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Casey: PA Should Not Do Business With Companies That Violate Securities Laws; Auditor General Takes Third Step to Protect Pennsylvania Investors And Billions in State Investments.

HARRISBURG, Pa. -- Auditor General Robert P. Casey, Jr. has called on Governor Mark Schweiker to strengthen Pennsylvania's Contractor Responsibility Program (CRP) to provide for the debarment or suspension of any state contractor that violates federal or state securities laws. Casey would also deny state work to any company that engages in accounting fraud, misstates its earnings or issues erroneous financial statements.

"Each year the Commonwealth of Pennsylvania spends billions of dollars contracting for goods and services from private sector contractors," Casey said in a July 25th letter to the Governor. "It is imperative that the Governor take action immediately to ensure that companies engaging in unethical accounting practices are not enriched with taxpayer dollars."

Casey's department is currently conducting an audit of the CRP, which was established in 1990 as a tool to ensure that the Commonwealth contracts only with responsible, capable and law-abiding companies. Casey said he did not want to wait until the audit's completion before expressing his concern that the broad list of violations that can disqualify state contractors does not contain a specific reference to violations of securities laws.

"The prudent expenditure of public dollars requires that the Commonwealth procure goods and services only from qualified contractors who conduct their business ethically and consistent with existing laws and regulations," Casey said.

In addition to recommending that the Governor strengthen the CRP's ability to debar or suspend unethical companies, Casey's audit will also recommend additional steps that the Commonwealth should take prior to awarding state contracts to ensure that only ethical businesses receive work funded by the taxpayers.

Casey's recommendations for the CRP come on the heels of two other actions in recent weeks to protect Pennsylvania investors and billions of dollars in state investments.

Last month, Casey invited Governor Schweiker and State Treasurer Barbara Hafer to join him in developing a new state policy that would require financial firms to adopt certain ethical and disclosure standards as a pre- condition to being considered to underwrite Commonwealth debt. A meeting between the three state offices is scheduled for August 8.

Casey said that using the Commonwealth's position as a consumer of public financial services in this way would protect Pennsylvania investors and billions of dollars in state investments from conflicts of interest that may arise when financial firms provide both investment advice and corporate investment banking services.

"I believe we must do everything we can in state government to curb future abuses in the financial markets and restore investor confidence in our financial system," said Casey, who, along with the Governor and the Treasurer, issues Commonwealth debt.

"I am hopeful that we can use our power as a consumer of investment banking services to ensure that financial firms underwriting Commonwealth debt adhere to the highest standards of ethics and disclosure in providing services to their investment advisory clients," Casey said.

In another effort to protect state taxpayer and retirement funds, Casey last month also wrote to the heads of Pennsylvania's three public pension plans to ask that they consider adopting requirements for the money management firms retained by their respective state investment officers.

"Certain requirements, properly applied, could provide an additional level of protection against potential conflicts of interest which may taint investment recommendations and decisions made by money managers doing business with the pension funds," Casey said. "Given the present climate of corporate malfeasance and accounting scandals, this will send a strong message to investment advisors and money management firms that if they wish to play a role in managing the pension funds supporting retired Pennsylvania teachers and government employees, they will be expected to adhere to the highest of ethical standards."
 Copies of Casey's three recent letters are attached.
 July 25, 2002
 The Honorable Mark J. Schweiker
 Governor
 Commonwealth of Pennsylvania
 225 Main Capitol Building
 Harrisburg, Pennsylvania 17120
 Dear Governor Schweiker:


Two weeks ago, I wrote to you and Treasurer Hafer recommending we require financial firms to adopt certain ethical and disclosure standards as a pre- condition to being considered to underwrite Commonwealth debt. By using the Commonwealth's position as a consumer of public financial services in this way, we will be doing our part as state officials to help protect Pennsylvania investors and billions of dollars in state investments from conflicts of interest which may arise when financial firms provide both investment analysis and corporate investment banking services. However, I believe our role as a consumer should not end there.

