 27th, of which 
you were quoted, quote, ``We had a fair amount of discussions 
with Alliance about what was happening with our Enron shares,'' 
Mr. Stipanovich said, ``There were plenty of red flags, and we 
would talk about them.'' Who is the ``we'' in this particular 
case?
    Mr. Stipanovich. That would be the domestic equity staff 
under the leadership of Ms. Schueren. And you can see, as we 
take these meeting notes, we always record who are attending 
these meetings--but from the executive director through myself 
down to the domestic equity staff, including Trent Webster and 
a number of other people, again, with the chief of domestic 
equities.
    Senator Nelson. And what were the red flags?
    Mr. Stipanovich. Well, Senator, I've got a--you know, I can 
go through the list here, but it was certainly the fact that--
it really kind of began on August 14th, when Skilling left, is 
when the majority of the red flags really began to, you know, 
wave red. But it was just things, in terms of the new 
partnerships that we were finding off balance--off the balance 
sheet and so on and so forth.
    Senator Nelson. Well, of those red flags--you know, on that 
same day--October the 30th, the same day that you had that 
particular telephone conference call, they went out, and they 
bought another 317,000 shares, and that was on October the 
30th. November the 8th, Enron admits that it overstated its 
profits by over a half a billion dollars. And then another 
581,000 shares are bought on November the 13th; and another 
478,000 were bought on November the 14th; and another 209,000 
shares bought on November the 16th. And I'm curious--the 
Committee would want to know why were the red flags ignored?
    Mr. Stipanovich. Senator, that's a question that Alliance 
would have to answer. We kept asking the same question you're 
asking, ``Why are you ignoring these red flags? You bought this 
stock for $79.25 in November of 2000, and it's now down in in 
the single digits.'' There had been red flags literally 
starting since almost January 2001--or some flags were out 
there, in terms of people leaving the firm. But certainly, come 
August, there were more red flags than you could shake a stick 
at.
    Senator Nelson. As you all went through the discussions, 
once you'd hang up, for example, or when you'd have just 
regular discussions among your staff about the watch list--and 
in this case, only one company, you've testified, was on the 
watch list--did you ever talk about, did you ever ask, whether 
or not this company should be de-funded?
    Mr. Stipanovich. We absolutely were talking about de-
funding Alliance at that point in time. We had actually been 
talking about de-funding Alliance for several months prior to 
that, because, again, at that point in time, when you get on 
the watch list, you have to start considering what your 
alternatives are in terms of any de-funding. Your options are 
you de-fund them or you fire them or you fund them, and they 
certainly weren't--they were on the de-funding--under 
discussion for de-funding and, again, possible termination, 
because they were on this watch list.
    And, you know, there were a number of things we'd ask. For 
example, the statement was made awhile ago that Mr. Glassman 
said something about their weighting compared to S&P 500. In 
September 2001, they had 4-percent weightings. Senator, that 
was 20 times the weight of what the S&P 500 had in Enron. I 
don't know--he said something about reading it in the paper, 
and that kind of leads us to believe maybe you can't always 
believe what you read in the paper, but this is off Bloomberg, 
and they were 20 times the weight of Enron.
    So these were the kind of questions that we would ask 
about. You know, why the overrating? Do you really have that 
much belief in the stock with this kind of, you know, warning 
signals.
    Senator Nelson. Well, what were some of the other red 
flags? Help us to understand. Specifics would help us very 
much.
    Mr. Stipanovich. OK. January 2001, highly respected short-
seller shorts Enron. They continue to buy stock. Analysts, 
Skilling values Enron stock at $126. Skilling becomes CIO. 
Janus becomes--Janus Fund, one of the most successful funds in 
the country--becomes a net seller of Enron. Also a lack of 
disclosure and transparency in Enron financials reported by 
Goldman Sachs analysts. This is March of 2001. March 5th, Enron 
accounting again arises material red flags. Skilling, ``People 
want to throw rocks at us.'' Enron in blockbuster, cancel video 
and demand on deal. Enron vice chairman, Cliff Baxter leaves 
after complaining of Enron partnerships. And fiberoptics 
collapse of $180 million charge, May 21st. Enron's power and 
generating venture in India falters. Power contracts fail. In 
June, S&P credit review, concern over international assets. 
Skilling abruptly resigns in August. September, Lay announces 
Enron would divest $4.5 billion in assets to restructure and 
emphasize trading options. September 19th, Enron claims India 
calls $5 billion in damages in violating their power agreement 
which caused part of their reasons for losses. Crude oil 
futures were falling to the lowest level in 2 years. Release of 
earnings, analyst calls, $618 million lost, shareholder equity 
written off. Also 13 or 14 analysts downgraded Enron after 
October 16th earnings report at a press conference. Crude oil 
falls to lowest level in 1999. October, SEC opens an inquiry. 
We're still buying the stock. Lay defends CFO Fastow, and CFO 
Fastow resigns a week later. Egan Jones downgrades Enron debt 
to junk. Enron--Alliance is talking to their creditors who do 
the credit analysis in the fixed income, which is fairly--I'm 
not too sure it's that usual. Enron creates special committee 
on partnership. November 8th, former--reflects additional 
details of accounting partnerships and restates earnings from 
1997 to 2001, reduced by $586 million, largely due to these 
partnerships that are out there with all the previous red 
flags. Dynegy merger officially announced. And then that's all 
we begin to hear about is Dynegy, and that's the answer. Lay, 
Enron made billions--says, ``Billions of very bad investments 
were made at Enron.'' This is a quote from Lay in November 
15th. November 19th, Enron announces Enron may take additional 
$700 million pre-tax charge. November 20th, Enron warns of 
continuing credit worries, asset restatement, and reduced 
trading activity. November 28th, S&P downgrades Enron to debt, 
to junk, and triggers a billion dollar debt payment. Dynegy 
calls off the merger. Crude's at $12.50 a barrel. Enron file 
bankruptcy. Alliance sells.
    Senator Nelson. And what in the discussions that you all 
had did you decide to do about all of those red flags? Was it 
as you said earlier, that you decided to keep hands off and let 
the money manager do it, despite the red flags?
    Mr. Stipanovich. What we decided to do was fire Alliance. 
Unfortunately, we didn't fire them soon enough.
    Senator Nelson. Earlier you had said that folks would ask 
you whether you agreed or disagreed with the actions. And I 
can't remember the specific quote, but you remember what I'm 
referring to. And I would like to ask you, was there any 
specific matter that you were consulted about when people would 
ask you if you agreed or disagreed with actions on overseeing 
the watch list? As we are doing this reform legislation, you 
said folks would ask you whether you agreed or disagreed. Is 
there anything in those actions that we should know about as we 
craft this legislation?
    Mr. Stipanovich. Actions, as in--I'm sorry, Senator.
    Senator Nelson. When people--as I understand your 
testimony, you said that folks would ask you whether you agreed 
or disagreed with actions of a particular investor--in this 
case, Alliance.
    Mr. Stipanovich. Well, unfortunately, we're not in the 
position to really make those kinds of decisions, which are 
really what I think you're referring when you say ``agree or 
disagree,'' and that is the purchase of the stocks. We are not 
in a position to make stock-selection decisions. We don't have 
the resources, Senator, or the staff to make those type of 
decisions. That's why we hire external managers and pay them 
for them to make those decisions.
    What we do do is, we do serious performance monitoring, in 
terms of trying to make sure that they're providing the type of 
performance in the aggregate that we're looking for to reach 
our investment objectives at the board.
    Senator Nelson. I'm going to miss this vote if I don't get 
up and go right now. So the Committee will stand in recess, 
subject to the call of the chair, and it will take me about 7 
minutes to go over and vote and get back. The Committee is in 
recess.
    [Recess.]
    Senator Nelson. All right. Well, thank you very much, Mr. 
Stipanovich, and excuse me for having to stop here and go vote, 
but that's the way it goes around here.
    Mr. Stipanovich. Thank you, Senator.
    Senator Nelson. All right. Mr. Webster, why don't you 
describe for the Committee your position at the SBA?
    Mr. Webster. Yes. I'm a portfolio manager of domestic 
equities within the State Board of Administration, and I have 
two roles at the board. The first--my primary role is that I 
run the special situations fund, which is the only internally 
actively managed fund at the board. And I would say probably 80 
or 90 percent of my job, or at least until the Enron debacle, 
was managing money. The other part of my job is facilitating 
the information flow of market to other staff members within 
the board so that we can make a decision about whether to fund, 
de-fund, terminate, hire managers. And that was the capacity 
that I had when I went out to visit Alliance in June.
    Senator Nelson. And who do you report to in the pecking 
order?
    Mr. Webster. My direct boss is Ken Menke, who is the 
assistant chief of domestic equities, and ultimately to Susan 
Schueren, who is the chief of domestic equities.
    Senator Nelson. All right. And the lady that was referred 
to earlier----
    Mr. Webster. Susan Schueren?
    Senator Nelson. Is that one and the same?
    Mr. Stipanovich. Yes, sir.
    Mr. Webster. Yes.
    Senator Nelson. OK. Then I did not understand the 
pronunciation of her name. It's Schueren.
    Mr. Webster. Schueren.
    Senator Nelson; Schueren.
    Mr. Webster. Yes.
    Senator Nelson. I see. And then she reports to Mr. 
Stipanovich.
    Mr. Webster. That's correct.
    Senator Nelson. OK. Now, can you describe the Florida SBA 
internal review process, in terms of putting individual money 
managers on a watch list?
    Mr. Webster. I don't really actually think I am the one to 
answer that question. What I do is give the information about 
the stocks that are in the portfolio to the people who make 
that decision on what managers go on or off the watch list.
    Senator Nelson. You give information about the stocks.
    Mr. Webster. Yeah. Well, for example, because I manage a 
portfolio, I'm in the stock market every day buying and selling 
stocks. So I am probably the most connected to the stock market 
at the board. And so, because of that, I have a role in 
overseeing the manager's portfolio, the list of stocks in their 
portfolio, to see if what they're buying and selling makes 
sense relative to their strategy.
    Senator Nelson. And so you'd be involved in bringing up any 
of these red flags that were testified to earlier.
    Mr. Webster. That's correct.
    Senator Nelson. OK. And I suppose that some of the other 
red flags that maybe we didn't even mention here was--you'd be 
seeing different lists, like Forbes and newspapers or 
publications like Forbes. You'd be looking at other analysts 
and seeing what they would say you ought to buy or sell and a 
commentary on it and whether or not they would give a downgrade 
or an upgrade--you'd see all of that.
    Mr. Webster. Well, I'd see, you know, some--the majority of 
it.
    Senator Nelson. All right. I'm going to put in the record 
an analyst's history of the Enron Corporation over that period 
of November and October 2001 with regard to analysts like 
Warburg, Goldman Sachs, A.G. Edwards, Merrill Lynch, Solomon 
Smith Barney, Prudential, Bank of America, so forth, all of 
which had a downgrade through that period of time. *
---------------------------------------------------------------------------
    * The information referred to was not available at the time this 
hearing went to press.
---------------------------------------------------------------------------
    Now, is that something that you would have considered at 
the time?
    Mr. Webster. Well, yes. Yes and no. In my decisionmaking 
process, when I buy and sell stock, the analyst ratings have 
some informational content, but it would certainly be one of 
the things we'd be looking at.
    Senator Nelson. And having seen this kind of stuff, what 
did you say at that particular time about Enron and the 
portfolio with Alliance?
    Mr. Webster. Well, what we were inquiring about was--we 
were trying to determine the decisionmaking process that 
Alliance was undertaking to buy Enron. And so we would ask 
Alliance about, you know, the issues surrounding Enron--for 
example, the charge-offs, the resignations, things like that, 
specific issues relating to Enron  and if they had taken that 
into account and if their decisionmaking process was consistent 
and logical with what they had--you know, what they were 
supposed to be doing.
    Senator Nelson. And as a portfolio manager, what did your 
analysis tell you about Enron as a company?
    Mr. Webster. Well, I never looked in depth at Enron to make 
a buy or sell recommendation. I read the press reports, and I 
had listened to the analysts, but I never made--I never spent, 
for example, 2 weeks learning about Enron. It was more an 
amalgamation of news over time that made me familiar with the 
events at Enron.
    Senator Nelson. Well, you offered some commentary, did you 
not?
    Mr. Webster. Yes. I mean, I understood the basic issues, 
but--and I was making my superiors aware of those basic issues, 
but I did not take the--I did not undertake a sufficient amount 
of research to at least make a buy decision on Enron.
    Senator Nelson. There has been a widely quoted memorandum. 
Why don't you tell us about that memorandum that you wrote?
    Mr. Webster. Which memorandum is that, Senator?
    Senator Nelson. October 24.
    Mr. Webster. Yeah, the reason why I had written that 
memorandum was to make my superiors aware of what was happening 
in the Alliance account. We knew that Alliance had purchased 
Enron and it was in their account. And as we watched the stock 
fall, I decided, as a means of communication, to let the people 
who are on--you know, who are on the memo aware of what was 
happening in the Alliance account concerning Enron.
    Senator Nelson. If I recall, you had some pretty strong 
quotes in that memo. You want to share those with us?
    Mr. Webster. Well, if you refer to them, I'll perhaps 
comment.
    Senator Nelson. Well, how about, ``A stock that is falling 
when a company has accounting problems is almost always a bad 
time to buy,'' Webster wrote. ``Alliance buying Enron since 
August has clearly been a mistake,'' Are those your words?
    Mr. Webster. Yes. And I think the subsequent events, at 
least in this case, were borne out to be true or consistent 
with what I said at that time.
    Senator Nelson. Can you pull that back over here? That was 
on October the 24th, over here.
    Mr. Webster. Uh-huh.
    Senator Nelson. And it's trading at about sixteen bucks a 
share, and it continues to go down. Did you share that memo 
with anybody?
    Mr. Webster. Oh, yes. I distributed it on October 24th to 
Susan Schueren and Ken Menke and to Martha Hurdle, and I 
assumed it went up to Coleman and Tom eventually.
    Senator Nelson. Did you expect this kind of buying to 
continue in light of what you said?
    Mr. Webster. I guess I would say that I don't expect 
managers to buy or sell at any time. It's just--they either buy 
or they sell.
    Senator Nelson. Well, you had the--you had a concern, did 
you not, when you wrote those words?
    Mr. Webster. That's correct, yes. And the reason for my 
concern was merely to communicate to my superiors what was 
happening in the Alliance portfolio so that they were aware of 
what was occurring in the Alliance portfolio.
    Senator Nelson. Do you know--did the board of trustees 
receive your concerns or your memo?
    Mr. Webster. Well, they did eventually, but I don't--I have 
no idea if it was passed on to them at the relevant time.
    Senator Nelson. Well, in those pretty strong words, what 
was your concern? Why don't you restate that for the record?
    Mr. Webster. My concern was the stock was falling on the 
issues that were in the press at the time that were being 
reported. And some of the--and the issues were that, in 
retrospect now, we find out that the accounting was a fraud at 
Enron, and the issues were trickling out into the market 
causing, or at least contributing to, the fall of Enron stock.
    Senator Nelson. The previous spring, the spring of 2001, 
Alliance sold Enron stock on April the 17th, sold 112,600 
shares. Do you have any knowledge of that?
    Mr. Webster. Yes.
    Senator Nelson. Tell us about it.
    Mr. Webster. I actually--well, I think for a more accurate 
explanation, you probably should ask Alliance. My 
understanding, though--and, you know, I don't want to put words 
into Alliance's mouths, but it's my understanding that they 
were executing a V strategy where they'd buy as it fell and 
then sold it as it rose. But, again, I'm not the person who can 
give you the exact explanation for that.
    Senator Nelson. In your capacity, did you participate in 
this teleconference that I have the notes of from September the 
17th?
    Mr. Webster. No, sir.
    Senator Nelson. How about October the 30th?
    Mr. Webster. Yes, sir.
    Senator Nelson. OK. And you want to tell us something about 
that teleconference meeting?
    Mr. Webster. On October 30th?
    Senator Nelson. Right.
    Mr. Webster. It was part of our increased oversight of 
Alliance, and we had questioned them about the purchases of 
Enron and why they were continuing to purchase.
    Senator Nelson. And what was your feeling at the time of 
that teleconference?
    Mr. Webster. I guess what we were just trying to understand 
was what was the thought process and the decisionmaking process 
that Alliance was undertaking in making the purchases. At the 
time, we didn't know if it was correct or not. We just knew 
that it was falling, and they were buying it as it was falling, 
but we had--at least I certainly did not know what the outcome 
of Enron would have been.
    Senator Nelson. As I read some of your quotes in other 
publications, it seems to me that you had some misgivings about 
Enron for quite awhile. For example, you stated in a March 24th 
St. Petersburg Times article, quote, ``Enron was a stock that 
we had watched for years, and we couldn't understand why it 
kept going up,'' end of quote.
    Mr. Webster. Uh-huh.
    Senator Nelson. Why don't you explain what you meant by 
that?
    Mr. Webster. Well, I'd like to first preface that with 
saying there are thousands of stocks in the stock market, and 
on some of them, we're right, and some of them, we're wrong. 
And fortunately, on Enron, as it turned out, we were correct on 
it. We had--we had an idea of what Enron's basic business plan 
was, and we viewed it more as an arbitrage house, if you want 
to say it. And that's not necessarily a bad thing, but rather, 
you know, the valuation that you'd pay for something like that 
was what was curious to us.
    Senator Nelson. Well, that was back at a time that Enron 
was still flying high in its stock price.
    Mr. Webster. And we were--yeah, in money management for 
that time period, we were wrong, because the stock kept going 
up.
    Senator Nelson. And so your comment, ``Enron was a stock 
that we had watched for years, and we couldn't understand why 
it kept going up,'' is that a statement that you had confidence 
in it or that you did not have confidence in it?
    Mr. Webster. I think that that's actually taken a little 
bit of--out of a little bit of context, because we did 
understand why it was going up. And the reason why it was going 
up was because its earnings were growing. What we didn't 
understand about it was how it grew its earnings. It just--we 
didn't understand it. But we understood why the stock was 
rising, because earnings were rising.
    Senator Nelson. Since Alliance was on the watch list at 
that point, having gone on the watch list in the fall of 2000, 
was there any sharing of your statement, your concerns, as you 
had these monthly meetings?
    Mr. Webster. We--to my recollection, we first--we brought 
it up in October--in the October meetings. Enron--even though 
Enron was a stock that we didn't understand the fundamental 
business model, we also didn't necessarily believe it was a 
house of cards, either. And so, for example, in 1999 or 2000, 
there may not have been a reason necessarily to flag it as a 
potential bankruptcy. It was only after the charges--the 
charge-offs from the company and the resignations and the other 
red flags that Mr. Stipanovich had mentioned earlier, when it 
became a real issue for us.
    Senator Nelson. All right. Thank you very much, Mr. 
Webster. I appreciate it.
    Mr. Herndon. Senator, do you mind?
    Senator Nelson. Yes, Mr. Herndon?
    Mr. Herndon. I apologize, but I wonder if it's possible, if 
you're going to move away from us, if I could be excused. I 
have a commitment that I'd like to try and make, if that's 
feasible.
    Senator Nelson. Certainly.
    Mr. Herndon. Thank you.
    Senator Nelson. All right. Let's move to Mr. Harrison.
    Mr. Calvert. Senator?
    Senator Nelson. Yes?
    Mr. Calvert. Pardon me. Before we begin the questioning, 
would you mind if we just corrected a couple of points for the 
record. Some statements have been made that are not factual.
    Senator Nelson. Please, Mr. Calvert. We'll recognize you.
    Mr. Calvert. OK, thank you very much. First, I'd just like 
to correct a statement. We did not make an exception to our 
policy for Mr. Savage. We followed that policy to the letter. 
Second, we never owned a 6-percent position in Enron in the 
portfolio, and that's well known by all the parties. We did not 
sell the stock in a private placement. That simply is not 
correct. And, as you've heard before, it is not true that the 
SBA was not notified of the sale for several days. They were 
notified in exactly the same way that they're notified by all 
of our transactions, on the very next morning.
    Thank you, sir.
    Senator Nelson. Thank you for your statement.
    Mr. Harrison, welcome. Let's see if we can learn something 
for the Committee that will help us as we craft this 
legislation.
    It's my understanding--and you tell me if it's correct--
that you met during this period of time about 10 times with 
Enron personnel. Is that correct?
    Mr. Harrison. During the year, we met physically with them 
both at the portfolio-management level and at the research-
analyst level. I have a team, as I've indicated, of 25 people 
working with me. I was involved in a number of those meetings. 
Other people would be involved either as portfolio managers or 
the analysts on Enron stock.
    Senator Nelson. And in addition to staff, you met with the 
principals, as well. Is that correct?
    Mr. Harrison. Oh, very definitely. I mean, we would 
normally meet with the CEO, probably somebody from the 
financial, the treasurer, and maybe the investor-relations 
people.
    Senator Nelson. You met with Mr. Lay?
    Mr. Harrison. Yes, indeed.
    Senator Nelson. And Mr. Skilling?
    Mr. Harrison. He did a video conference with us in, I 
believe, July.
    Senator Nelson. And put it in context for us. When you 
would meet with Mr. Lay, for example, how many people would be 
in the meeting?
    Mr. Harrison. There would usually be anywhere between three 
and six from Enron and maybe anywhere between 10 and 20 of my 
colleagues, and we would almost surely have it on oral or video 
conference with our other offices so that people would be able 
to hear what was going on. That is a normal part of the 
Alliance research intensity, that anybody--any management 
coming into any office to discuss a stock can be heard by every 
other office at the same time.
    Senator Nelson. And when you refer to 10 or 20 of your 
colleagues, you're talking about people in Alliance.
    Mr. Harrison. The people in Minneapolis would be there 
physically in the room, and then the others would be there by 
either phone or video conference.
    Senator Nelson. Now, these meetings 10 times took place 
over the entire year?
    Mr. Harrison. Correct.
    Senator Nelson. Did any of those meetings take place in 
this period of time, from October the 17th to November 30th?
    Mr. Harrison. Yes, the--as I previously mentioned, one of 
the meetings took place immediately after Skilling resigned in 
August, a week after he resigned. But the key meeting was when 
the announcement of the $1.2 billion writeoff and the loss 
reported on a--for the third quarter there, led to us having 
the seven or eight people in New York meeting with management 
there 1 day after their announcement.
    Senator Nelson. And at the time you were having these 
meetings with Enron, you were also having meetings with the 
State Board of Administration of Florida.
    Mr. Harrison. The meetings with the State Board of 
Administration obviously were meetings that took place 
sporadically during that 2-month period.
    Senator Nelson. And in the March 3rd edition of the New 
York Times, they refer to it--which was disputed by the SBA 
people--that you had met some 31 times in that last year, 
according to internal memos released by the fund.
    Mr. Harrison. I don't know where the 31 times came. And I 
heard Mr. Herndon, or somebody, talk about dozens of times. I 
think that those numbers are picked of the wall.
    Senator Nelson. When you--but it was quite a few.
    Mr. Harrison. It was quite a few.
    Senator Nelson. When you met with the Enron people in these 
10 meetings over this period of time--and how many of those 10 
were in that period of time right there represented by that 
chart?
    Mr. Harrison. I've already indicated, on October the 17th, 
that would be the only, I think, unless your chart goes back 
early, which I don't think it does.
    By the way, could I just clarify one thing? When I say 10 
meetings, these might be meetings over the phone, as well, not 
physical meetings.
    Senator Nelson. OK. And when you had these meetings, did 
Enron urge you to buy their stock?
    Mr. Harrison. Every time management comes in, they are 
presumably trying to clarify us as to their prospects. And in 
that context, I suppose they would be said to be urging us to 
buy the stock, but that's our decision. Our decision is going 
to be made on the basis of the research that we do and, as I 
said, the combination of our understanding of the fundamentals 
and where the price is at any point in time.
    Senator Nelson. I understand. What I'm trying to find out 
is: What did they communicate to you? Did they say, ``Buy our 
stock?''
    Mr. Harrison. Oh, absolutely not. No.
    Senator Nelson. Well, how did they urge you to buy their 
stock?
    Mr. Harrison. Well, I've said that really--they only urge 
indirectly through basically being very forthright as it 
relates to their prospects, the businesses they're in, which 
businesses they're divesting, which they're concentrating on, 
where capital is flowing, and a multiple of other questions 
that we would be feeding them.
    Senator Nelson. OK. So you had that meeting on October the 
17th, when the stock's here, and 5 days later, it's down to 
here, and you purchase 311,000 shares. Tell us what was in your 
mind to do that.
    Mr. Harrison. Yes. As a result of the meeting on October 
the 17th, we obviously had a decision to make as to whether or 
not the core business was still intact, and was Mr. Lay doing 
what, in essence, he had promised to do in terms of providing a 
greater level of openness and also writing off non-core assets. 
Our conclusions was that, yes, the core business was still 
intact. He reiterated to us the $1.80 estimate for the year and 
$2.15, $2.20 for the following year. This was a clearing of the 
decks, as I indicated. However, the price was in free fall, and 
we made our next purchase on the 22nd of October, as you've 
indicated, at a price of twenty-two, eighty-two cents.
    Senator Nelson. Did anybody in Florida ask you to buy this 
stock?
    Mr. Harrison. No.
    Senator Nelson. Did anybody intimate any kind of 
communication to that effect?
    Mr. Harrison. No.
    Senator Nelson. Who would you typically talk to when you 
talked to the--your client in Florida?
    Mr. Harrison. The normal contact would be Ken Menke. When I 
would go down to visit Florida, the person that is not here 
today, the chief investment officer of equities, Susan 
Schueren, would be the chair of any meetings that we had.
    Senator Nelson. You heard the quote by Mr. Webster just a 
few minutes ago, and I'll give it to you again, quote, ``A 
stock that is falling when the company has accounting problems 
is almost always a bad time to buy. Alliance buying Enron since 
August has clearly been a mistake,'' in an October 24th memo, 
is what he says.
    Mr. Harrison. Right.
    Senator Nelson. Did you ever see that memo?
    Mr. Harrison. Of course, I don't see any internal memos 
that Mr. Webster is alluding to.
    Senator Nelson. You did not see that memo.
    Mr. Harrison. No, that would be internal to Florida.
    Senator Nelson. I understand. But have you seen that 
particular quote, whether you've seen that memo or not, at the 
time? Was it conveyed to you verbally?
    Mr. Harrison. No, not at all.
    Senator Nelson. I see. Well, what do you think about Mr. 
Webster's comment, since apparently the two of you have a 
considerable difference of opinion on----
    Mr. Harrison. Mr. Webster's comments are obviously personal 
to him.
    Let me just, if I could, just read the first three lines of 
what we're supposed to be doing for Florida. ``Alliance 
Capital's large-capitalization growth strategy emphasizes stock 
selection, portfolio concentration, and opportunistic trading 
to capitalize on unwarranted price fluctuations.'' This is very 
clear in my mind, that what we were doing is basically 
balancing all of the news that we had that was positive against 
the negatives that basically was out there in the press, and 
then making a price judgment. And we determined that the core 
business was still intact, from the intensive research that we 
had done, and we continued to buy the stock.
    Senator Nelson. Were you, Mr. Harrison, aware of all of the 
outside analysts that we referred to a moment ago that will be 
made a part of the record--were you aware of their 
recommendations that people ought to sell instead of buy?
    Mr. Harrison. Not only am I aware of the firms that you 
spoke to, sir, but I believe that most of them had been 
carrying buy recommendations, including the one big bear on the 
street that has been--hit the press, and that is an analyst 
down in Houston as late as September. He turned from basically 
being a bear to a very strong buy on the stock, and I think 
you'll find that most analysts were still of a buying mode 
right until the very end.
    Senator Nelson. At one point, you were quoted in one 
article--I believe it was the New York Times--as saying you 
didn't know who Frank Savage--that you did not know that Frank 
Savage was a member of the Enron board.
    Mr. Harrison. That is correct.
    Senator Nelson. Did you read the annual statement of Enron?
    Mr. Harrison. I didn't read it in the sense of checking the 
directors. Generally speaking, that is something that--I'm more 
interested in the income statement and the balance sheet of a 
company. You know, obviously every corporation has got a list 
of directors. That is not No. 1 on my priority.
    Senator Nelson. Tell me about the October 30th conference 
call.
    Mr. Harrison. The October 30th conference call was 
obviously related to the fact that, for 2 years, growth stocks 
had been under pressure in the marketplace. As was previously 
indicated, we had taken the Florida funds up to $6.2 million. 
Over that 2-year period, most growth managers suffered 
something like a 30- or 40-percent decline, which was similar 
to our own. And that conference call was an attempt to isolate 
the various stocks that had perhaps been hurting us. And Enron 
was one of those stocks. And obviously Enron, given what was 
happening in the press, was probably receiving more of the 
dialog than the others. But we talked about the portfolio in 
general.
    Senator Nelson. Did members of the State Board of 
Administration staff express to you in that October 30th 
teleconference their misgivings about Enron?
    Mr. Harrison. No, sir. They listened to what we had to say 
and presumably took note of what we had to say, that we had 
been meeting with Enron management. We had basically done our 
research. We were of the view that the core trading operations 
of this company were still intact.
    Senator Nelson. So the comments of Mr. Webster written in 
an October 24th memo, some 6 days previously, was not conveyed 
to you in the October 30th teleconference?
    Mr. Harrison. Only to the extent that there might have been 
a dissatisfaction as it relates to the losses in the portfolio 
by the various stocks, of which Enron would be one, but nothing 
specific on Enron, certainly no direction to do anything about 
it.
    Senator Nelson. And after that teleconference on October 
the 30th, then you went back out and bought another 317,000 
shares.
    Mr. Harrison. The stock was now $12.22, correct.
    Senator Nelson. And so there was nothing conveyed to you of 
a concern from the staff of the State Board of Administration 
about what had happened thus far on that October 30th 
teleconference.
    Mr. Harrison. This was obviously one of the stocks on which 
we were losing money, so if you would call that concern, 
obviously we talked about it.
    Senator Nelson. But there was no message that was given to 
you that you should not buy, therefore you felt at liberty to 
go back out on that very same day, right after the telephone 
conference, to purchase more.
    Mr. Harrison. Absolutely. We have the authority and the 
fiduciary responsibility to do the best for our clients. And as 
far as we were concerned, based on all of the information that 
we had and the price of the stock, it seemed very attractive.
    Senator Nelson. The State of Florida, as stated by Mr. 
Herndon, has filed suit against you all. They've distributed 
copies of the lawsuit, the pleadings, to the entire Committee. 
These are serious allegations. Are they true?
    Mr. Harrison. Sir, what----
    Senator Nelson. Are they true?
    Mr. Harrison. The allegations?
    Senator Nelson. That's correct.
    Mr. Harrison. Sir, we did everything in our fiduciary role 
here, as far as I was concerned, to exercise the care and skill 
and prudence that is part of our mandate, and I think that we 
can show that, on this particular stock, the faults were 
clearly with Enron and the fact that we had misleading 
information, incomplete information, and that the auditors did 
not do their job. We certainly did our job.
    Mr. Calvert. May I just interject, Senator?
    Senator Nelson. Please.
    Mr. Calvert. We've stated publicly, and we would state 
again here, that we believe these allegations are totally 
without merit, and we plan to defend ourselves vigorously in 
this suit.
    Senator Nelson. OK, were you able to hear that? OK. Thank 
you, Mr. Calvert. Thank you, Mr. Harrison.
    Mr. Calvert, how about giving me--give the Committee some 
examples of your public and private clients, your client list.
    Mr. Calvert. Well, as I said earlier, we manage money for 
45 of the Fortune 100. And, you know, I don't have a client 
list with me, and I'm a little nervous about--some clients ask 
us not to use their names, others say it's fine. But 45 of the 
Fortune 100 public funds in 43 of the 50 states.
    Senator Nelson. Public funds, there wouldn't be any problem 
in telling that, would there, because it would be public 
record?
    Mr. Calvert. Generally not. We manage money for funds in 
the State of New York, the State of North Carolina, the state 
of South Carolina. We manage funds, not state--well, also the 
state funds in California, in Oregon, in Missouri. Those are 
the ones that come quickly to mind, but that's a small sample.
    Senator Nelson. Help the Committee understand, with regard 
to your client in New York, that Alliance, being the money 
manager for the pension fund there, sold Enron shares in the 
month of August 2001.
    Mr. Calvert. Uh-huh.
    Senator Nelson. Whereas, the experience in Florida was the 
opposite----
    Mr. Calvert. Correct.
    Senator Nelson.--that the funds were purchased. Share with 
us there, what was the decision with regard to the selling of 
those shares in New York.
    Mr. Calvert. Yeah. In the final analysis, it was 
mechanical. As I stated at the beginning, we are a multiple-
product firm. We offer a variety of investment services. Each 
of those teams has an investment philosophy, an investment 
process and so on. We don't try to coordinate across all those 
teams, because that would be against the objectives of the 
clients, who selected the team to do it the way they said they 
would do it.
    In that particular portfolio, the money is managed directly 
by members of our research staff, and they have a rule that 
only one-rated securities can be held in the portfolio. Perhaps 
I should explain. One being their highest rating, two being 
their next rating, three being their lowest rating. And the 
analyst changed her rating from a one to a two on Enron 
primarily because she wanted to focus on some other companies 
in the same industry. And given that rule, the stock was 
automatically sold in that portfolio when that downgrade 
occurred.
    Senator Nelson. Is it typical that, under the umbrella of 
your own house, that one hand would be selling and another hand 
would be buying?
    Mr. Calvert. It's--it doesn't happen very frequently, but 
it happens. For example, as you may know, one part of the firm 
invests in growth stocks in a number of different kinds of 
portfolios, but another firm, largely under the Sanford 
Bernstein name, which is a company we acquired, has a value 
approach to investing, and it's possible that stocks can be 
sold from one portfolio manager to another. It's not a frequent 
occurrence, but it happens.
    Senator Nelson. Do you have any knowledge of anyone in 
Enron calling you to urge you to buy Enron stock in the fall of 
2001?
    Mr. Calvert. No, sir. In fact, I should say, Senator, I 
have never met or talked to anyone from Enron directly. I've, 
you know, watched some presentations and so on, but I've never 
had a personal conversation.
    Senator Nelson. You have no knowledge of anyone in your 
firm, other than has been represented by Mr. Harrison in his 
typical kind of meetings with his colleagues, that there was 
any kind of particular effort that was made by Enron to get you 
all to buy Enron stock in the fall of 2001?
    Mr. Calvert. No, sir, nothing out of their ordinary kind of 
presentations. And I'm quite sure it would have been brought to 
my attention had that occurred anywhere in the firm.
    Senator Nelson. Mr. Savage, who you have previously 
testified about--it's my understanding that he resigned from 
Alliance along about August 2001. Is that correct?
    Mr. Calvert. July. Yes, sir.
    Senator Nelson. And why did he do that?
    Mr. Calvert. Frank, was working on a project to raise money 
for a private equity fund that was going to invest in Africa, 
and he had a team of people working with him. And we had had an 
agreement with Frank, made roughly 2 years prior, that Alliance 
was going to support that activity for a defined period of 
time, but if he had not been successful in raising funds for 
that activity by a certain date, we were going to essentially 
pull the plug on that project.
    As that date came and went, we entered into conversations, 
and we said that we were going to stop financing that project. 
And at that time, Mr. Savage decided that he was going to leave 
Alliance and form his own firm to pursue that project, which he 
still believed in.
    Senator Nelson. Was he a member of the Enron board at the 
time?
    Mr. Calvert. Yes, he was.
    Senator Nelson. And how long had he been a member of the 
board?
    Mr. Calvert. I believe he went on the board in 1999.
    Senator Nelson. And how long had he been with Alliance?
    Mr. Calvert. We acquired a company called Equitable Capital 
Management in 1992, and so Frank became part of Alliance at 
that time, but he had been with that predecessor company for 
considerably longer.
    Senator Nelson. And you have no knowledge that he had, at 
any point during this period of time--we're basically talking 
year 2001--urged any acquisition of Enron stock.
    Mr. Calvert. I have no knowledge of that, and I have gone 
out of my way to inquire about that, and I don't believe there 
were any such conversations.
    Senator Nelson. When Mr. Lay came back to be chairman of 
Enron last year, he told the press that his focus was investor 
relations. Aside from what Mr. Harrison has testified to with 
regard to promoting Enron and Enron stock, are you aware of any 
additional things that Mr. Lay and/or other executives at Enron 
did to promote their company and their stock?
    Mr. Calvert. No, I'm not.
    Senator Nelson. I understand that Alliance bought more 
shares of Enron than any other shareholder in the country, some 
43 million shares by the fall of 2001. Were you, as the CEO, 
aware of Alliance's purchases of Enron?
    Mr. Calvert. I was, and we--I don't know that we had bought 
more by that time--some people may have been larger--but it is 
true that on September 30, we were the largest institutional 
shareholder, owning about--a little over 5 percent of the 
stock.
    Senator Nelson. And what was your company's strategy in 
accumulating that fairly large percentage of a company.
    Mr. Calvert. Actually, Senator, that's a relatively small 
percentage, or it's an average sort of percentage. Recall that 
Alliance manages $450 billion, and over $300 billion of that is 
in equities, so usually when we take a position in a company, 
we become a relatively large shareholder for the company, even 
if, as in this case, it wasn't owned in all portfolios and it 
was only a 3- or 4-percent position in the portfolios where it 
was owned on that date, on September 30th.
    Senator Nelson. How many of your portfolio managers 
purchased shares in Enron during the year 2001?
    Mr. Calvert. I don't know that number exactly, Senator. 
I'll be happy to get it for you, but, order of magnitude, I 
would say 10 or 12.
    Senator Nelson. And do you know how many were purchasing 
shares of Enron in the month of August?
    Mr. Calvert. Perhaps Mr. Harrison can answer that 
specifically, but it would have been 6 or 7 at that point, 
probably.
    Mr. Harrison. That's fine.
    Senator Nelson. And September?
    Mr. Calvert. The same.
    Senator Nelson. October?
    Mr. Calvert. The same.
    Senator Nelson. So 6 or 7 are purchasing, while at least 
some number are selling, as in the case of New York.
    Mr. Calvert. Well, within the large-cap growth discipline, 
others were holding. Within another discipline, yes, there were 
some sales, and----
    Senator Nelson. Were you aware that Mr. Harrison was on a 
watch list in Florida?
    Mr. Calvert. I actually was not aware of that until 
recently. I am now aware of it. I wasn't aware of it at the 
time. We understand that--you know, that procedure, and that 
would not have been of particular concern to me. And if I can 
explain----
    Senator Nelson. Please.
    Mr. Calvert.--why. I think all investment managers, no 
matter how good, do not perform the benchmark every quarter and 
every year. And, as has been said, I think it's the long-term 
record that matters. And from time to time, we--if we under 
perform for a short period of time, there's procedures where 
people put us under closer scrutiny or say that they are going 
to watch us. And I believe I'm correct in saying that we had, 
in fact, been in that position with the state of Florida in 
1994, and, of course, went on to have very strong performance 
after that. And it would have been my belief that we would go 
on to have very strong performance after this period on the 
watch list.
    Senator Nelson. So the bottom line is you weren't aware 
that he was specifically on a Florida watch list.
    Mr. Calvert. I was not.
    Senator Nelson. And certainly you wouldn't have been aware, 
then, that he was on it for that period of time, 17 months.
    Mr. Calvert. I was not, but it--I would have viewed that--I 
would not have--I would--I view that as something that's--kind 
of happens in the normal course of our business, and I would 
not have expected it to be reported to me. On the other hand, I 
was very aware of all of our Enron purchases.
    Senator Nelson. So you were aware that the Florida pension 
fund was more heavily invested in Enron than most other public 
funds.
    Mr. Calvert. I was aware that we were making the purchases. 
I was aware then, and am aware, that Mr. Harrison treated all 
of his portfolios identically, as did other members of the 
team, and as is required of us, but I was also aware that there 
were some portfolio managers who chose not to own Enron, and 
there were other groups in the firm that didn't own Enron. And 
again, that's not atypical.
    Senator Nelson. Back at the beginning of the year, of 2001, 
Alliance sent out a notice to its clients stating--to caution 
about risks associated with buying stocks in a downturn. Do you 
have any knowledge of that?
    Mr. Harrison. Senator, may I take that question? I sent out 
a memo early in 2001 saying that, given the decimation in 
technology stocks, I did not expect an early recovery in 
technology stocks, and, therefore, I felt that the market 
overall was vulnerable. Do remember what I said. Enron looked 
like a standout in relation to the collapse of technology 
stocks. So that memo that you're referring to referred to 
essentially the technology stocks, which people thought of as 
being leaders in the market.
    Senator Nelson. And in your case, you said Enron was on the 
list.
    Mr. Harrison. No, I'm saying that Enron, at that time I 
sent out the memo, was basically a standout in relation--its 
earnings were going up at 20, 25 percent a year. Technology 
stocks were totally collapsing.
    Senator Nelson. Well, I--my question, though, is to the 
CEO, because I think it goes beyond you, Mr. Harrison, that a 
communication came from Alliance in January 2001 to its clients 
and to its stockholders cautioning about the risk associated 
with buying stocks in a downturn.
    Mr. Calvert. The communication came from our large-cap 
growth group, not from the firm as a whole. Each, again, of our 
investment services, has communications with their specific 
clients, which is relevant or germane to what they're doing. 
And, as Al said, I think what he was cautioning against was 
buying companies where earnings were falling dramatically. In 
the case of Enron, we believed that earnings were still 
growing, so that memo was not a concern to me.
    Senator Nelson. OK. Well, thank you for your comments. I'm 
sorry to have kept you here so long. Now I can get to Mr. 
Glassman.
    Mr. Glassman, you've heard everything here. It's gone back 
and forth. Why don't you give us the benefit of your commentary 
on the basis of the answers that you've heard to the questions 
that have been proffered here today.
    Mr. Glassman. Thank you, Senator, for that open-ended 
question. Well, I think it's very important to understand the 
function that someone like Mr. Harrison plays in a large state 
pension fund. As has been stated earlier, there are a number of 
managers who are chosen typically to have different styles and 
to balance the styles in the fund. Mr. Harrison's particular 
style, which I this is--I think it's well known to most people 
in the investment community is, in fact, to look for companies 
that have been beaten up, companies that he believes are 
undervalued, and then to buy those stocks.
    And I don't really think that the relevant question is did 
he--was one of his investments not profitable. I think the 
relevant question is the structure of his portfolio. Was he 
dangerously overweighted in any one stock. And we've heard 
different numbers, but I understand that in his portfolio he 
never had more than, let's say, 4 percent, maybe it was 5, but 
even that is not particularly high, in Enron stock. So that's 
one question.
    And then I think the other question is did his losses in 
Enron seriously impair his overall performance. And, of course, 
it depends on how far back we go with the performance, but he's 
had a history the Florida pension fund over 17 years, and he's 
turned in what I would say is a pretty sensational performance. 
And I think it's really up to the fund--to the managers of the 
Florida State Pension Fund to decide whether they want to 
retain him as a manger. And I think they can say, well, he 
hasn't done very well in the last couple of years. I know what 
he did publicly--I mean, his public fund, which is called 
Alliance Premier Growth, between 1994 and 1999, according to 
Morningstar, he returned 46 percent in 1995, 23 percent in 
1996, 32 percent in 1997, 48 percent in 1998. That's pretty 
darn good. Then he had two bad years. I'm sorry, in 1999, he 
was 28 percent. Then 2000 and 2001 were bad years. So maybe 
they should fire him. I think--you know, that's up to them.
    What bothers me about a lot of the testimony that I've 
heard today is it almost sounds like, I don't know, sour grapes 
on behalf of the managers of the Florida pension fund that he 
made an investment in Enron that lost money. The chart that 
you're showing up there certainly does show the stock falling 
and then continuing to fall and continuing to fall. But that's 
through the benefit of hindsight.
    You know, if we looked at, let's say, his investment in 
Continental Airlines immediately after September 11th, after 
September 11th, there was no flying in this country for a week. 
Airlines, subsequent to that, were in terrible shape. I mean, 
some of them were on the brink of bankruptcy. People felt, you 
know, who's ever going to fly? The stock price of Continental 
and a number of other airlines dropped at least 50 percent. You 
could have shown exactly that chart for Continental stock. He 
bought it, and it went up.
    He has winners. He has losers. And I think overall you need 
to look at the--his entire record.
    I just want to correct--or at least clarify my statement 
about the proportion of Enron stock in the overall Florida 
portfolio, because I think this is relevant, and actually I 
think it's a credit to the Florida pension fund, the people who 
manage it overall. Based on my calculations, they could be off 
by a little bit, I don't think at any time Florida had more 
than 0.3 percent of its entire $95 billion in assets in Enron 
stock. Florida was not placing a huge bet on Enron stock. The 
Standard & Poor's 500 stock index, which is a basket of pretty 
much--you know, most of--the vast majority of the market's 
capitalization--in January, the value of Enron was 0.53 
percent. So that was my point about that.
    But I think to look at Mr. Harrison's performance, you 
know, I would say it's pretty good. I certainly never owned 
Enron stock. I never advised any of readers to own Enron stock. 
I didn't particularly like the company, never would have bought 
it at that point, but I've got to say that, based on Mr. 
Harrison's record over the long term, I would not want to 
second guess him. If I were Florida, I would have hired him for 
a specific reason, which was to invest in this style with this 
amount of money while other people are investing with a 
different style with other amounts of money. And I think that's 
actually quite a successful practice.
    But it does bother me, as I said earlier, that there's an 
attitude abroad, and perhaps significantly in the halls of 
Congress, that when you make money in the stock money, that's 
fine, that's yours to keep. But if you lose money, somebody 
must be doing something, you know, illegal or immoral. That's 
not the nature of stock investing.
    The nature is, over the last 76 years, stocks have lost 
money 22 times. Stocks go down. Stocks go up. And I think 
that's important for all Americans to understand. And they need 
to protect themselves against risk. And the only way they can 
do is through diversification.
    Thank you.
    Senator Nelson. Mr. Glassman, what's unusual is the fact 
that the Florida pension funds lost more--almost as much as the 
next three pension funds lost together on an Enron investment--
the University of California Regents, Georgia State Pension 
Funds, and Ohio State Pension Funds. And three is clearly 
something unusual about this. And this is part of the reason 
we're having a hearing, because we want to see if there's 
anything we can do about it.
    Does the staff have any questions for the first panel? OK, 
thank you all very much for your patience. We appreciate it 
very much, and we'll call up the second panel.
    Good afternoon. One of the witnesses on the second panel, 
because of the lateness of the hour, had to leave, Mrs. Sarah 
Teslik, executive director of the Council of Institutional 
Investors. And we will insert her testimony as a part of the 
record.
    [The prepared statement of Ms. Teslik follows:]

