FASB: Time to Define Cash-Balance Plans

Companies may find new rules much less attractive. Also: Inadequacies, but no ''rampant, criminal misconduct'' at Freddie Mac; former Ernst and Young partner arrested on Sarbox-related charges; and more.

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The Financial Accounting Standards Board is considering new rules that could wipe out the appeal of cash balance pension plans, according to published reports.

On Wednesday, according to Reuters, FASB spokeswoman Sheryl Thompson said that the accounting rule maker will add to its agenda a project aimed at defining cash balance pension plans and measuring obligations under those plans. “The board wants to nail down what a cash balance plan is,” Thompson told the wire service, “and to provide an accounting method that can be used consistently by companies.”

Cash balance plans promise employees a lump sum when they retire, based on their average salary over their years of employment.

FASB’s decision is a complete reversal from its position in May, Reuters pointed out, when the board backed away from a proposal to change how obligations under such plans are valued, in the face of major protests from a number of companies.

A FASB task force had initially recommended that companies use an interest rate tied to a market index, such as a one-year Treasury bill, to value liabilities under cash balance plans. As the wire service explained, however, companies and compensation consultants preferred to continue using the higher rates for high-quality, long-term corporate bonds; a switch would force companies to report increases in pension liability on their balance sheets.

“There’s no two ways about it; the higher the liability, the less you’re going to want to do it,” Eric P. Lofgren, global director of the benefits consulting group at Watson Wyatt Worldwide, told The New York Times. Lofgren estimated that some companies’ pension obligations could jump as much as 20 percent if the changes were adopted, which, in turn, would reduce reported earnings.

Cash balance plans began to catch on in the 1980s since they result in lower overall pension costs, and since they appeal to younger employees who tend to change jobs more frequently. Reuters, citing a survey by Buck Consultants, noted that about 20 percent of companies in the Fortune 500 now offer cash balance plans.

Last month, a federal judge ruled that IBM’s cash balance pension plan discriminated against older employees. Under traditional pension plans, the retirement benefits of workers increase at a much faster rate during their last years of service because workers generally make more money near the end of their careers. The big criticism of cash-balance plans is that if such plans are instituted right as experienced workers approach retirement age, companies will deprive those employees of anticipated gains and leave them without enough working years to accrue equivalent cash balance benefits.

(See also CFO magazine’s recent article that examined how special retirement plans for top executives are becoming a target for other stakeholders.)

Inadequacies, but No ”Rampant, Criminal Misconduct” at Freddie Mac

James R. Doty, the former SEC general counsel who investigated accounting failures at Freddie Mac, said Thursday that his investigation did not reveal “rampant, criminal misconduct” at the mortgage giant, according to Dow Jones.

“It is important at the outset to say what we did not find,” Doty said in prepared remarks for a hearing of a House Energy and Commerce subcommittee examining Freddie Mac’s accounting failures. “There was no indication that the company was creating fictitious profits. Nothing we have found calls into question the fundamental financial safety and soundness of the company.”

“While we found misapplication of accounting principles, our investigation did not reveal rampant, criminal misconduct, misappropriation of corporate funds for personal gain or other types of intentional wrongdoing that have characterized recent scandals,” Doty added.

Doty blamed the accounting errors on inadequacies of corporate accounting relating to the firm’s derivatives activities.

Another witness before the House subcommittee, Prof. Baruch Lev of NYU’s Stern School of Business, was much more critical of Freddie Mac, reported Dow Jones. “I don’t believe that such elaborate schemes over an extended period of time were benign,” he said, adding that the Freddie Mac case exposes “fundamental deficiencies, fundamental weaknesses in the accounting system.”

In January, the mortgage company said it would restate earnings for 2000, 2001, and possibly 2002. In June, Freddie Mac’s board sacked its president and switched CFOs. On Thursday, the company announced that it will delay the release of its restated financials, originally expected by September 30, until November.

When the mortgage company does finally issue the restatement, it could exceed $4.5 billion, the upper end of the previously announced range.

“This delay does not result from new accounting errors,” said Martin F. Baumann, executive vice president-finance and chief financial officer, in a statement. “As part of the final review of one of the categories identified in our June 25 announcement — asset transfers and securitizations — our control procedures uncovered the need for computer system modifications, additional data processing and validation of the results. This additional work is essential to ensure our financial results are right.”

The company reiterated that all of the accounting corrections expected to be addressed in the restatement fall into the same five categories identified in its June 25 announcement: security classification, accounting for derivative instruments, asset transfers and securitizations, valuation of financial instruments, and “all other corrections.”

(Read CFO magazine’s recent article that asks whether credit derivatives will encourage more lending or harm the interests of borrowers.)

Former E&Y Partner Arrested on Sarbox-Related Charges

The FBI arrested a former partner of Ernst & Young for allegedly altering and destroying audit working papers related to online credit group NextCard Inc.