Each year the Commonwealth of Pennsylvania spends billions of dollars contracting for goods and services from private-sector contractors. Many of the companies receiving the largest contracts are large publicly traded multi- national companies, at least one of which is under criminal investigation for engaging in serious financial reporting improprieties. The prudent expenditure of public dollars requires that the Commonwealth's procurement process result in the selection of qualified and responsible contractors, who not only have the capability to perform the contract but who also are conducting their businesses ethically and consistent with existing laws and regulations. Just as in the investment banking context, the Commonwealth has the leverage as a consumer to choose to procure goods and services only from those companies who maintain high standards for ethics and integrity, especially as it pertains to accurate and ethical financial reporting.

The Commonwealth's Contractor Responsibility Program (CRP), established in 1990, is an essential tool to ensure the Commonwealth only contracts with responsible, capable, and law-abiding entities. In this regard, the CRP provides for the debarment or suspension of contractors that violate state and federal law in many different ways. Since its inception, the CRP has contained a broad list of such violations (see Management Directive 215.9 Amended, Section 7(k)), ranging from anti-trust to employment discrimination. There is an oblique reference in the list to acts or omissions indicating a lack of business integrity and honesty. However, under the current Management Directive there is no specific reference to the debarment or suspension of any contractor that has violated federal or state securities laws, or that has otherwise been found to have engaged in accounting fraud, misstatement of its earnings, or issuance of erroneous financial statements.

In view of the rampant financial and accounting improprieties reported in the press the last few months, I feel it is imperative a more definitive provision be added to the CRP. Doing so would put contractors interested in obtaining state contracts on notice of the importance of accurate financial reporting, as well as provide clearer direction to state officials charged with implementing the CRP.

Our department is currently auditing the CRP program. We intend to include a recommendation that your administration add such language debarring or suspending companies that engage in financial reporting fraud or other reporting irregularities. However, in light of the recent public disclosure of various instances of accounting fraud at several large public companies -- several of which have large public sector contracts -- I feel it is critical your administration adopt this additional CRP language now. By doing so, you will ensure that companies engaging in such unethical behavior are not enriched with taxpayer dollars.

In our audit, we also intend to recommend additional due diligence steps for the Commonwealth to implement prior to awarding a state contract to ensure it only contracts with law abiding and ethical entities. In the meantime, we urge you to amend the Contractor Responsibility Program now to close the loophole referred to above.
 Sincerely,
 /s/ Robert P. Casey, Jr.
 Robert P. Casey, Jr.
 Auditor General
 July 19, 2002
 The Honorable Barbara Hafer
 Chair Mr. Nicholas J. Maiale
 Public School Employees' Retirement Chair
 System State Employees' Retirement System
 5 North Fifth Street 30 North Third Street
 Post Office Box 125 Post Office Box 1147
 Harrisburg, Pennsylvania 17108-0125 Harrisburg, Pennsylvania 17108-1147
 Mr. George E. Gift, Jr.
 Chair
 Pennsylvania Municipal Retirement System
 Eastgate Building, Suite 301
 1010 North Seventh Street
 Post Office Box 1165
 Harrisburg, Pennsylvania 17108-1165
 Dear Chairpersons Hafer, Maiale and Gift:


As you well know, recent corporate accounting abuses at companies such as Enron and WorldCom, as well as allegations of tainted investment advice given by firms such as Merrill Lynch, have shaken investor confidence and eroded the integrity of our national financial markets.

Recently, I asked Governor Schweiker and Treasurer Hafer to join with me -- as officials responsible for issuing Commonwealth debt -- in adopting initiatives to protect Pennsylvania investors and billions of dollars in state investments from conflicts of interest which may develop when financial firms provide both investment analysis and corporate investment banking services. As issuing officials, we can use Pennsylvania's position as a substantial client of financial firms underwriting Commonwealth debt to demand that these firms maintain proper separation between their corporate investment banking activities and the investment analysis and management services they provide to individual and institutional investment clients.