Prepared Statement of Sarah Ball Teslik, Executive Director, Council of 
                        Institutional Investors
    You have called this hearing to ask how pension funds can avoid 
losing money in the stock market. Many investors lost a lot of money in 
Enron and in other corporate disasters.
    There is one clearly wrong answer. It is the answer that seems like 
the obvious right answer.
    ``Don't buy losing stocks'' sounds good, but it doesn't work. Big 
pension funds will not--repeat will not--avoid losing money in the 
stock market by trying to pick winners and sell or avoid losers. The 
more a pension fund tries to do this--the more it buys and sells--the 
more it loses. Over three-quarters of managers lose money when they try 
to do well by active buying and selling. With large amounts of money 
you cannot, over time, avoid the losers. Instead, you aggravate losses 
by incurring large fees. I am happy to explain this key point further 
in plain English during the question period if you want. It takes two 
minutes and I only have five. I'll just say for now that it has been 
demonstrated with ample data that large funds that try to avoid 
investments in losing stocks by hyperactively managing their money fail 
to avoid the losers and instead incur large trading costs on top of 
losses.
    Pension funds, in other words, should not have been trying to avoid 
Enron by hyperactive management. This is why most of the best-managed 
pension funds in the country had some Enron stock. In all cases of 
which I am aware, the amount of Enron stock the funds held was tiny 
compared to overall assets.
    But that doesn't mean that something can't be done to reduce losses 
from future Enrons. A number of things can be done. Rather than reduce 
the chances of particular funds holding rotten companies' stocks, we 
should reduce the numbers of rotten companies. This is the better 
approach and it happens to be the only approach you can promote 
legislatively.
    Our antiquated securities laws and conflict-ridden oversight 
systems give us poor quality information and prevent us from acting 
effectively on information we do get. Many companies like Enron would 
not have had to implode if owners had gotten key information and been 
empowered to act on it. Owners hate losing money; they don't need to be 
encouraged to act. And it doesn't cost taxpayers anything when owners 
spend their own money to prevent fraud and encourage good corporate 
behavior.
    But the information investors get is flawed, incomplete and 
sometimes grossly misleading. And additional laws prevent or severely 
inhibit investors from acting on the information they get. Combine 
these two and you get Enron. Global Crossing. Xerox. Rite Aid. Sunbeam. 
Waste Management. MicroStrategy. Cendant. And on and on.
    The problems have been obvious for decades before Enron. If you 
don't require companies to disclose stock option plans, and if you 
don't require companies to let shareholders vote on stock option plans, 
if you don't require companies to expense stock options, you get 
runaway compensation that turns companies into Ponzi schemes.
    If you allow companies to hide their directors' financial 
conflicts, if you allow companies to hide their debt just because a 
tiny portion of its equity is held by someone else, if you allow people 
who want wiggle room to write accounting standards, if you let brokers 
vote when shareholders do not, you will get more Enrons.
    If you saddle shareholders with restrictions that make it look like 
the government is overseeing pedophiles rather than property owners, if 
you maintain disclosure requirements that give company managements 
ammunition to sue shareholders who question them, if you fail to 
prosecute individual wrongdoers and instead levying corporate fines 
that hurt victims but not wrongdoers, you will get more Enrons.
    Worse yet, you will get markets that start to slip. All great 
societies start to crumble at some point. Many do when special 
interests start to dominate. The fact that we've had a good run of it 
doesn't mean we will continue to do so. We need accurate disclosure of 
company financials. We need accurate disclosure whenever officers' or 
directors' or auditors' interests are not aligned with shareholders. 
But we need more than disclosure: being told we're being taken to the 
cleaners is not helpful unless we can act to prevent it. I am 
submitting previous testimony of mine in which I catalog what needs to 
be done.
    The key concept is this. Wall Street and some executives are 
enriched when shareholders bet on the horses. Betting, indeed, is 
strongly encouraged by those who profit at shareholders' and employees' 
expense. But while betting on the horses is encouraged, training the 
horses is actively discouraged. A significant collection of laws and 
regulations make it nearly impossible for shareholders to act like the 
owners they are. These laws and regulations are not accidental. There 
has been a major power struggle over the past many decades over who 
controls major companies, and, by and large, directors and managers 
have won.
    Over time, the fact that shareholders are encouraged to do a lot of 
buying and selling and are discouraged from acting like owners has 
meant that shareholders are betting on slower horses. If everyone bets 
on the horses and no one trains them, our economy will suffer. If our 
regulators do not exhibit leadership to correct these problems rather 
than put Band-Aids over them, capital flight will start to occur.
    I urge you to pass legislation and encourage regulation that gives 
shareholders both the information and the tools they need to oversee 
America's big corporations. This is America's grocery money at stake 
and you are the ones who can take--or not take--the right actions to 
protect it. Lean on regulatory bodies who don't demonstrate leadership. 
Assist training, discourage betting, and you'll create a more 
consistent field of thoroughbreds.
                                 ______
                                 