Government officials said this is one of the first cases of document destruction brought under the Sarbanes-Oxley Act.

Thomas C. Trauger faces criminal charges for obstructing investigations by both the Office of the Comptroller of the Currency (OCC) and the Securities and Exchange Commission. In addition, the SEC instituted two administrative proceedings — an unsettled proceeding against Trauger and former E&Y audit manager Michael Mullen, and a separate settled proceeding against Oliver Flanagan, a former senior manager at the firm.

The complaint against Trauger, a former partner in Ernst and Young’s San Francisco office, contains one count charging him with obstructing the examination of a financial institution and a second count charging falsification of records in a federal investigation in violation of Sarbanes-Oxley. The charges follow a guilty plea by Flanagan to one count of obstructing the examination of a financial institution.

In a separate administrative proceeding, the SEC’s Division of Enforcement alleged that Trauger and Mullen engaged in unethical and improper professional conduct as a result of their alleged alteration and destruction of documents. The SEC also instituted a settled administrative proceeding against Flanagan for his role in the alleged document destruction.

According to the allegations in the criminal and civil actions, Trauger, assisted by Flanagan and Mullen, began to alter and destroy copies of working papers related to E&Y’s audit work for its client NextCard Inc., a San Francisco-based issuer of credit cards over the Internet. The document destruction allegedly occurred after the working papers had been completed and during an OCC examination of NextCard’s banking subsidiary, NextBank.

The bulk of the destruction of documents allegedly followed an October 31, 2001, announcement by NextCard that the OCC and the Federal Deposit Insurance Corp. would require NextBank to revise certain accounting assumptions, which would in turn cause the bank to be severely undercapitalized under federal banking regulations.

According to an affidavit filed by an FBI agent in support of the criminal complaint, Trauger destroyed, altered, and falsified both hard and electronic copies of working papers related to E&Y’s audit of NextCard’s financial statements for its fiscal year ended December 31, 2000, and E&Y’s review of NextCard’s financial statements for quarters ending March 31, 2001, and June 30, 2001.

The complaint also alleges that between approximately March 2002 and April 2002, Trauger assisted in the collection and production of altered working papers to the OCC, in response to a subpoena addressed to Trauger.

Finally, the complaint alleges that in April 2003, Trauger gave sworn testimony to the SEC related to NextCard, where he allegedly concealed his alteration and destruction of documents when questioned about his role in the production of E&Y’s audit working papers to the OCC.

“This is a bellwether day for the Corporate Fraud Task Force,” said Robert McCallum, chairman of the President’s Corporate Fraud Task Force and acting deputy attorney general, in a statement. “Today’s actions mark one of the first instances in which prosecutors have been able to use an important weapon in the fight against corporate fraud given to us by Congress under the Sarbanes-Oxley Act of 2002 — the ability to prosecute those who would seek to destroy, alter or falsify financial information and records. Today’s plea and arrest should remind accountants and lawyers not only of their commitment to represent their clients professionally, but also of our strong commitment to enforcing the law.”

For the charge of obstructing the examination of a financial institution, Trauger faces a maximum penalty of five years in prison and a fine of $250,000. For the charge of falsification of records in a federal investigation — the charge brought under Sarbanes-Oxley — he faces a maximum penalty of 20 years in prison and a fine of $250,000.

Short Takes

  • H. Carl McCall announced that he is resigning from the board of the New York Stock Exchange. “I have brought about some significant reforms,” he said in an interview on Thursday, adding that, now, “I think I should get out of John’s way.”

“John” is John S. Reed, who was named interim NYSE chairman, succeeding Richard Grasso. According to The New York Times, McCall’s last day will be Monday, and Reed will assume his duties on Tuesday.

  • Enron Corp. filed a complaint against six of its former banks, alleging they gave poor advice that contributed to the energy company’s downfall, according to The Wall Street Journal, citing a court filing. The complaint names Merrill Lynch & Co., Citigroup Inc., J.P. Morgan Chase & Co., Deutsche Bank AG, Barclays Plc, Canadian Imperial Bank of Commerce, and subsidiaries and affiliates of those companies, according to the paper.
  • Bucking a recent trend, Eastman Kodak Co. slashed its dividend more than 72 percent, the first such reduction in its history. The company cited the need for “financial flexibility.”
  • The New York Stock Exchange hired Sullivan & Cromwell Chairman H. Rodgin Cohen to provide legal advice in severance negotiations with Richard Grasso and may reduce the role of its chief corporate governance lawyer Martin Lipton, according to Bloomberg.
  • Qwest Communications International Inc. announced that it received an extension for reporting its restated financials, from September 30 until November 30. This is the embattled telecom’s third delay, according to reports.

Qwest added that it can delay reporting its financials for the first and second quarter of 2003 until as late as December 31.

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