Specifically, I proposed that, in selecting firms to manage the issuance of Commonwealth debt, Pennsylvania adopt a standard such as the "Merrill Lynch principles" adopted by the State Treasurer of North Carolina, the Comptroller of the State of New York, and the State Treasurer of California on July 1, 2002. As embodied in the agreement between Merrill Lynch and New York State Attorney General Eliot Spitzer dated May 21, 2002, the "Merrill Lynch principles" are outlined as follows:
 -- Sever the link between compensation for analysts and investment
 banking;
 -- Prohibit investment banking input into analyst compensation;
 -- Create a review committee to approve all research recommendations;
 -- Require that upon discontinuation of research coverage of a company,
 firms will disclose the coverage termination and the rationale for
 such termination;
 -- Disclose in research reports whether the firm has received or is
 entitled to receive any compensation from a covered company over the
 past 12 months; and
 -- Establish a monitoring process to ensure compliance with the
 principles.


As fiduciaries of public pension plans responsible for billions of dollars in retirement funds, I am sure that you are working diligently to ensure the investment advice these plans receive is untainted by any potential conflicts of interest. Additionally, because the pension plans you oversee are substantial clients of investment advisors and money management firms, you are in a position to aid investors throughout Pennsylvania by ensuring that advice these firms provide to individual investors is free of any potential conflicts of interest. For example, many money management firms that handle investments for public pension funds also handle investments for corporate pension plans and 401(k) plans. This creates a potential conflict of interest, because the money managers may feel pressured to add the stocks of their corporate clients into the public pension fund portfolios, even if it is not in the best interest of the pension funds. Similarly, money manager research analysts may be reluctant to provide objective research advice, knowing that adverse recommendations may cause their firms to lose corporate clients. Other potential conflicts of interest exist with respect to those money management firms that are subsidiaries of investment banking firms.

In order to protect their state taxpayer and retirement funds, on July 2, 2002, North Carolina, New York and California, including the North Carolina Public Employees Retirement Systems and the New York State Common Retirement Fund, adopted the following requirements for money management firms retained by their respective state investment officers:
 1. Money management firms must disclose periodically any client
 relationship, including management of corporate 401(k) plans, where the
 money management firm could invest state or pension fund moneys in the
 securities of the client.
 2. Money management firms must disclose annually the manner in which their
 portfolio managers and research analysts are compensated, including but
 not limited to any compensation resulting from the solicitation or
 acquisition of new clients or the retention of existing clients.
 3. Money management firms shall report quarterly the amount of commissions
 paid to broker-dealers, and the percentage of commissions paid to
 broker-dealers that have publicly announced that they have adopted the
 Investment Protection Principles.(1)
 4. Money management firms affiliated with banks, investment banks,
 insurance companies or other financial services corporations shall
 adopt safeguards to ensure that client relationships of any affiliate
 company do not influence investment decisions of the money management
 firm. Each money management firm shall provide the state investment
 officers with a copy of the safeguards plan and shall certify annually
 to the state investment officers that such plan is being fully
 enforced.
 5. In making investment decisions, money management firms must consider
 the quality and integrity of the subject company's accounting and
 financial data, including its 10-K, 10-Q and other pubic filings and
 statements, as well as whether the company's outside auditors also
 provide consulting or other services to the company.
 6. In deciding whether to invest state or pension fund moneys in a
 company, money management firms must consider the corporate governance
 policies and practices of the subject company.
 7. The principles set forth in paragraphs five and six are designed to
 assure that in making investment decisions, the money management firms
 give specific consideration to the subject information and are not
 intended to preclude or require investment in any particular company.
 (1) Referred to above as the "Merrill Lynch principles."