Previous Testimony
    We are all Enron exhausted, so I'll start with the bottom line.
    Accountants sign off on financials that trick investors because we 
let them. CEOs pay themselves hundreds of millions of dollars, even 
when they bankrupt their companies, because we let them. Boards look 
the other way because we let them.
    There are almost no consequences for individuals who commit 
corporate crimes. There are almost no consequences for board members, 
CEOs, auditors, analysts, rating agencies and government employees who 
fail to do their jobs. Even honest people start behaving badly when 
there are no consequences. Especially when the reward is hundreds of 
millions of dollars.
    This is not an Enron issue. Enron is already old news--questions 
about Global Crossing, PNC, WorldCom and A.C.L.N. all post-date it.
    People will behave badly to get great wealth if the stock exchanges 
don't stop them. If the SEC doesn't deter them. If FASB and the AICPA 
enable them. If prosecutors rarely go after them. And if you legislate 
loopholes.
    The causes of this problem are not recent. Frauds are bigger and 
more frequent because the laws that were passed 65 years ago to protect 
shareholders have been steadily worn down by special interests. Indeed, 
our laws now protect executives, accountants and financial wheeler/
dealers at shareholders' expense instead of the other way round. We are 
reaping the harvest of this multi-decade legal hijacking now.
    Great civilizations in history crumble when special interests take 
control of government machinery and use it for their benefit. I am well 
aware that these special interests are applying heavy pressure to each 
of you right now. If history is any guide, you will give in. I am 
begging you not to. The fact that we've had a good run of it the past 
200 years doesn't mean we will in the future unless you reverse this 
erosion average Americans' protections.
    What most urgently has to be done? Let's start with the auditors.
    Right now we allow managers to pick and pay people to bless their 
work. If fifth graders picked their teachers, fifth graders would get 
As. People invariably act in their self interest.
    Not only that. We allow auditors and managers to write accounting 
and auditing standards. If fifth graders wrote grading standards, all 
fifth graders would pass. People invariably act in their self interest. 
So who can be surprised that we have loophole-ridden, outdated 
standards that permit amazing things--what is permissible under current 
standards is more amazing than what is not.
    Not only that. We allow auditors to fund and run their own 
professional oversight. You all know better than that. No profession 
self polices effectively. People invariably act in their self interest.
    What should you pass? Legislation that aligns auditors' interests 
with shareholders' and that stops aligning auditors' interests with the 
managers whose numbers they review. Unless it is in auditors' financial 
interest to protect shareholders, it won't happen reliably enough. You 
also need legislation that keeps oversight and enforcement power free 
of undue influence by auditors and issuers.
    Specifically: (1) Require the board audit committee, not the 
managers, to hire the auditors. This is critical. (2) Fix FASB's and 
the AICPA's accounting and audit standard-setting systems with 
guaranteed funding and better accountability to investors--current 
accounting principles gave Enron crater-size loopholes. In other words 
fix the system for setting accounting and auditing standards, not just 
a couple of the worst products of the current systems. (3) Require 
CEOs, audit committee members and outside auditors to sign the 
financials as true and accurate--just like you and I sign our tax 
returns. (You think twice, don't you, when you sign?) (4) Remove non-
trivial conflicts of interest--conflicts affect behavior. And (5) Come 
down hard on individuals--not just companies--who break the law. If you 
merely fine audit companies for fraud, you simply increase a company's 
cost of doing business. Anderson settled case after case, wrote checks 
and moved on.
    Relying on peoples' honor or professionalism will not work. Chinese 
walls never work. Independent bodies don't remain independent long. 
Unless you harness self interest as the legislative motivator, you will 
keep getting misleading financials.
    But auditors are only partly to blame for this mess. If your 
legislation focuses mostly on audit reform, it will be ineffective.
    It is not the auditor's job to oversee the company. It is not the 
auditor's job to detect fraud, absent certain red flags. It is not the 
auditor's job to prevent self dealing or make business decisions. It is 
not the auditor's job to set the tone at the top and say it is wrong to 
lend a rich CEO 341 million dollars. It is not the auditor's job to 
create secure jobs and shareholder value. These are jobs for managers 
and boards.
    Why have so many boards allowed terrible things to happen? Let me 
ask you this: if your staffers had absolute power to remove you from 
office, would you discipline them if they were stealing? Our system 
allows executives to pick the boards who are supposed to police them. 
So, although boards are supposed to represent shareholders, they don't. 
You participate in real elections so you care about your constituency. 
We shareholders should be so lucky.
    Fixing this fundamental misalignment is more important to fraud 
prevention than auditor independence because a board's responsibilities 
are more critical to a company's health. Yet current laws, rather than 
helping shareholders keep companies accountable, do the opposite. I'll 
give you a few examples.

