WASHINGTON -- Rep. Edward Markey, D-Mass. has asked the SEC if it would consider requiring major derivatives dealers and users to set up independent audit committees and to report on the adequacy of their internal controls for derivatives.
Markey, who chairs the House Energy and Commerce Committee's subcommittee on telecommunications and finance, grilled the Securities and Exchange Commission on its position on audit committees and internal controls reporting in an eightpage letter that was sent to SEC chairman Arthur Levitt last week.
The letter follows a recent hearing in which Levitt testified that the SEC has encouraged companies to establish audit committees and to file reports on their internal controls, but opposes mandatory requirements such as those proposed by the General Accounting Office in its recent derivatives report.
Levitt told the subcommittee that an audit committee requirement could be a problem for a small local company that might be unable to find qualified outside individuals willing to participate on such a committee.
But Markey pointed out, in his letter to Levitt, that the GAO report recommends that audit committees and internal controls reporting requirements be established for major derivatives dealers and users, not small companies.
Markey asked Levitt if the SEC might support the idea of imposing such requirements only on those dealers and end user companies that are major derivatives players.
"In other words, is it possible for the commission to identify thresholds for when audit committees and internal control reporting should be required with respect to derivatives?" Markey asked.
Markey told Levitt that the purpose of the letter was to "carefully assess" the GAO's recommendations and to "fully understand" the underlying basis for the SEC's opposition to them "in light of the strong leadership role the commission has historically taken on the issues of audit committees and internal controls."
The SEC has worked with self-regulatory organizations to require companies listed on exchanges to have audit committees, Levitt told the subcommittee at the hearing last month.
The commission has also twice proposed requirements that registered companies report on the effectiveness of their internal controls, Levitt said at the hearing. But these proposals were withdrawn either because the companies opposed them or volunteered to take some initiatives in this area, he said.
Markey asked Levitt in the letter how these past SEC proposed requirements differ from the GAO's current recommendation to require reporting on internal controls from registered companies involved in derivatives.
He also asked the SEC chairman for detailed information about the past proposed requirements. One was proposed in the 1970s and withdrawn in the 1980s. The other was proposed in 1988 and withdrawn in 1992, the letter said.
Markey requested copies of the proposed requirements and all related internal memorandums, correspondence, public comments, and other documents.
He also asked the SEC to describe the voluntary private sector initiatives that were undertaken by companies and how they would compare with a new mandatory reporting requirement.
The letter asked Levitt to explain some of the statements he made about the GAO's recommendations at the hearing last month.
The GAO's report, for example, suggested that derivatives participants would develop, and be held accountable for, stronger derivatives risk management systems if they were made to document them and report on their effectiveness, Markey said.
But Levitt told the subcommittee at the hearing: "It is unclear why or how the management of a registrant will understand better the risks inherent in derivative and cash instruments" if it is required to publicly report on the effectiveness of its internal controls.
"Please explain why the commission believes that these benefits are unlikely to accrue in this case," Markey said in the letter.
Levitt said at the bearing that investment companies, broker-dealers, and transfer agents are already required to file with the SEC reports from independent auditors that deal with inadequacies in their accounting systems, internal accounting controls, and procedures for safeguarding assets.
Markey asked Levitt how the SEC uses these filings and whether they have ever resulted in investigations or enforcement actions.
He also asked Levitt whether the recent events at Kidder, Peabody & Co. in New York have led the SEC to consider revising its filing requirements to better detect accounting problems. Kidder, in recent weeks, dismissed employees for allegedly hiding losses from a bond-related derivatives transaction and creating phantom trades and profits in the government strips market to inflate earnings.
Levitt also said at the hearing that the Foreign Corrupt Practices Act amended securities laws to require companies registered with the SEC to devise and maintain a system of internal accounting controls.
Markey asked the SEC for information about company compliance with these provisions, including a summary of all enforcement actions that the SEC or self-regulatory organizations have brought during the last five years for violations of the provisions.
Markey asked Levitt to provide the subcommittee with all of this information by Aug. 5, thirty working days after the request was made.