I am writing to you today to ask you to consider similar requirements on the money management firms that do business with your pension funds. I understand that these firms are already subject to various fiduciary requirements pursuant to state law and contractual agreements, and it is not my intention to suggest that the requirements delineated above supplant or diminish any existing responsibilities placed on these firms. Additionally, I understand that some of the requirements listed above may have limited application to certain types of asset managers such as those managing indexed portfolios or hedge funds. At the same time, I believe that these requirements, properly applied, could provide an additional level of protection against potential conflicts of interest which may taint investment recommendations and decisions made by money managers doing business with the funds.

Given the present climate of corporate malfeasance and accounting scandals, your leadership in establishing stronger investor protections such as those embodied in the principles and requirements cited above will send a message to investment advisors and money management firms that if they wish to play a role in managing the pension funds supporting retired Pennsylvania teachers and government employees, they will be expected to adhere to the highest of ethical standards.
 Sincerely,
 /s/ Robert P. Casey, Jr.
 Robert P. Casey, Jr.
 Auditor General
 July 11, 2002
 The Honorable Mark J. Schweiker
 Governor
 Commonwealth of Pennsylvania
 225 Main Capitol Building
 Harrisburg, Pennsylvania 17120
 The Honorable Barbara Hafer
 Treasurer
 Commonwealth of Pennsylvania
 129 Finance Building
 Harrisburg, Pennsylvania 17120
 Dear Governor Schweiker and Treasurer Hafer:


As you know, financial reporting irregularities at companies such as Enron and WorldCom, as well as allegations of tainted investment advice given by firms such as Merrill Lynch, continue to erode investor confidence and call into question the integrity of our national financial markets. In our joint roles as issuers of Commonwealth debt, we are uniquely situated to adopt initiatives to protect Pennsylvania investors and billions of dollars in state investments from the devastating effects of conflicts of interest which may develop when financial firms provide both investment advice and investment banking services.

On July 1, 2002, the State Treasurer of North Carolina, the Comptroller of the State of New York, and the State Treasurer of California announced that every provider of investment banking services retained or utilized by their states should adopt the terms of the agreement between Merrill Lynch and New York State Attorney General Eliot Spitzer dated May 21, 2002. As embodied in the agreement between New York, California and North Carolina, the "Merrill Lynch principles" are outlined as follows:
 -- Sever the link between compensation for analysts and investment
 banking;
 -- Prohibit investment banking input into analyst compensation;
 -- Create a review committee to approve all research recommendations;
 -- Require that upon discontinuation of research coverage of a company,
 firms will disclose the coverage termination and the rationale for such
 termination;
 -- Disclose in research reports whether the firm has received or is
 entitled to receive any compensation from a covered company over the
 past 12 months; and
 -- Establish a monitoring process to ensure compliance with the
 principles.


I am writing to you today to ask you to join me in developing a similar policy regarding the issuance of Commonwealth debt that would enable us to use our power as a consumer of investment banking services to ensure that financial firms underwriting Commonwealth debt adhere to the highest standards of ethics and disclosure in providing services to their investment advisory clients. Put simply, our message to financial firms should be if you want to do business with the Commonwealth of Pennsylvania we demand that you adopt and follow such standards in your dealings with individual and institutional investors.

At a minimum, I am proposing that Pennsylvania require that investment banking firms involved in the underwriting of Commonwealth debt adhere to the "Merrill Lynch principles" limiting the influence their investment bankers may have over their securities research analysts.

As more and more information about troubled corporations and unethical corporate policies emerges, I believe we must act immediately to do our part in state government to curb future abuses in the financial markets and restore investor confidence in our financial system. I think it is important that we work together on this initiative. Toward that end, I have asked Richard Spiegelman, this Department's Chief of Staff/Chief Counsel, to contact appropriate members of your respective staffs.
 Sincerely,
 /s/ Robert P. Casey, Jr.
 Robert P. Casey, Jr.
 Auditor General


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