    (1) If a shareholder buys a mere 5 percent of a company's stock, 
he/she has to file forms as if the government is tracking a pedophile 
rather than an owner. The only way a shareholder can avoid this is to 
file a form promising to be passive. I'm not making this up. So 
shareholders without expensive form-filing lawyers have to promise to 
remain inert. Large pension funds that might otherwise be willing to 
pressure a troubled company, and who do not seek control, remain inert 
rather than filing burdensome forms that bring litigation risks with 
them. These requirements should be reworked.
    (2) The government tells us what issues we can and cannot bring up 
with our own employees--company executives. The SEC decides what issues 
shareholders can raise for a shareholder vote. Have any of you read 
these rules? They take almost every issue a shareholder ought to want 
to raise off the table:

   We cannot ask about anything that is ``ordinary business''--
        which covers almost everything we should care about.

   We can't ask about anything that is extraordinary business 
        either if an issue affects only a small part of the company.

   We cannot ask about the thing we should most want to ask 
        about--the election of the company's actual board. I'm still 
        not kidding.

    Many of the problems at Enron would be off limits for shareholders 
to raise under current rules.
    Worse, the SEC is free to, and often does, change its 
interpretations of these rules, without warning or recourse, so we 
don't know from one year to the next what we can ask.
    (3) When the SEC does allow a shareholder to raise an issue for a 
vote, it requires the shareholder to send someone to the annual 
meeting, even though few companies require their own directors to 
attend and most shareholders vote by proxy and not in person. If the 
shareholder's rep isn't there, the company can cancel the vote. So if 
you are disabled, have a job, are not rich or can't travel, forget it.
    (4) As if this isn't enough, companies can, and do, move their 
annual meetings to hard-to-reach places, even foreign countries, so 
shareholders can't get there. Annual meetings of major U.S. companies 
have been held in Russia--or in towns without airports in Alabama on 
Friday afternoons before holidays. I'm not kidding.
    (5) Managers can call off a shareholder vote on election day if 
they see they are losing. (Though a Council member sued a company over 
this recently and more or less won.) Can you imagine if a U.S. Senator 
could do this--people would howl.
    (6) If a shareholder wins a majority of votes cast for its 
proposal, companies can, with few exceptions, ignore the vote. Most do. 
Some companies ignore majority shareholder votes even when an issue 
passes year after year. This makes the shareholder franchise a joke.
    (7) Shareholders used to get to vote once a year on directors. But 
this year AT&T and Comcast have agreed to bar shareholders from voting 
again on the board of the new company until 2005.
    (8) Some shareholder ballot items are rigged. The New York Stock 
Exchange allows brokers to stuff ballot boxes and vote for management 
when shareholders with broker accounts don't vote. Most shareholders 
don't know this. Studies show this throws important votes. The SEC and 
NYSE ignore our pleas to fix this.
    On this subject, I would caution you not to put the New York Stock 
Exchange in charge of any investor protections. The NYSE is a private 
sector corporation. It gets money from corporate executives--listing 
fees. Never expect private-sector bodies to act against those who fund 
them--they won't do it. Not surprisingly, the NYSE has, in my opinion, 
consistently used its government powers to harm investors and protect 
managers, not the other way round. In my opinion, anyone who assigns 
investor protections to the NYSE doesn't want to protect investors. 
Democracies were designed to avoid precisely the problems we see over 
and over in this guild-like, government-protected, reportedly highly 
profitable franchise.
    So, if you do want to make a real difference, what legislation do 
you pass?
    We need better and immediate information about companies' executive 
compensation practices and directors' and CEOs' buying, selling, 
borrowing and hedging activities. And we need better ways to control 
this compensation--votes on all stock option plans and an ability to 
put up board candidates if existing boards are giving away the shop. 
Fraudulently calculated pay needs to be returned.
    Why is all this so important? Because if we cannot control our 
employees' compensation, even honest people will gradually pay 
themselves more and more. It is happening all over. Power corrupts. In 
extreme cases companies become Ponzi schemes. Executives siphon money 
out in mega option grants and companies crash.
    There is a reason that nearly a quarter of major-company CEOs get 
their companies to give them huge loans--loans as high as a third of a 
billion dollars to one person. There is a reason these loans are often 
forgiven, subsidized and/or used to hide CEO stock dumping. When 
shareholders' hands are tied behind their backs and key information 
stays secret, or stays secret until it is useless, executives get more 
and more generous with themselves. They do it because they can.
    If you curb executive compensation abuse, frauds become less 
profitable to fraudsters. Money is the main motivator. Focus on it.
    Neither the SEC nor the NYSE has used the powers they already have 
to address this problem adequately; if it doesn't come from you, it 
won't happen.
    What else? Senator Nelson's bill gets at many of the issues I've 
raised today. It requires that companies disclose directors' conflicts 
better--something we asked the SEC to do years ago but which just sits 
over there. In fraud after fraud we discover undisclosed director 
conflicts. There is no excuse for hiding this critical information.
    Nelson's bill also gets at board independence effectively because 
it uses a real-world definition of independence, not a weak definition, 
like those used by the NYSE and some companies.
    At our meeting next week Council members will be discussing 
legislative language that would make it easier for shareholders to put 
director candidates on the company's proxy and get issues on company 
ballots. Why do you let companies ignore our majority votes? Why does 
the NYSE throw shareholder votes by letting brokers, who are not 
shareholders, vote? Shareholders will keep markets clean, at no 
government expense, if only you'd let us by removing our handcuffs.
    Corporate governance should be at the heart of this debate, not at 
the periphery. Structures to stop frauds in the first place, rather 
than efforts to catch them when they arrive in auditors' hands, should 
be the starting point. Better information is useless without ways to 
act on it. We need both.
    Finally, enforcement. There is too little enforcement and too much 
of it targets companies and not human wrongdoers. Five years from now 
when this hubbub is history and you are an auditor or a director being 
pressed privately by management to go along with a fraud, will you be 
more deterred by the thought that your company may be fined or by the 
thought you may go to jail?
    When you punish companies, you punish innocent shareholders, the 
victims. I am therefore very pleased by the enforcement proposals in 
the Leahy, Daschle bill. Fraudsters will do anything you let them. 
Please stop letting them. And please do not go for mid-level 
scapegoats. Those who get the big bucks need to shoulder the 
responsibility. A CEO or a director going to jail would be a corporate 
governance shot heard round the world.

    Senator Nelson. And I want to thank the remaining two 
witnesses for your patience. As you see, we have intended to be 
quite thorough in this hearing, and balanced, and it just took 
us a long time. So you are very kind to be so patient.
    So why don't I just take you all in alphabetical order, Mr. 
Musuraca, assistant director, Department of Research and 
Negotiations, District Council 37, AFSCME, and Mr. Travis 
Plunkett, legislative director of the Consumer Federation of 
America. So if you will proceed. Thank you.

 STATEMENT OF MICHAEL MUSURACA, ASSISTANT DIRECTOR, DEPARTMENT 
  OF RESEARCH AND NEGOTIATIONS, DISTRICT COUNCIL 37, AMERICAN 
 FEDERATION OF STATE, COUNTY, AND MUNICIPAL EMPLOYEES (AFSCME)

    Mr. Musuraca. Good evening, Senator. On behalf of District 
Council 37 members and the 1.3 million AFSCME member throughout 
the nation, I'd like to thank the Committee for the opportunity 
to discuss Enron's collapse on public pension funds.
    The nation's 37 largest public pension funds lost nearly $2 
billion at the hands of Enron. AFSCME believes that in order 
for this not to happen again, worker and retiree representation 
is essential on all public fund pension boards. And blatant 
conflicts of interest between corporate executives, auditors, 
and investment advisors must be eliminated in the capital 
markets.
    The New York City Employers Retirement System, NYCERS, is 
the largest of New York City's five pension systems, funds with 
combined assets of over $85 billion. While our member benefits 
were never threatened, the combined losses of New York City's 
funds, due to Enron's collapse, was $109 million. The stock 
losses came from holdings in the plan's domestic equity index 
funds.
    Now, most all institutional investors rely on index funds 
to provide a relatively cheap way to reduce risk and achieve a 
broad exposure to the full equity market. The obvious pitfall 
for index investors is that the manipulation of a company's 
financial condition can lead to a company's stock being 
artificially valued in the marketplace. Hence, if a company's 
filings with the SEC are fraudulent, or if market participants 
have reasons other than a company's performance or prospects to 
buy a stock and, thus, artificially inflate a stock's value, 
the index investor is the natural victim. This certainly 
happened in the case of Enron to index investors who bought 
Enron shares at prices based on what we now know to be Enron's 
false and misleading statements prior to the company's 
collapse. Other public pension funds, like Florida, as you just 
heard, lost in the stock market through accounts under active 
management as a result of Enron's demise.
    Now, as Florida told you here, the majority of their losses 
came from an active account under management by Alliance 
Capital. Alliance, I should note, also manage such accounts as 
the New York City Firefighters Pension Fund and the New York 
State Common Fund, neither of which system reported losses on 
the scale of Florida. And AFSCME really has been unable to 
determine the decisionmaking process, even after listening to 
the testimony from these gentlemen, of either SBA or Alliance 
Capital on how Alliance continued purchasing Enron shares after 
the company was under SEC investigation. The SBA's own 
investment policy on stock purchases seems to have been 
breached. And the SBA analysts assigned to Alliance warned the 
board that Enron's stock price was in free fall.
    AFSCME members that are part of the Florida system are most 
concerned that the SBA's own investment policies were broken 
when Alliance's Enron purchases topped 7 percent of the Florida 
portfolio, exceeding the 6-percent limit that the SBA had set 
for Alliance investment in any one stock. And the AFSCME 
Council 79 in Florida has recently filed a Freedom of 
Information request to ascertain what exactly happened.
    As a trustee from New York City, the chronology of Alliance 
Enron purchases raises questions; and, moreover, the inaction 
of the SBA trustees is difficult to understand in light of 
their fiduciary duty that all trustees have to plan members and 
beneficiaries. Such duty would have led the trustees to fully 
examine the actions taken by Alliance and the warnings of its 
own staff members.
    AFSCME believes that the structure of the SBA in which the 
three trustees are the Governor, the state controller, and the 
state treasurer, may, in fact, be a big source of the problem. 
Most retirement systems have an independent board of 
fiduciaries which include worker representatives or plan 
participants and retirees. Such representation helps to create 
a nonpartisan environment where loyalty to the plan is the most 
important consideration, ensures the board's independence, and 
more easily allows for the necessary oversight of the 
investment process. Worker representation also brings to the 
boardroom a better understanding of what workers and retirees 
need from their pension system. And even in plans in which one 
elected official is the sole fiduciary, as in New York State or 
Connecticut, there are mechanism to ensure a high level of 
member input and oversight. Such, to my knowledge, is not the 
case in Florida.
    AFSCME asks the Committee to consider three suggestions to 
help ensure that public funds act as true trustee fiduciaries 
and manage retirement assets solely in the interests of plan 
members and beneficiaries. These changes could help prevent 
future catastrophic losses and strengthens trustees role as 
fiduciaries for worker retirement assets. The first is require 
all public funds to have half of the system's trustees 
appointed or elected from the ranks of the plan members and 
beneficiaries. Second, institute some type of pay-to-play 
requirements that prevent political contributions to trustees 
from investment managers that do business with the public fund 
on which they serve. Third, provide incentives for states to 
close the revolving door between asset managers and political 
leaders.
    Unlike Mr. Glassman, I believe Enron's collapse has sparked 
a crisis of confidence in the nation's capital markets. In 
order for Americans to regain a sense of confidence in the 
capital markets and the security of their retirement funds, 
equal representation of workers on public pension funds is 
vital. So is worker representation on private company 401(k) 
plans, as is provided in Senator Kennedy's bill.
    AFSCME also strongly supports reform of our nation's 
capital markets, the markets our members retirements systems 
are invested in. Senators Nelson and Carnahan have proposed 
strong legislation in these areas to prevent the kind of 
blatant conflicts of interest that we now know exist, through 
Enron.
    AFSCME members are the beneficiaries of trillions of 
dollars invested in our nation's capital markets. This money is 
their future. Public servants and all working families deserve 
better from our markets, our money managers, and the regulators 
than we got at Enron.
    Thank you very much for your time.
    [The prepared statement of Mr. Musuraca follows:]

Prepared Statement of Michael Musuraca, Assistant Director, Department 
of Research and Negotiations, District Council 37, American Federation 
           of State, County, and Municipal Employees (AFSCME)
    Good afternoon. My name is Michael Musuraca. I am an Assistant 
Director in the Department of Research and Negotiations, District 
Council 37, AFSCME, AFL-CIO, and a designated trustee to the New York 
City Employees Retirement System (NYCERS). On behalf of the 125,000 
members of District Council 37 and the 1.3 million AFSCME members 
throughout the nation, I am grateful to the Senate Commerce Committee 
for the opportunity to discuss the impact of the collapse of Enron on 
large institutional investors and public pension funds. The nation's 37 
largest public pension funds suffered combined losses exceeding $2 
billion at the hands of Enron. AFSCME believes that in order to reduce 
the likelihood of this happening again, workers and retirees should be 
equally represented on pension fund boards and blatant conflicts of 
interest by corporate executives, auditors and investment advisors must 
be eliminated.
    NYCERS is the largest of New York City's five pension funds, with 
over 300,000 active and retired members, the majority of which receive 
an annual benefit of less than $25,000. The total assets of NYCERS, the 
Teachers, Police, Fire, and Board of Education employees pension funds 
is approximately $85 billion, of which NYCERS accounts for slightly 
over $35 billion. While member benefits were not threatened, the 
combined losses of the five funds due to Enron's collapse was $109 
million, $83 million of that total was from losses in the value of 
Enron stock, while $26 million came from assorted bond holdings.
    The stock losses suffered by the NYCERS and the other City pension 
funds came from their holdings in a domestic equity index run on behalf 
of each system. Like many other large institutional investors, NYCERS 
and the other City pension funds have increased their exposure to the 
U.S. stock market through index funds over the past decade. NYCERS, for 
example, currently allocates over $17 billion, or 87.5 percent of all 
domestic equity investments, to two index funds, the Russell 3000 and 
the S&P 500.
    There are a number of reasons that large institutional investors 
use index funds for their U.S. equity portfolios. Index funds provide a 
relatively cheap method for pension funds to have a broad exposure to 
the full domestic equity market. Another, and perhaps the primary 
reason, that institutional investors have increased their exposure to 
the U.S. equity markets, especially for large cap companies like Enron, 
is that the information about the companies being traded is widely 
available to investors large and small. The widespread availability of 
information about companies to the investment community makes it more 
difficult for active managers to add value to a client's portfolio 
based on information that may not be in the public domain. Hence, not 
only are index funds seen as a cheaper method for achieving broad 
exposure to the equity markets, but one that allows institutional 
investors to fully capture value as well.
    The obvious pitfall for institutional investors who are heavily 
invested in index funds is that the manipulation of a company's 
financial condition can lead to the price of a company's stock being 
artificially valued in the marketplace. In other words, if a company's 
filings with the Security and Exchange Commission (SEC) are fraudulent, 
or if market participants have reasons other than the company's 
performance and prospects to continue buying a stock, and thus 
artificially inflating the value of a stock within the index, the 
indexed investor is the natural victim of those practices.
    This certainly happened in the case of the Enron Corporation, where 
NYCERS and other indexed investors held Enron as part of their S&P 500 
or other indexed portfolio, stock we bought at prices based on what we 
now know to be Enron's false and misleading disclosures. Then, 
beginning in October 2001, the company made a number of negative 
disclosures about the company's financial condition and certain 
related-party dealings between Enron and entities owned and controlled 
by its Chief Financial Officer, Andrew S. Fastow. The disclosures led 
to a loss of over $600 million in the third quarter of 2001, the write-
down of millions in assets, and a $1.2 billion decline in shareholder 
value. Shortly thereafter, the disclosure of accounting irregularities 
led the company to restate its earnings from Fiscal Years 1997 through 
the third quarter of 2001, so that reported net income for the period 
was lowered by nearly $600 million, nearly 20 percent.
    These disclosures led to a swift decline in the Enron's stock and 
total market capitalization. The disclosures also accounted for the 
losses suffered by NYCERS and some of the 150 other public pension 
funds from New York to California in which AFSCME members participate 
throughout the country, and the nation's perception that something was 
seriously amiss in the nation's capital markets.
    Unlike the New York City funds, other public pension funds suffered 
losses in accounts under active management. The Florida State Board of 
Administration (SBA), with whom the New York City funds joined in a 
failed attempt to achieve lead plaintiff status in the class action 
suit brought against the Enron directors, reported losses of more than 
$330 million, three times greater than the next largest loss, as a 
result of Enron's demise. The vast majority of the SBA's losses came 
from a domestic equity account managed by Alliance Capital Management.
    Alliance Capital also managed such accounts for the New York City 
Firefighters Pension Fund and the New York State Common Retirement 
System. The fortunes of those pension funds, however, were dramatically 
different from that of Florida. While Florida reported losses of over 
$330 million, neither the City Firefighters nor New York State Common 
funds suffered losses of such magnitude. Indeed, the Florida SBA fired 
Alliance Capital shortly after Enron's bankruptcy, and earlier this 
month brought legal action against Alliance.
    While it is a bit easier to fathom NYCERS' losses, we have not been 
able to determine the decision making process of either the Florida SBA 
or Alliance Capital that allowed Alfred Harrison, the Alliance 
investment manager in control of the Florida portfolio, to continue 
purchasing Enron shares even after the company was under SEC 
investigation; the SBA's investment policy on stock purchases had been 
breached; and the SBA analyst assigned to Alliance warned the board 
that the company stock price was in a free fall.
    The AFSCME members that are members of the state pension system are 
most concerned that the SBA's own investment policies were broken when 
Alliance's purchases of Enron topped 7 percent of the Florida 
portfolio, exceeding the 6 percent limit the SBA had set for Alliance's 
investment in any stock.
    As a pension fund trustee in New York City, the chronology of the 
Alliance Enron purchases raises additional red flags, and the inaction 
of the SBA trustees is difficult to understand in light of the 
fiduciary duty that all trustees have to plan members and 
beneficiaries. While I do not know the specifics of the Florida 
investment statutes, the common law duties of prudence and care would 
have led for trustees to fully examine the actions taken by the manager 
of the Alliance portfolio.
    On October 22, 2001, for example, the day that the Securities and 
Exchange Commission announced it would investigate Enron, Alliance 
bought 311,000 shares for the State of Florida.
    In an October 24, 2001 memo, SBA staff member Trent Webster, who 
was responsible for reviewing the Alliance portfolio, alerted his boss, 
Deputy Executive Director Susan Schueren, to Harrison's Enron buying 
activity. The memo, in part, reads: ``Enron's stock is being crushed. 
The primary cause is the concern about the company's accounting . . . A 
stock that is falling when a company has accounting problems is almost 
always a bad time to buy.''
    Despite the internal staff warning, Harrison continued to buy Enron 
stock on behalf of Florida, paying $23 million for 2.1 million shares 
from October 25th, when Enron traded at $15 per share, through November 
16th, when its shares had dipped to $9 per share.
    Earlier this month, AFSCME's Florida Council 79 filed a Freedom of 
Information request with the SBA for all documents and communications 
with Alliance concerning purchases involving Alfred Harrison and other 
Alliance personnel to get to the bottom of what took place.
    The Florida Retirement System is part of the Division of 
Retirement, which is headed by a director appointed by the Governor and 
confirmed by the State Senate. The Division is responsible for 
administering the trust and distributing benefits. The State Board of 
Administration, a state agency with its own staff, handles all 
investment issues. The SBA is composed of the Governor as Chair, the 
State Treasurer and State Comptroller. A 6 person Investment Advisory 
Council makes recommendations on investment policy, strategy, and 
procedures. All of its members are financial professionals and do not 
necessarily represent the interests of rank and file plan participants.
    AFSCME believes that the structure of the SBA may, in fact, be a 
source of the trouble. Many public retirement systems have an 
independent board of fiduciaries, which include worker representatives 
or plan participants and retirees. Such representation helps to create 
a non-partisan environment where loyalty to the plan is the most 
important consideration, ensures a board's independence, and more 
easily allows for the necessary oversight of the investment process. 
Worker and retiree representation also brings to the boardroom a better 
understanding of what members need from their retirement system. Even 
retirement systems in which one elected leader is the sole fiduciary as 
in New York State and Connecticut, there are mechanisms in place that 
ensure a high level of plan member input and oversight. Such is not the 
case in Florida. AFSCME asks that the Committee consider 3 suggestions 
to help ensure that public funds trustees act as true trustee 
fiduciaries and manage retirement assets solely in the interests of 
plan members and beneficiaries. These changes could help prevent future 
catastrophic losses in their investment portfolios and strengthen their 
role as fiduciaries for worker retirement assets.

   Require all public funds to have half of the systems 
        trustees appointed or elected from the ranks of the plan 
        members and beneficiaries.

   Institute some type of pay to play requirements that prevent 
        political contributions to trustees from investment managers 
        that do business with the public fund on which they serve.

   Provide incentives for states to close the revolving door 
        between asset managers and political leaders.

    The Enron debacle has sparked a crisis of confidence in the 
nation's capital markets that Business Week recently suggested has 
raised the public's furor at the business community to levels last seen 
during the trust-buster era of Theodore Roosevelt. More recent 
revelations, uncovered by New York State Attorney General Eliot 
Spitzer's investigation of Merrill Lynch, about the complicity between 
investment management firms research analysts and their investment 
banking business, has only served to stoke the flames.
    Clearly Americans, who as members of defined benefit pension plans 
like NYCERS or who participate in their company's deferred contribution 
plans, have come to believe that the deck is stacked against them as 
they seek to invest a portion of their earnings for their children's 
college educations and their own retirement. The daily revelations 
about new Security and Exchange Commission investigations, indictments, 
and company restatements of earnings only serves to convince more 
average Americans that the system is rigged to their disadvantage.
    In order for Americans to regain a sense of confidence in the 
nation's capital markets and the security of their retirement funds 
equal representation of workers and retirees on public pension funds is 
vital. So is worker representation on private company 401-k plans, as 
is provided in Senator Kennedy's pension reform bill. AFSCME also 
strongly supports reform of our nation's capital markets--the markets 
our members' retirement savings are invested in. Senators Nelson and 
Carnahan have proposed strong legislation in these areas, as has 
Senator Sarbanes and Senator Leahy.
    In the face of inaction from the SEC and inadequate reforms passed 
by the House, the Senate needs to move quickly on these measures to 
protect working families' retirement savings from conflicts in the 
capital markets.
    AFSCME's members are the beneficiaries of trillions of dollars 
invested in our nation's capital markets. This money is their future. 
Public Servants and all working families deserve better from our 
markets, our money managers, and the regulators than we got at Enron. 
Thank you.

    Senator Nelson. Mr. Musuraca, I think you brought some 
very, very compelling points to the testimony with regard to 
reform of the laws. I appreciate it. Mr. Plunkett?

 STATEMENT OF TRAVIS PLUNKETT, LEGISLATIVE DIRECTOR, CONSUMER 
                     FEDERATION OF AMERICA

    Mr. Plunkett. Senator Nelson, it's good to be with you. 
Thank you for holding such a thorough hearing on this important 
topic. I am the legislative director of the Consumer 
Federation. We have 300 members organizations with a combined 
membership of 50 million Americans.
    As you've heard extensively, many mutual funds and pension 
funds, not just individual investors, also invested heavily in 
Enron. As a result, workers who never heard of the energy giant 
had their retirement savings put at risk by Enron's practice of 
hiding debt and inflating earnings, and Arthur Andersen's 
willingness to let them.
    So the next question is: What are the lessons that are 
learned? Let's move on. And what are the reforms that the 
Congress should be putting in place?
    The first thing to say is that when a company hides debt 
and inflates earnings, this isn't just a stock that's getting 
beaten up. These aren't just bad business decisions that are 
being made. That's certainly immoral. And I think we're going 
to find that it's also illegal. So Mr. Glassman's statements 
about risk in the stock market--the point is well taken, but we 
have an altogether different situation here.
    We have a situation where the company lied to the American 
people and lied to their investors. Therefore, the solution, 
the fixes that Congress needs to put in place, are very 
significant.
    The central lesson that we've learned, the inescapable 
lesson, is that the market can't function without reliable 
information. And the key to reliable information is a truly 
independent audit. Unless the auditor is free of bias, brings 
an appropriate level of professional skepticism to the task, 
and feels free to challenge management decisions, the audit has 
no more value than if the company were allowed to certify its 
own books. When you hear from sophisticated institutional 
investors, as we have today, who say they've been easily duped, 
the average retail investor, then, doesn't have a chance.
    I have to say that hopes for a real reform in Congress on 
this key issue now rests with the Senate, because the bill that 
passed the House last month does not do what is necessary to 
restore integrity to the independent audit. Several bills have 
been introduced. You've put a bill in with Senator Carnahan. 
And I think the possibility, given our look at these bills, of 
real reform does exist.
    On auditor and corporate board independence, we believe 
that the gold standard is the bill that you've put in with 
Senator Carnahan. Senator Sarbanes has also put in a much 
broader bill. It makes a number of significant steps forward, 
particularly on oversight of auditors. It's weaker on 
independence. It would create a very strong, effective, 
independent new regulatory body for auditors. It would enhance 
the independence of the Financial Accounting Standards Board, 
FASB. And both of your bills establish additional corporate 
governance reforms. Taken together, these two bills are a very 
strong package of reforms.
    Now, let me get specific here for a minute on the key 
issue, auditor independence. The Nelson-Carnahan bill is a very 
comprehensive approach to auditor independence. It requires 
mandatory rotation of auditors every 7 years. It strictly 
limits the non-audit services that an audit firm may provide to 
those--to firms that are receiving audits. Tax consulting 
services are excluded from this ban, but they'd have to be pre-
approved by audit committees of the corporate board. Finally, 
the bill proposes a 1-year cooling-off period before an audit 
firm employee could accept employment in a management or a 
policymaking position at a company that is an audit client of 
the firm.
    The key here, for us, is really twofold. First, the 
mandatory rotation requirement. This diminishes the basic 
conflict that exists, because the auditor works for the audit 
client. The knowledge that a rival firm will soon be evaluating 
the books should also provide an incentive to get it right. 
Some have argued against this requirement by citing research 
that shows the preponderance of audit failures in the first 
year of an audit. But there's an inescapable fact that 
investors have suffered their largest losses in audit failures 
that involved ongoing, often very long-term audit 
relationships. And here I'm speaking not just of Enron but 
Waste Management, Microstrategy, Cendant, RiteAid, Sunbeam, and 
Lucent.
    The next thing the Nelson-Carnahan bill does correctly is 
to further lessen the auditor's financial dependence on a 
single-audit client by strictly limiting the non-audit services 
that they may provide. The argument put forward by opponents of 
this consulting ban, that providing consulting services makes 
auditors less financially dependent on the audit itself and, 
thus, more independent, is absurd on its face. It assumes that 
the audit firm can challenge management to the point of losing 
the company as an audit client but still retain the more 
lucrative consulting services. The real world simply doesn't 
work that way.
    Finally, the Nelson-Carnahan bill would impose tough new 
independent standards for both board audit and compensation 
committees. If audit committees are to bear greater 
responsibility for the oversight of the audit, as other bills, 
such as the Sarbanes bill propose, and we endorse, they must 
also have the independence and resources necessary to serve 
that function.
    Now, we have an extensive menu of proposed reforms, many of 
which are reflected in other bills. I'm not going to get into 
them. We need to do more on regulatory oversight of auditors. 
As I mentioned, the Sarbanes bill is very good there. We need 
to reform the private litigation laws and create a more fully 
funded, more aggressive SEC. We need to reduce incentives for 
managers so that they don't manipulate the numbers. And here, 
we like very much Senator McCain and Senator Levin's bill that 
require expending of stock options.
    We need to do a lot of things. But the first--first and 
foremost, you have to go after auditor independence and get 
that right. And we think the two bills that I've mentioned, 
especially the Nelson-Carnahan bill, are a step forward, a 
significant step forward, and also much more effective than the 
bill that has passed the House. And we'll be working hard to 
get significant reforms of this type to the floor of the 
Senate.
    Thank you, Senator.
    [The prepared statement of Mr. Plunkett follows:]

 Prepared Statement of Travis Plunkett, Legislative Director, Consumer 
                         Federation of America
    Good afternoon. I am Travis Plunkett, legislative director for the 
Consumer Federation of America. CFA is a non-profit association of more 
than 290 organizations founded in 1968 to advance the consumer interest 
through advocacy and education. Ensuring adequate protections for the 
growing number of Americans who rely on financial markets to save for 
retirement and other life goals is one of our top priorities.
    I would like to thank Chairman Dorgan, Ranking Member Fitzgerald 
and the other Members of the Subcommittee for the opportunity to offer 
our comments on this extremely important issue. When Enron suddenly 
collapsed last year amid allegations of accounting fraud and misleading 
financial disclosures, the magnitude of the damage was difficult to 
comprehend. As the dust has begun to settle, it appears that investors 
have lost roughly $93 billion dollars. \1\ To put that in perspective, 
this one case has caused losses that are nearly equal to the estimated 
$100 billion in investor losses resulting from faulty, misleading, or 
fraudulent audits over the previous six years. \2\ And that six-year 
total dwarfs similar losses in previous years. It is no wonder, then, 
that the Enron-Andersen fiasco has prompted Congressional, regulatory 
and judicial investigations into what went wrong and how to prevent 
such a debacle in the future.
---------------------------------------------------------------------------
    \1\ ``The Accountants' War,'' by Jane Mayer, The New Yorker, April 
22--29, 2002, pg. 64.
    \2\ Ibid. The article cites an estimate by former SEC Chief 
Accountant Lynn Turner.
---------------------------------------------------------------------------
    Early attention focused on the tragic cases of the Enron employees 
and retirees, who saw their 401(k) account balances dwindle nearly to 
zero because of their heavy concentration in company stock. It soon 
became clear that many mutual funds and pension funds had also invested 
heavily in Enron. As a result, workers who never heard of the energy 
giant had their retirement savings put at risk by Enron's practice of 
hiding debt and inflating earnings and Arthur Andersen's willingness to 
let them.
    Among the victims were public and private pension funds. One media 
account put the total of Enron losses in just 31 public retirement 
funds at a little over $1.5 billion. \3\ Others have estimated that 
total losses in state pension funds are closer to twice that amount. 
\4\ Pension managers, while outraged at the losses and at the apparent 
fraud that led to them, have nonetheless been quick to assure the 
public that pension benefits are not at risk. Diversification rules 
have guaranteed that, in most cases, losses totaled less than one 
percent of fund holdings, though concentrations are somewhat higher at 
certain individual funds.
---------------------------------------------------------------------------
    \3\ ``Enron's Many Strands: Fallout; The Enron Scandal Grazes 
Another Bush in Florida,'' Leslie Wayne, New York Times, January 27, 
2002.
    \4\ ``The Enron Wars,'' by Marie Brenner, Vanity Fair, April 2002.
---------------------------------------------------------------------------
    An unknown portion of those losses resulted from the practice of 
index investing which is common among pensions, and which nonetheless 
remains a sound strategy for reducing risk. Of greater concern are the 
funds whose private money managers invested considerable fund assets in 
Enron stock, even after signs had emerged that this was a company in 
serious financial distress. Money managers who are paid with taxpayer 
money to manage public funds have a responsibility, arguably greater 
even than the fiduciary duty that all money managers owe their clients, 
to ensure that they make prudent investment decisions based on thorough 
and sound research. It is certainly appropriate for Congress to explore 
whether those standards were met in this case.
    Still, just about everyone appears to have been fooled by Enron's 
false picture of financial health--from the media, which sang its 
praises, to the bankers, who loaned the company money, to the research 
analysts, who touted the stock, to the professional money managers who 
bought it. While Enron was clearly a speculative investment once the 
stock price had entered freefall, those who bought during its 
astronomical rise had little reason to think they were taking undue 
risks.
    There are many lessons to be learned from Enron. Lessons about the 
fundamental dysfunction of a system that rewards top executives with 
millions or even billions of dollars in profits while rank and file 
workers and shareholders are taken to the cleaners. Lessons about the 
dangers of relying on private accounts to fund retirement and the need 
to enhance protections for those accounts. Lessons about the failure of 
securities analysts to provide reliable research, particularly when 
their firm has, or hopes to have, an investment banking relationship 
with the company being analyzed. Lessons about the gross inadequacy of 
Securities and Exchange Commission resources to police the nation's 
financial markets.
    But the central, inescapable lesson from Enron is that the market 
can't function without reliable information. As this Committee's 
investigation today makes clear, even the most sophisticated 
institutional investors can be duped when corporate executives use 
financial disclosures to mask, rather than reveal, the true financial 
condition of the company. When the professionals can so easily be 
duped, the average retail investor doesn't have a chance.
    The beauty of our system of investor protections, of course, is 
that it was designed with just this potential for misleading behavior 
in mind. It was designed to protect investors, not just when corporate 
executives are honest, forthcoming and aboveboard, but also when they 
are greedy, unethical and deceptive. That's why we have standardized 
rules that govern what companies have to disclose and how. It's why the 
SEC reviews financial disclosures for accuracy, completeness, and 
compliance with appropriate accounting rules. It's why rating agencies 
pore over massive amounts of information to determine the 
creditworthiness of companies that issue debt. It's why corporate 
boards have audit committees, made up primarily of independent board 
members, to supervise the audit. And, first and foremost, it is why we 
require an outside, independent auditor to review and approve a 
company's financial statements.
    In the Enron case, as in others before it, all of those safeguards 
failed. The accounting rules failed to produce an accurate picture of 
Enron's finances, even where the company complied with the rules. The 
corporate board failed to ask tough questions, challenge questionable 
practices, or require more transparent disclosure. The auditors signed 
off on financial statements that clearly presented a misleading picture 
of company finances. The SEC had not reviewed the company's financial 
statements in several years. The credit rating agencies and securities 
analysts that investors rely on for an expert assessment of the 
company's prospects failed to provide any advance warning of possible 
trouble.
    All of these issues deserve congressional and regulatory attention. 
But none is more crucial than the failure of the independent audit to 
serve its public watchdog function. Independent auditors are our first 
line of defense against misleading disclosure and accounting fraud. But 
as the rising tide of audit disasters in recent years makes clear, the 
system of independent audits is broken. It seems to work fine when 
companies are honest, and it is our good fortune that so many companies 
today maintain their commitment to providing investors with full and 
accurate information about their operations. But when the independent 
audit is really needed, when the company is both intent on deceiving 
investors about its true financial condition and powerful enough to 
assert itself, some auditors are all too willing to appease the client, 
devise justifications for the misleading disclosures, or, worse, earn 
millions helping to design structures and transactions with no purpose 
but to hide the company's true financial condition.
    Investors burned by the Enron collapse and witness to a rising tide 
of failed audits are understandably skeptical about the ability of the 
system to produce reliable information. That doubt imposes costs on the 
system that harm not just those companies that engage in misleading 
disclosure, but all companies that raise capital in the securities 
markets. Unless Congress fixes this central problem, investors will 
continue to harbor those doubts, and with good reason.
    A number of bills have been introduced with the intent of restoring 
integrity to the outside audit by enhancing the independence of 
auditors, improving regulatory oversight of audits, and improving the 
ability of corporate boards to supervise the audit. Just last month, 
the House passed a bill, H.R. 3763, that claims to do all that, though 
frankly it is in our view a waste of the paper it is printed on. At 
best, it codifies the status quo. At worst, it would actually make it 
harder for the SEC to create an effective independent regulator for the 
auditing profession.
    Hopes for real reform now rest with the Senate. Several bills have 
been introduced or are being drafted which could provide for truly 
independent audits, effective oversight of the audit by corporate 
boards, and a strong new regulator to set and enforce standards for the 
conduct of those audits. On auditor and corporate board independence, 
the gold standard is S. 2056, a bill introduced by Sen. Bill Nelson and 
Sen. Jean Carnahan. In addition, Sen. Paul Sarbanes and the Banking 
Committee will soon be marking up legislation that would, among other 
things, create a very strong, effective, independent new regulatory 
body for auditors, enhance the independence of the Financial Accounting 
Standards Board, and establish additional corporate governance reforms. 
Taken together, these two bills would provide a very strong package of 
reforms.
    The remainder of this statement describes in more detail what we 
view as the key steps needed to restore integrity to and confidence in 
the capital markets, how these and other legislative proposals would 
address these issues, and the changes we recommend to make the 
legislation more effective.
I. Restore real independence to the independent audit.
    The whole point of requiring public companies to obtain an 
independent audit is to ensure that outside experts have reviewed the 
company books and determined that they not only comply with the letter 
of accounting rules but also present a fair and accurate picture of the 
company's finances. Auditors have profited handsomely over the years 
from performing this important public watchdog function. Unless the 
auditor is free of bias, brings an appropriate level of professional 
skepticism to the task, and feels free to challenge management 
decisions, however, the audit has no more value than if the company 
were allowed to certify its own books.
A. The independent audit has never been more important.
    The independent audit is arguably more important today than it has 
been at any time since the requirement was first imposed in the 1930s. 
More than half of all American households today invest in public 
companies, either directly or though mutual funds. They do so primarily 
to save for retirement. As a result, their financial well-being later 
in life is dependent on the integrity of our financial markets.
    At the same time, corporations today are under great pressure to 
keep their stock prices on a smooth upward trajectory. As one writer 
has noted:

        No longer is a higher stock price simply desirable, it is often 
        essential, because stocks have become a vital way for companies 
        to run their businesses. The growing use of stock to make 
        acquisitions and to guarantee the debt of off-the-books 
        partnerships means, as with Enron, that the entire partnership 
        edifice can come crashing down with the fall of the underlying 
        stock that props up the system. And the growing use of the 
        stock market as a place for companies to raise capital means a 
        high stock price can be the difference between failure and 
        success. \5\
---------------------------------------------------------------------------
    \5\ ``Deciphering the Black Box: Many Accounting Practices, Not 
Just Enron's, Are Hard to Penetrate,'' by Steve Liesman, Wall Street 
Journal, January 23, 2002, pg. C1.

    Both because they will be judged by the company's success and 
because much of their compensation often takes the form of stock 
options, corporate managers have a strong incentive to manage their 
earnings in order to present the picture of steadily rising 
profitability that Wall Street rewards. And, as the Enron case clearly 
illustrates, murky accounting rules that rely on numerous subjective 
judgments make it easier than it should be to construct a false picture 
of financial health. The Enron case also makes it abundantly clear that 
an auditor whose independence is compromised may be all too willing to 
sign off on financial statements that conceal, rather than reveal, the 
company's true financial state.
B. Many factors undermine auditor independence.
    Because of the central importance of the outside audit in upholding 
the integrity of our system of financial disclosure, the Supreme Court 
has stated that this ``public watchdog function demands that the 
accountant maintain total independence from the client at all times.'' 
\6\ Unfortunately, accountants have been unwilling to accept the 
responsibility for maintaining their independence that goes with the 
privilege of performing audits. This lack of independence takes several 
forms.
---------------------------------------------------------------------------
    \6\ U.S. Supreme Court, United States v. Arthur Young, 1984.
---------------------------------------------------------------------------
    Much of the debate over auditor independence has focused on their 
provision of consulting and other non-audit services to audit clients. 
Since the mid-1990s, most of the big firms have dramatically increased 
their sales of such services to audit clients, despite the clear 
conflict-of-interest that this creates. Today, virtually all big 
companies receive both audit and non-audit services from their 
accountants, and they typically pay between two and three times as much 
for the non-audit services as they do for the audit itself. In some 
cases, the disparity between audit and non-audit fees is far greater. 
Furthermore, consulting services increasingly drive the profitability 
of accounting firms. If an auditor's tough questioning of management 
were to threaten its more profitable consulting arrangement, that 
auditor might expect to face tough questioning of his own from higher 
ups at the firm.
    Other factors also undermine auditor independence. The lack of 
independence starts with the fact that auditors are hired, paid, and 
can be fired by the audit client. This basic conflict is exacerbated by 
the general lack of client turnover. Auditors may reasonably expect to 
keep the same client for 20, 30, even 50 years. The prospect of such 
long relationships make it that much harder for the auditor to 
challenge management aggressively, not only because of the friendships 
that are likely to develop up between auditors and company management, 
but also because they risk losing this seemingly endless stream of 
future audit (and consulting) revenues if their tough stance on the 
numbers causes them to lose the client.
    Another problem that clearly needs to be addressed is the revolving 
door that all too often exists between auditors an their audit clients. 
This was true at Enron, it was true at Waste Management, and it is a 
common feature in many failed audits. A constant flow of personnel from 
the auditor to the audit client helps to create an environment in which 
external auditors are viewed as just another part of the corporate 
family. Such intimacy is not conducive to true independence.
C. Comprehensive reforms will be needed to restore auditor 
        independence.
    Legislation to restore independence to the audit must tackle all 
these issues. It must lessen the influence audit clients have by virtue 
of the fact that they hire, pay, and fire the outside auditor. It must 
limit the financial dependence of the auditor on the audit client that 
results from providing both audit and non-audit services to the same 
firm. And it must close the revolving door that all too often exists 
between companies and their auditors.
    The Nelson-Carnahan bill provides just this sort of comprehensive 
approach to reform. S. 2056 would require mandatory rotation of 
auditors every seven years. It would strictly limit the non-audit 
services an audit firm may provide to those that are closely related to 
the audit and pose no conflict-of-interest. Tax consulting services are 
excluded from the ban, but would have to be pre-approved by the audit 
committee of the board. Finally, the bill proposes a one-year cooling 
off period before an audit firm employee could accept employment in a 
management or policymaking position at a company that is an audit 
client of the firm.
    The mandatory rotation requirement is key to diminishing the basic 
conflict that exists because the auditor works for the audit client. 
First, an audit firm that knows it has a limited term of engagement has 
far less to lose by challenging management than one that expects to 
retain the client indefinitely. The knowledge that a rival firm will 
soon be evaluating the books should also provide an incentive to get it 
right. And the new auditor would have no reason to hesitate in setting 
past mistakes right. Some have argued against this requirement by 
citing research that shows a preponderance of audit failures occur in 
the first year of the audit, but it is an inescapable fact that 
investors have suffered their largest losses in audit failures in cases 
like Enron, Waste Management, Microstrategy, Cendant, Rite Aid, 
Sunbeam, Lucent, and others that involved ongoing, often very long-term 
audit relationships.
    The Nelson-Carnahan bill would further lessen the auditor's 
financial dependence on a single audit client by strictly limiting the 
non-audit services they may provide. We strongly support this approach. 
The argument put forward by opponents of a consulting ban--that 
providing consulting services makes auditors less financially dependent 
on the audit itself and, thus, more independent--is absurd on its face. 
It assumes that the audit firm can challenge management to the point of 
losing the company as an audit client, but still retain the more 
lucrative consulting services. The real world simply doesn't work that 
way.
    Our one suggestion for improving the bill in this area is would be 
to add a requirement that audit committees pre-approve all non-audit 
services. This would clarify that audit committees are directly 
responsible for determining what non-audit services are permissible 
based on a determination that they are ``directly related to the 
audit'' and pose no conflict-of-interest.
    Finally, we support the cooling off period in the Nelson-Carnahan 
bill as a good first step, though we would like to see it strengthened. 
The bill effectively addresses the clearly inappropriate practice of 
members of the audit team applying for work at an audit client while 
engaged in conducting the audit. A further problem is the conflict that 
arises when certain high placed executives responsible for over-seeing 
the preparation of financial disclosures are former partners or 
employees of the audit firm. To address this problem, we advocate 
adding a requirement that a company change auditors if it hires an 
individual who has worked at its current audit firm during the past 
three years to fill certain key positions, such as chief executive 
officer, chief financial officer, or chief accounting officer.
    Although it offers a less comprehensive package of auditor 
independence reforms than is contained in the Nelson-Carnahan bill and 
than we believe is needed, the draft bill being circulated by Sen. 
Sarbanes nonetheless offers some progress in this area. First, it would 
expand the list of prohibited non-audit services to reflect the 
definitions in the original SEC rule proposal under Levitt. All of 
those definitions were watered down in the final rules, not just those 
pertaining to internal audits and financial system design and 
implementation. In addition, the Sarbanes bill would require audit 
committee pre-approval of non-audit services. This would clarify that 
audit committees have the ultimate responsibility to ensure the 
independence of the audit. We can only hope that they have learned the 
lesson of Enron and other previous audit failures, that auditors who 
have millions of dollars at stake in consulting contracts are not the 
independent arbiters of financial disclosure that our system demands. 
The bill would also enhance the ability of audit committees to oversee 
the audit by requiring auditors to make separate reports on key issues 
to the committee.
    Unlike the Nelson-Carnahan bill, the Sarbanes draft does not 
require mandatory rotation of audit firms. Instead, it calls for a 
General Accounting Office study of the issue and requires rotation of 
audit team members on a five-year basis. Like the Nelson-Carnahan bill, 
it would impose a one-year cooling off period. However, the cooling off 
period in the Sarbanes draft applies to only a few top positions at the 
audited company. We believe that provision should be expanded as 
outlined above.
    Both Senate bills are significantly stronger than the House bill on 
the issue of auditor independence. The Nelson-Carnahan bill in 
particular offers the comprehensive package of reforms that we believe 
the current crisis of investor confidence demands.
II. Provide effective regulatory oversight of auditors.
    Auditors' lack of independence makes them vulnerable to pressures 
to sign off on questionable accounting practices. This problem is 
exacerbated by the fact that they face relatively little fear of 
sanctions if they do so. Although a variety of groups including the 
SEC, state accountancy boards, and the AICPA all have power to 
discipline auditing firms and their employees for ethical and legal 
infractions, even serious violations typically receive little more than 
a hand slap.
A. The current ``regulatory'' system is under-funded, ineffective, and 
        captive of the industry.
    In theory, the real authority over auditors lies with the SEC. It 
has the power to bar individuals and firms from auditing publicly 
traded companies. It also has authority to impose potentially 
substantial fines. In reality, however, the agency does not routinely 
review how auditors perform their audits, and instead delegates that 
responsibility to the AICPA's SEC Practice Section and the Public 
Oversight Board. Furthermore, according to past agency officials, the 
SEC only has the resources to tackle the very worst cases of alleged 
accounting abuse, and it typically settles even those cases without an 
admission of wrongdoing. It took no action, for example, against a 
former Arthur Andersen managing partner whom the SEC said had allowed 
persistent misstatements on Waste Management's financial reports to go 
uncorrected. \7\ Similarly, a PricewaterhouseCoopers partner ordered by 
the SEC in 1999 to cease and desist violating securities laws didn't 
even lose his position as lead partner on the audit in question. \8\
---------------------------------------------------------------------------
    \7\ ``Deciphering the Black Box: Many Accounting Practices, Not 
Just Enron's, Are Hard to Penetrate.''
    \8\ Ibid.
---------------------------------------------------------------------------
    The AICPA sets audit standards, the Public Oversight Board (POB) 
oversees a peer review system to determine compliance with those 
standards, and the AICPA has disciplinary authority over its members 
for violations. According to former SEC chief accountant Lynn Turner, 
however, the audit standards adopted by AICPA are ``so general that, as 
a practical matter, it's difficult to hold anyone accountable for not 
following them.'' \9\ The POB, \10\ which is responsible for overseeing 
the industry's peer review system and other ethics investigations, is 
notable for having never sanctioned a major accounting firm in its 25 
years of existence, even when peer reviews have uncovered serious 
short-comings in a firm's audit procedures. \11\ Furthermore, the POB 
can't act against a firm without the AICPA's cooperation. In one case 
where, at the SEC's prompting, the POB did attempt to investigate 
possible stock-ownership violations at the major firms, the AICPA 
refused funding for and cooperation with the investigation, which as a 
result went nowhere. \12\
---------------------------------------------------------------------------
    \9\ ``After Enron, New Doubts About Auditors,'' by David 
Hilzenrath, Washington Post, December 5, 2001, pg. A1.
    \10\ The POB recently voted itself out of existence in protest over 
SEC Chairman Harvey Pitt's proposal to create a new self-regulatory 
body for the accounting industry.
    \11\ ``Peer Pressure: SEC Saw Accounting Flaw,'' by Jonathan Weil 
and Scot J. Paltrow, Wall Street Journal, January 25, 2002, pg. C1.
    \12\ The case is described both in a May 12, 2000 letter from Rep. 
John Dingell (D-MI) to the SEC Chairman Arthur Levitt and in a May 22, 
2000 Business Week editorial, ``Why the Auditors Need Auditing.''
---------------------------------------------------------------------------
    Even if they had the will to act, the AICPA and POB are also 
hampered by a severe lack of investigative authority. They cannot 
subpoena evidence or compel testimony, for example, and as a result are 
forced to rely on the public record in building a case. If the SEC 
settles a case confidentially, with neither a public ruling nor an 
admission of guilt, there is no public record the AICPA or POB can rely 
on in bringing its own enforcement actions. Where the AICPA does act, 
its maximum sanction is expulsion from the organization, which can have 
serious consequences, but does not prevent the individual from 
continuing to practice.
    In reality, however, AICPA has shown itself to be a reluctant 
regulator. According to a Washington Post investigation, the AICPA took 
disciplinary action in less than a fifth of the cases in which the SEC 
imposed sanctions over the past decade. Even when AICPA determined that 
SEC-sanctioned accountants had committed violations, they closed the 
vast majority of ethics cases without disciplinary action or public 
disclosure. \13\ The disciplinary action AICPA was most likely to take, 
according to the Post investigation, was issuing a confidential letter 
directing the offender to undergo additional training. Ethics committee 
member Dave Cotton has reported seeing ``ethical lapses that resulted 
in millions of dollars of losses getting punished with as little as 16 
hours of continuing education.'' \14\
---------------------------------------------------------------------------
    \13\ Ibid.
    \14\ ``CPAs (and I'm One) Can Reverse Their Losses,'' by Dave 
Cotton, Washington Post, January 27, 2002, Op Ed.
---------------------------------------------------------------------------
B. A complete overhaul of the system is needed.
    There seems to be general agreement that a new, independent 
regulator is needed to oversee the auditors of public companies. We 
agree that such a body, operating under SEC oversight, could offer a 
vast improvement over the current system. To do so, however, it must be 
entirely independent of the accounting industry, be adequately funded, 
and have extensive rule-making, standard-setting, investigative, 
enforcement, and sanction authority.
    As one former SEC official observed to Business Week, ``The 
accounting profession is very creative at taking over every group 
that's ever tried to rein it in.'' \15\ For a self-regulatory 
organization (SRO) to have any credibility, therefore, its independence 
must be unassailable. At a minimum, a super majority of board members 
must have no ties whatsoever to the accounting industry, and they must 
be subject to conflict-of-interest rules that prohibit ties to the 
industry for a significant period before they join the board, while 
they are on it, and after they leave it.
---------------------------------------------------------------------------
    \15\ ``Accounting in Crisis,'' by Nanette Byrnes with Mike McNamee, 
Diane Brady, Louis Lavell, Christopher Palmeri and bureau reports, 
Business Week, January 28, 2002, pg. 44-48.
---------------------------------------------------------------------------
    Just as important, funding for the organization must be totally 
free from threat by industry members. The AICPA and the Big Five firms 
have shown their willingness to use strong-arm tactics to head off 
potentially embarrassing investigations in the past. They must have no 
such hold over any SRO that is created to provide enhanced oversight in 
the wake of the Enron-Andersen disaster. Funding must also be adequate 
to support an aggressive oversight program.
    Once its independence is guaranteed, the new regulator must be 
endowed with full authority for overseeing the conduct of audits of 
public companies. This includes authority for setting auditing 
standards. Both the bill that has passed the House and the proposal put 
forward by SEC Chairman Harvey Pitt would leave authority for 
developing auditing standards with the AICPA. This is unacceptable. 
Rules on how to conduct audits clearly need to be strengthened and 
clarified. That is the job of an independent regulator, not an industry 
trade association. The AICPA, as a trade association, should have no 
government-recognized role in the regulatory process.
    A new regulator to oversee accountants must also have the ability 
to conduct routine, thorough inspections of audit firms to determine 
their compliance with auditing standards. It must have extensive powers 
to conduct timely investigations of suspected abuses, including the 
power to compel testimony and documents from both auditors and the 
public companies they audit. And it must have the ability to impose 
meaningful penalties for violations.
C. The Sarbanes draft bill offers the complete overhaul that is needed.
    The Sarbanes draft would create a single new regulatory body to 
which all accountants that audit public companies would have to belong. 
It would be overseen by a 5 member full-time board whose members could 
include up to two current or past CPAs. The board would be funded 
through a combination of mandatory registration and investigation fees 
paid by members and a fee imposed on issuers. This should ensure a 
secure source of adequate funding that is free from influence by 
accounting firms.
    The bill gives the board broad authority and the powers it needs to 
fulfill those responsibilities effectively. Specifically, the board 
would be responsible for: registering accounting firms that audit 
public companies; setting auditing, quality control, ethics, 
independence, and other standards relating to the preparation of audit 
reports for issuers; conducting inspections; conducting investigations 
and disciplinary proceedings; enforcing compliance with the act, the 
rules of the board, professional standards, and rules of the 
Commission; and, when appropriate, imposing sanctions on firms or 
individuals associated with a firm for violations.
    Upon registering, audit firms must provide extensive information 
about their operations, which information is to be made available to 
the public. They must also consent to comply with requests by the board 
for documents or testimony and to obtain similar consents from firm 
partners and employees. Failure to comply is ground for suspension of 
registration, which costs the firm the ability to audit public 
companies. This gives the board the authority it needs to conduct 
effective investigations.
    The board is also required to conduct routine inspections of firms 
on a regular basis. The bill specifies that inspections must include a 
review of selected audit engagements, which may include those subject 
to ongoing litigation. A written report detailing inspection findings 
must be provided to federal and state regulators and be made available 
to the public. The bill gives the board extensive sanction authority, 
including the ability to impose civil fines of up to $750,000 per 
person per violation and $15 million per firm per violation for fraud 
and deceit.
    The bill includes a number of provisions designed to ensure the 
independence of the governing board in addition to the requirement that 
they serve full-time. Members would be appointed by the SEC, the 
Federal Reserve Board, and the Treasury Department. Members could not 
receive any compensation, except pension payments, from an accounting 
firm while serving on the board. This is a substantial improvement over 
the Oxley bill, which requires that two board members be current CPAs 
recently engaged in the practice of auditing public companies, permits 
an additional two members to be current or past CPAs, so long as they 
have not been associated with an audit firm for at least 2 years, and 
only requires that 1 member of the 5 person board actually be free of 
ties to the accounting industry.
    Nonetheless, we are concerned that the bill does not do enough to 
ensure the independence of the board. A retired academic who is a CPA 
but is otherwise free of ties to the accounting industry would be 
subject to limitations on his or her ability to serve. A non-CPA who 
has spent a career in the accounting industry would not. To avoid these 
inconsistencies, we believe a better approach would be to define strong 
independence standards for the board and to require that a super-
majority of board members meet those standards. To accommodate that 
requirement, the board would have to be expanded to 7 members. Despite 
this one concern, we believe the Sarbanes draft bill would dramatically 
improve the quality of regulatory oversight for auditors.
III. Reform private litigation laws to provide a real deterrent to 
        wrongdoing.
    Private litigation has long been viewed as an important supplement 
to regulation, since the threat of having to pay significant financial 
damages provides an incentive to comply with even poorly enforced laws. 
Even a reinvigorated system of auditor oversight would benefit from 
this support. In 1995, however, Congress passed the Private Securities 
Litigation Reform Act (PSLRA), which significantly reduced auditors' 
liability in cases of securities fraud. \16\ It did so, both by making 
it more difficult to bring a case against accountants and by reducing 
their financial exposure where they are found to have contributed to 
fraud.
---------------------------------------------------------------------------
    \16\ PSLRA also all but guaranteed that Enron's victims will 
receive mere pennies on the dollar in any recovery.
---------------------------------------------------------------------------
    Under PSLRA, it is not enough in a securities fraud lawsuit to show 
that an auditor made a materially false statement. You must also show 
that the auditor acted with an intent to defraud or a reckless 
disregard for the truth or accuracy of the statement. PSLRA set 
pleading standards with regard to state of mind that create a Catch 22 
for plaintiffs' attorneys. They must present detailed facts showing the 
defendant acted with requisite state of mind, and they must do this 
before they gain access through discovery to the documents they need to 
establish state of mind. If plaintiffs can't meet the pleading 
standards, the case is dismissed. One result is a dramatic reduction in 
the number of cases filed against secondary defendants. By the time 
victims of fraud gain access to discovery and uncover the evidence that 
would support their case against such defendants, the statute of 
limitations has often expired.
    In addition to making it more difficult for securities fraud 
victims to bring private lawsuits against accountants, PSLRA reduced 
accountants' liability when they are found to have contributed to 
fraud. The primary way it accomplished this was by replacing joint and 
several liability with a system of proportionate liability. Thus, 
accountants who are found to have contributed to securities fraud no 
longer have to fear being forced to pay the full amount of any damages 
awarded should the primary perpetrator be bankrupt. Under proportionate 
liability, the culpable accountant cannot be forced to pay more than 
their proportionate share of damages. As a result, according noted 
securities law expert Professor John C. Coffee, Jr., accountants will 
rarely be forced to may more than 25 percent of the losses. \17\
---------------------------------------------------------------------------
    \17\ ``The Enron Debacle and Gatekeeper Liability: Why Would the 
Gatekeepers Remain Silent?'' Professor John C. Coffee, Jr., Adolf Berle 
Professor of Law, Columbia University Law School, testimony before the 
Senate Committee on Commerce, Science and Transportation, December 18, 
2001.
---------------------------------------------------------------------------
    PSLRA was also notable for what it didn't do. It failed to extend 
the federal law's very short statute of limitations for securities 
fraud of no more than 3 years from the time of the wrong-doing and 1 
year from discovery. This rewards those who are able to cover up their 
fraud for the relatively short period of 3 years and guarantees, for 
example, that some claims against Enron and Andersen will be time-
barred. It also, as described above, helps to keep cases against 
secondary defendants from being filed. PSLRA also failed to restore 
aiding and abetting liability under securities fraud laws, which the 
Supreme Court's 1994 Central Bank of Denver decision eliminated as a 
potential cause of action. Thus, accountants can only be sued as 
primary perpetrators of securities fraud, not for their role in aiding 
and abetting that fraud.
    The result is that the threat of private lawsuits now poses a 
diminished deterrent to accounting fraud. Restoring reasonable 
liability for culpable accountants should be part of any overall reform 
plan. This should include provisions: to enable plaintiffs to gain 
access to documents through discovery before having to meet the 
heightened pleading standards regarding state of mind; to restore joint 
and several liability where the defendant recklessly violated 
securities laws and the primary wrong-doer is bankrupt; to restore 
aiding and abetting liability for those who contribute to fraud but are 
not the primary culprit; and to extend the statute of limitations for 
securities fraud lawsuits.
    Sen. Richard Shelby has introduced legislation to restore this 
needed deterrent to fraud. In addition, Sen. Patrick Leahy included a 
provision to lengthen the statute of limitations--to 5 years from the 
wrongdoing and 2 years from discovery--in legislation that was recently 
approved by the Judiciary Committee. We support passage of both those 
bills.
IV. The independent audit must be backed up by an aggressive, fully 
        funded SEC.
    In the wake of Enron's collapse, many have asked, ``where was the 
SEC?'' Given the SEC's responsibility for reviewing public companies' 
financial disclosures, why had the agency not detected the company's 
problematic accounting earlier? One answer is that the SEC had not 
reviewed Enron's financial disclosures since 1997. The reason is that 
the agency is so understaffed it is only able to review a small 
percentage of filings each year.
    The General Accounting Office released a study earlier this year on 
the devastating effect that under-funding is having on the SEC's 
ability to perform its assigned tasks. That report looks at the growth 
in workload at the agency since the start of the 1990s, and documents 
the degree to which funding has failed to keep pace. It tells only half 
the story. The real damage to SEC funding occurred before the period 
covered by the report, in the 1980s, when staffing stayed virtually 
flat while the industry experienced dramatic growth.
    In 1980, for example, there were just over 8,000 publicly traded 
companies filing annual reports, according to a report commissioned in 
1988 by the Securities Subcommittee of the Senate Banking Committee, 
\18\ and there were 710 new registration statements filed. Excluding 
the staff for electronic filing and information services, 420 staff 
years were devoted to disclosure matters. As a result, the agency was 
able to review all transactional filings.
---------------------------------------------------------------------------
    \18\ Self-Funding Study, prepared by the Office of the Executive 
Director of the U.S. Securities and Exchange Committee, submitted in 
partial response to the request of the Securities Subcommittee of the 
Senate Committee on Banking, Housing and Urban Affairs (S. Rpt. 100-
105), December 20, 1988.
---------------------------------------------------------------------------
    In 2000, the number of staff years devoted to full disclosure 
(again excluding the staff for electronic filing and information 
services), had dropped to 356, according to the SEC's analysis of the 
president's proposed FY 2002 budget. As a result of diminished 
staffing, dramatic growth in the number of publicly traded companies, 
and increased workload associated with review of initial offerings, 
``the percentage of all corporate filings that received a full review, 
a full financial review, or were just monitored for specific disclosure 
items'' decreased to about 8 percent in 2000, according to the GAO 
report. Because of a dramatic drop-off in the number of IPOs in 2001, 
the SEC was able to complete ``full or full financial reviews of about 
16 percent, or 2,280 of 14,060 annual reports filed'' last year, the 
GAO report found.
    Among the financial statements that were passed over for review 
because of this staffing shortfall were the financial statements for 
Enron from 1998, 1999, and 2000. Although it is impossible to know 
whether more regular, more thorough reviews would have nipped the 
accounting problems at Enron in the bud, it is reasonable to think they 
might have. Certainly, it is irresponsible to so grossly under-fund the 
federal regulators that they can't hope to fulfill the important 
responsibilities assigned to them.
    Last year, Congress had a historic opportunity to fix this problem. 
A decision was made not to use SEC-generated fees to fund other areas 
of the government. As a result, the agency no longer had to compete 
with other federal priorities in justifying its budget. Instead of 
taking that opportunity to dramatically boost agency funding, however, 
Congress approved a budget that required additional staffing cuts and 
passed legislation to reduce agency imposed fees to reflect that 
inadequate budget. The Senate fought to provide a funding boost, but 
those efforts were ultimately unsuccessful.
    The collapse of Enron has focused new attention on the issue of SEC 
funding. Because of Enron, most of that attention is focused on 
staffing issues related to full disclosure and enforcement. The 
Sarbanes draft, for example, would provide a significant funding boost 
for the agency targeted primarily at these two areas. These are 
important priorities that certainly deserve increased funding, but 
similar trends have affected all areas of SEC responsibility. Think of 
what has happened in that time in the area of mutual funds or financial 
planning since the beginning of the 1980s. Think of how many more 
households are now participants in the markets and thus vulnerable to 
wrong-doing.
    The GAO report has helped to make the case for across-the-board 
significant funding increases for the SEC. That case is even more 
powerful when the numbers from the 1980s are taken into account. 
Congress must undo the damage of last year's fee reduction legislation 
and provide a budget for the SEC that is commensurate with its 
responsibilities. The Sarbanes bill, which also would authorize full 
funding for pay parity at the agency, offers an important step in this 
direction, but it must be followed up with a more thorough analysis of 
agency funding needs.
V. Study credit rating agencies to determine why they failed to provide 
        an earlier warning of problems.
    Another troubling aspect of the Enron collapse is the failure of 
credit rating agencies to provide an early warning of trouble. In fact, 
both Moody's and Standard & Poor's still had Enron at investment grade 
until just five days before it filed for bankruptcy. According to a 
Bloomberg News account, Moody's had decided to downgrade Enron to junk 
in early November, but backed down in response to lobbying from Dynegy, 
which was then negotiating a takeover of Enron, and its bankers. \19\ 
Although this raises serious questions about the objectivity of the 
ratings, it is unclear that an earlier downgrade would have changed 
things for investors. A credit rating is not just an isolated measure 
of a company's financial health. A downgrade may not just reflect the 
company's worsening financial status, it can trigger further financial 
woes, as it did for Enron.
---------------------------------------------------------------------------
    \19\ ``Moody's Enron Rating Shows Lack of Independence,'' Mark 
Gilbert, Bloomberg News, November 15, 2001.
---------------------------------------------------------------------------
    We strongly encourage Congress to conduct a further study of this 
issue to assess whether the operations of credit rating agencies are 
adequate to ensure accurate ratings and, if not, what should be done to 
enhance the quality of ratings. That study should examine the extent to 
which recently announced changes by the rating agencies are likely to 
provide the desired improvement. It should also examine whether lack of 
competition in the industry is contributing to the problem. We expect 
that a thorough review will identify areas in need of additional 
reform.
VI. Provide additional protections to prevent securities analyst 
        conflicts-of-interest.
    Credit ratings agencies were not alone in missing the warning 
signs. In early November, after the SEC had already announced it was 
looking into Enron's partnership transactions, 10 of 15 analysts who 
followed Enron still rated it as a ``buy'' or ``strong buy.'' One 
reason, as the analysts are quick to point out, is that they were not 
getting good information from Enron's financial statements. Another is 
that Enron was apparently actively and intentionally misleading 
analysts about activity on its trading floor, for example.
    However, this offers only a limited explanation. Red flags were 
there for those who were looking. And many now looking back--albeit 
with the benefit of 20-20 hindsight--have been able to point out 
obvious danger signs. These included wide discrepancies between the 
company's reported earnings and its retained earnings, negative cash 
flow of $2.56 billion in 2000 once proceeds from asset sales and other 
one-time activities not part of its core business were deducted, and 
actual revenues on energy trading that were a mere fraction of those 
that accounting rules let the company claim. \20\ Surely it is 
analysts' job to look for just such clues and to probe deeper than the 
surface of company disclosures.
---------------------------------------------------------------------------
    \20\ ``How 287 Turned Into 7: Lessons in Fuzzy Math,'' by Gretchen 
Morgenson, New York Times, January 20, 2002, Section 3, page 1.
---------------------------------------------------------------------------
    Another reason analysts may have missed these signs is that they 
simply weren't looking. Institutional investors, who vote a key annual 
beauty contest ranking analysts, tend to frown on negative reports on 
stocks they hold in their portfolios. Even more important, negative 
reports don't attract investment banking business, and Enron was 
clearly seen as a huge potential source of such deals. Since investment 
banking business is far more profitable than the retail sales business 
for large Wall Street firms, it is hardly surprising that those firms 
use their research arms to support their investment banking business. 
In the process, their research has become so compromised by conflicts 
of interest that it has no real credibility.
    Recently, new rules have been adopted to address analyst conflicts 
of interest. They do so by attempting to limit the investment banking 
department's influence over research, limit analysts' investments in 
pre-IPO shares of companies in the industry they cover, limiting their 
purchase or sale of securities during a window of time around the 
release of a new research report, prohibiting trades against their own 
recommendations, and requiring better disclosure of conflicts. We view 
these rules as a positive first step. However, we believe more should 
be done in several areas, including banning compensation for analysts 
that is tied in any way to investment banking profits, improving the 
clarity and relevance of required disclosures, and extending disclosure 
to recommendations by sales representatives to retail clients based on 
the company's research. We are cautiously optimistic that the 
investigation being pursued by New York Attorney General Eliot Spitzer, 
and somewhat belatedly by the SEC, will force additional reforms along 
these lines. Absent regulatory action, Congress should intervene to 
impose higher standards.
VII. Protect FASB's independence.
    In the wake of Enron's collapse, Arthur Andersen has tried to blame 
inadequate accounting rules--rather than its own poor performance as 
auditor--for Enron's less-than-transparent financial disclosures. This 
ignores the fact that Enron's financial statements have been shown to 
contain several violations of existing rules. \21\ It also ignores 
Andersen's responsibility as auditor to ensure not just that Enron's 
disclosures complied with the letter of existing rules, but also that 
they presented an accurate picture of Enron's overall financial status. 
However, this is not an either-or proposition. It is in fact the case 
that Andersen failed in its responsibility as auditor and existing 
accounting rules are inadequate.
---------------------------------------------------------------------------
    \21\ In his January 24, 2002 testimony before the Senate Committee 
on Governmental Affairs, former SEC chief accountant Lynn Turner 
outlined four areas of noncompliance with existing rules.
---------------------------------------------------------------------------
    One reason is the inability of the Financial Accounting Standards 
Board to produce strong rules in a timely fashion when faced with 
entrenched opposition from large corporations and accounting firms. It 
is difficult to criticize FASB for moving too slowly on improved 
accounting rules governing special purpose entities, for example, when 
their past efforts to pass similarly controversial rules--regarding 
pooling of interest accounting for mergers, derivatives disclosures, 
and accounting for stock options--have met strong resistance, not just 
from business, but also from members of Congress.
    Something needs to be done to enhance FASB's independence. This is 
a difficult issue to tackle, since FASB is a private entity not subject 
to government oversight. The Sarbanes draft bill seems to offer a 
reasonable approach. It specifies that accounting principles recognized 
by the securities laws as ``generally accepted'' must be set by a 
private body, with a majority of independent board members and 
procedures to ensure prompt consideration. It also guarantees an 
independent funding source in the form of a fee imposed on issuers for 
the board. We believe this approach offers the possibility of real 
progress without exposing FASB to excessive risk of political 
interference. In addition, however, certain members of Congress must 
recognize that they have played a key role in undermining FASB's 
independence in the past and should refrain from interfering 
inappropriately in the future.
VIII. Improve corporate governance standards.
    Enron's independent board members, and particularly the board audit 
committee, have come in for considerable criticism for authorizing some 
of the company's more controversial partnership deals and for failing 
to ensure clear, accurate financial disclosures. While it may be 
unrealistic to suppose that board audit committees will ever be 
equipped to closely scrutinize and challenge the outside auditor's 
work, steps can and should be taken to enhance the independence and 
expertise of independent board members.
    The Nelson-Carnahan bill would impose tough new independence 
standards for both board audit and compensation committees. We strongly 
support those provisions of the bill. If audit committees are to bear 
greater responsibility for the oversight of the audit, as the Sarbanes 
draft bill proposes and we endorse, they must also have the 
independence and resources necessary to serve that function.
IX. Reduce incentives for managers to manipulate the numbers.
    Although the above protections are designed to work even when 
managers are corrupt, reforms are most likely to be effective if 
corporate managers' incentives to manipulate the numbers are minimized. 
The Sarbanes bill includes several provisions to accomplish this goal, 
including: requiring CEOs and CFOs of public companies to certify in 
writing that financial statements present a fair and accurate picture 
of the financial condition of the issuer; making it a violation of the 
law to fraudulently influence, coerce, manipulate, or mislead the 
auditor; requiring forfeiture by CEOs and CFOs of bonuses and profits 
on sales of company stocks during the 12-month period before an 
earnings restatement resulting from material noncompliance with 
disclosure requirements; enhancing SEC authority to force disgorgement 
of salary, bonuses, stock option payments and other profits to 
corporate officers; and expanding SEC authority to prohibit certain 
individuals from serving as officers or directors of public companies. 
We support all these provisions.
    We also support legislation introduced by Sen. John McCain and Sen. 
Carl Levin to require companies who claim stock option expenses on 
their tax filings to also show those expenses on financial statements 
to shareholders. The fact that corporate officers today earn a 
disproportionate share of their income in the form of stock option 
grants can give them a strong incentive to boost the company's share 
price. While that can be a positive incentive, within limits, it can 
also create an incentive to push the envelope on acceptable accounting. 
By lessening the incentive for companies to grant such outsized stock 
option compensation packages, the McCain-Levin bill should help to 
reduce those temptations. As such, we believe it is an important part 
of an overall reform package.
X. Conclusion
    The collapse of Enron has provided a clarion call for reform. It 
has exposed gaping holes in the investor protections we rely on to keep 
corporate managers honest. Enron is not unique. These same shortcomings 
apply to all publicly traded companies. We are fortunate that so many 
company managers have remained committed to providing clear, accurate 
disclosures to investors. But we cannot rely exclusively on their 
integrity. We need a system that works even when company managers are 
greedy and overly aggressive, and we need a system that reduces their 
incentives to be greedy and overly aggressive. Congress can repair the 
gaps in the current system. It is of paramount importance that you do 
so.

    Senator Nelson. It's so nice to hear so many nice things 
about my bill. Thank you very much, Mr. Plunkett.
    Mr. Musuraca, share with us, from your experience in New 
York and your knowledge of pension funds for AFSCME, and that 
is throughout the country, that you represent, tell us if you 
would typically see a large-cap money manager buying large 
positions of one particular distressed company.
    Mr. Musuraca. Let me clarify, I'm only a trustee at NYCERS 
in New York City.
    Let me say, also, that when a board hires a money manager, 
any money manager, whether they be an active manager in a 
large-cap growth or a large-cap value or whether they be an 
index fund, you put guidelines on how they are to manage the 
fund's money. So if the guideline suggests that there are no 
restrictions on how large a stake they can take with any one 
company, then maybe perhaps you would. But, in my experience, 
we usually put a guideline of no more than 5 percent of the 
portfolio should be invested in any one company.
    Senator Nelson. As a trustee, do you consider it part of 
your responsibility to monitor your outside money managers?
    Mr. Musuraca. It's one of my major responsibilities. Every 
month, I receive, on a chart prepared to me by staff of the New 
York City controller's office, the performance of all the 
active managers and the index funds that the NYCERS portfolio 
has. And it's done over a 1-month, 6-month, 1-year, 3-year, 5-
year, 10-year rolling basis so that I can gauge both the short-
term and long-term performance of the managers. And at any 
meeting of the board, I can instruct staff that the performance 
of any one of the managers has given me cause for concern. And 
as long as I can bring along a few more votes on the board, we 
can have a manager come in to sit down and discuss their 
performance and how they're doing things for the members of the 
fund.
    Senator Nelson. And as a trustee, are you informed when a 
fund staff gives reviews on money managers on watch lists? You 
heard the testimony today, all about that. Give us the benefit 
of your experience.
    Mr. Musuraca. We have two ways of finding out what staff 
believes to be going on with any given money manager at any 
time. The controller's office staff will monitor the 
performance of a money manager, as will our outside investment 
advisor. From time to time, firms will go on a watch list that 
we keep, as well, for a variety of reasons, including poor 
performance, merger with another company, change in personnel. 
And we will be told about meetings that have taken place 
between controller office staff and our investment consultant. 
They will report on how long they think the company should be--
the firm should be on the watch list. And we will--the board 
will either agree that that's a long enough time, disagree that 
that's a long enough time, or say, ``Listen, you know, things 
have gotten so bad at Company X. We really--you need to bring 
them in to see us, and we need to make some decisions.'' 
Ultimately, the decision to terminate rests with the board.
    Senator Nelson. Was it your fund that Alliance Capital 
Management sold the Enron shares in New York in August, or was 
that a different----
    Mr. Musuraca. That was a different fund.
    Senator Nelson. That was a different fund. Well, in the 
fund that you are a trustee of, does the fund have any exposure 
to Enron? And did they sell? Did they buy? What's your 
experience?
    Mr. Musuraca. As I suggested, we had exposure through our 
index fund----
    Senator Nelson. I see.
    Mr. Musuraca.--and you use index funds, large institutional 
investors, to, in fact, diversity your risk. And because of 
this--the notion--and this gets to the question that Mr. 
Plunkett raised about the reliability of information--one of 
the reasons you invest in index funds is that it's assumed, 
especially for large-cap companies like Enron, that the 
information is generally available to all investors, be they 
large or small, and it's reliable information, so that an 
active manager is not going to add value for you over the 
index. That's why you do an index fund.
    If the information is bad, as we found out, index investors 
get hurt, because the regulatory agencies failed, the auditors 
failed, to find the misleading information and the blatant 
lies, in this instance, that Enron was putting out.
    Senator Nelson. Do you want to comment about the fund that 
did lose--that did sell the Enron stock, the New York Common 
Fund?
    Mr. Musuraca. Well, I could talk to two. One is New York 
Common, and one is the New York City Firefighters, both of 
which had Alliance at one period of time as an active manager. 
It's my understanding that the portfolios that were run for 
them from a different office, a different Alliance officer, 
which had decided in August, after Skilling's resignation, to, 
in fact, pare back and sell their shares of Enron. I don't know 
exactly the dates that such sales took place, but I do know 
that Mr. Harrison's group acted in one way, and another 
Alliance group acted in a different way. And in this instance, 
luckily for both the State Common and the Firefighters system, 
they weren't exposed to such great losses.
    Senator Nelson. Did Alliance meet with you in January of 
this year, 2002?
    Mr. Musuraca. Yes, sir, they did.
    Senator Nelson. And was it Mr. Calvert, the CEO of 
Alliance?
    Mr. Musuraca. Yes, sir.
    Senator Nelson. Can you describe the meeting for the 
Committee?
    Mr. Musuraca. This was a meeting that took place at the 
request of myself, representing the New York City Employees 
Retirement System, and a number of other public pension funds, 
the Taft Hartley funds, to discuss two concerns that had been 
raised by the Enron collapse and Alliance's stake in Enron. One 
was the role of Frank Savage sitting on both the Enron board 
and the Alliance board. And the other was how Alliance had come 
to arrive at its decision--at least Mr. Harrison--to buy 
throughout the fall--to buy Enron stock throughout the fall of 
2001.
    Senator Nelson. And who else attended there for Alliance? 
Was it just Mr. Calvert?
    Mr. Musuraca. It was Mr. Calvert, Liz Smith--I can't 
remember the counsel's name, but a general counsel, as well, 
and an expert on corporate governance that the firm had.
    Senator Nelson. And in that explanation, did he describe 
the different investment patterns of different portfolio 
managers?
    Mr. Musuraca. Yes, he did. He was actually fairly 
forthcoming, although he could not comment directly, as he did 
today--the major difference was he could not comment directly 
on the relationship that Savage may have had and what Savage 
may have known. It was still fairly groundbreaking news at the 
time, so he hadn't come up with the formulation that he came up 
with today.
    Senator Nelson. And what did Mr. Calvert say in that 
January meeting this year about Enron?
    Mr. Musuraca. He basically made similar comments that both 
he and Mr. Harrison made today, that Alliance was as much a 
victim as were large institutional investors who lost money in 
their index funds. Their due diligence did not produce evidence 
of the lies and deceit that were involved in Enron's case, and 
they kept investing thinking that they were buying a relatively 
sound company as its price was going down.
    Senator Nelson. With your knowledge of pension funds, do 
you have any commentary on why you think Florida lost so much 
money while other plans did not?
    Mr. Musuraca. It's commentary, right?
    Senator Nelson. Commentary.
    Mr. Musuraca. I wasn't in the Florida boardroom. They 
obviously have made an asset allocation decision and then 
structured the asset investment in a way that I differ with. I 
was--our system is much more heavily indexed. What is striking 
to me, however, is that the trustees never seemed to get 
involved in the process. Mr. Herndon is a very well-respected 
and qualified individual. I have nothing but the utmost respect 
for him. But at some point, it's the trustees' decision to make 
when looking at the performance of the fund.
    And I come from a board that has 3 city-wide elected public 
officials: the mayor, the controller, and the public advocate. 
It also has 3 representatives of the workers. At any given 
time, from either side of the aisle, we can ask questions and 
take initiatives that I didn't see trustees at the SBA making. 
And that struck me, even here today.
    I've had to defend to members of my system the losses that 
we suffered. It just seems that one would expect the same.
    Senator Nelson. That's well stated. And you'll remember 
that Mr. Herndon also said, in response to my question whether 
you ought to insulate trustees from raising money from people 
that have business before the SBA--he said he thought that 
would be a good reform, as well, just like it is that some of 
those same trustees that sit as the Florida cabinet sitting as 
the Division of Bond Finance are prohibited by law from raising 
money in their campaigns from bond firms.
    Mr. Musuraca. I would tend to agree with Mr. Herndon's 
final comment, that it is something that should be regulated 
and prohibited.
    Senator Nelson. Mr. Plunkett, you've been so gracious in 
your comments about Jean Carnahan's and my bill. Given the fact 
of practical politics, do you have any suggestions as we go 
forth, thus far, knowing that our bill is going to have an 
array of opponents who don't want to see reforms enacted. Have 
you got any suggestions of--that you'd share with the Committee 
of how we ought to approach it?
    Mr. Plunkett. Other than divine intervention?
    [Laughter.]
    Mr. Plunkett. Well, obviously, the major focus of your bill 
is--has proven to be, in both houses, the most controversial 
approach, because it is the approach the accounting industry, 
which is extremely powerful, opposes. And that is a real ban on 
consulting services, virtually all consulting services, in the 
same year that an audit is done for a particular client. So 
other than working with obvious allies who support that 
approach, like the Council of Institutional Investors and 
consumer groups, and all together doing our best to educate 
members over here, starting with the banking committee--and 
we're doing meetings on that as we speak--I don't have any 
pearls of wisdom.
    Our point that we keep making is if you can't assure the 
independence of the audit, why bother? And any--you know, I'll 
go back to Mr. Glassman's comments--any child or fool can see 
that there is a conflict of interest if, on average, firms are 
receiving two to three times more in consulting fees than they 
are in auditing fees. And if you don't go at the heart of that 
problem, you don't solve it.
    Senator Nelson. You know, I'm usually an optimist, and I 
still am, although sobered sometimes, but I really believe that 
there is so much agitations out there in America over this 
Enron situation that we ought to have a decent shot of passing 
the legislation that will contain the part of separating the 
auditing from the consulting functions. And if we don't, shame 
on us for special interests preventing that from occurring, 
because that clearly is a reform that has come out of this 
whole debacle of which we have only examined one little part of 
it today, but a necessary part.
    Does the staff have any further questions? OK, thank you 
all for being so patient. It's almost 6 o'clock.
    The meeting is adjourned.
    [Whereupon, at 5:55 p.m., the hearing was adjourned.]