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Report: SEC Nixes Telco Swap Shop

Revenues or barter? Reportedly, SEC goes with the latter; some telcos may have to restate. Plus: survey says directors getting tough, and AOL set to buy back stake from AT&T
Joseph Radigan, | US
August 20, 2002

The Securities and Exchange Commission has reportedly ruled invalid a controversial accounting strategy used by some telecommunications companies. The bookkeeping approach has enabled managers at telcos to justify deals where they appeared to merely trade access to each other's wires.

According to a story in The Washington Post, the American Institute of Certified Public Accountants has warned the SEC's ruling means any telco that relied on the rationale to boost revenue may be forced to restate its financial results.

At issue: deals in which telecom companies purchased and sold access to their networks with one another. In some cases, critics claim the deals represented little more than a swap of rights between one company and another.

When booked as a single transaction, the swaps represent no problem. But The Post reports that senior executives at several telcos embraced an interpretation of accounting rules that allowed them to treat the negotiations as two separate transactions. Hence, some companies apparently counted revenue from the sale of access right away -- but spread out the cost of buying access on another network over the life of the deal. In some cases, that spreading out extended over 25 years.

Federal regulators, members of Congress and others have been investigating the practice. In a memo dated Aug. 6, the AICPA made it clear that not all of the transactions at issue have necessarily been booked incorrectly. But the memo reportedly stated that a company's chief executive and chief financial officer "should be advised to give consideration to this matter prior to certifying the financial statements previously filed with the SEC."

The Post said the AICPA distributed the memo to the accounting community at the request of the SEC.

The new SEC policy comes as the agency steps up its examination of swap transactions to boost revenue in a variety of industries, including the energy and Internet sectors.

Now that the SEC has decided to rule on the issue, it's unclear if applying the new standards to actual transactions will be any easier, accounting industry executives told The Post.

The nearly dozen accounting experts interviewed agreed that reasonable people can reach differing, but equally plausible, interpretations of the generally accepted accounting rules that apply to sales of access rights. Some said the rules are fuzzy enough to allow broad leeway over whether these round-trip sales can be booked as revenue, or whether they amount to asset swaps that leave revenue unchanged.

Most of the transactions in question took place in 2000 and 2001, when a glut of fiber-optic capacity in the telecommunications industry drove down prices. Managers at some telcos found themselves under pressure to find new sources of revenue.

Accounting experts told The Post that many factors go into determining whether sales of capacity are really separate from each other -- not the least of which is whether either transaction would have occurred without the other. Another factor to be considered: whether the assets in a deal are similar in value.

"If it's a barter or non-monetary exchange, then it was accounted for improperly because it would not affect revenue," said an accounting and tax expert at a large investment-banking firm.

Still Waiting: SEC Yet To Approve Mirant, CMS Filings
After some early bumps, it appears the SEC will approve the lion's share of the certified statements filed by corporate CFOs and CEOs.

On Monday, regulators approved the certifications from AOL Time Warner Inc. and Bristol-Myers Squibb Co. Both of those companies are being investigated for accounting irregularities and initially did not get their filings approved.

But other corporations in the accounting hot seat -- like Mirant Corp. and CMS Energy Corp. -- weren't so lucky. Those two businesses are still lumped in the SEC's "All Others" category, meaning the commission's staff isn't ready to approve their executives' certifications.

Apparently, CMS is still trying to clean up its accounting for as much as $4 billion in suspect trades. But CMS isn't the only energy company that employed round-trip transactions. Enron Corp. and Dynegy Inc. also booked round-trip trades. The swaps reportedly enabled the companies to artificially inflate their revenue and help drive up wholesale energy costs. The trading strategy allegedly contributed to California's power crisis last year.

As for Mirant: management at that company is still trying to explain $85 million in overstated natural gas inventories. The Associated Press reported last week that the overstatement relates to accruals made in 1999, 2000, and 2001 in the company's risk management and marketing operations.

While Bristol-Myers' certification statements got the green light from the SEC, it's unclear if the company's accounting problems are behind it. Last week, Dow Jones Business News reported that the pharmaceuticals giant is being investigated by the SEC for encouraging wholesalers to overbuy drugs. The company has already announced that wholesaler buying may have inflated revenue by as much as $1.5 billion during 2000 and 2001.

For AOL, too, passage of the SEC certification test may not mean the media company's accounting woes are over. In fact, hardly a day goes by without the pressure being turned up a notch on AOL.

As reported last week, former AOL CFO Michael Kelly is still apparently being investigated. Based on the latest reports, the Justice Department (DOJ) may let the SEC take the lead in any possible prosecution.

That tack would probably make it easier for authorities to win a case against AOL, or current or former executives of AOL. Why? The threshold for a conviction in a civil trial is lower than in a criminal trial (the SEC is restricted to filing civil charges against publicly traded companies; criminal cases are handled by the DOJ).

Teams of investigators from both agencies are reported to be especially interested in round-trip deals entered into by David Colburn, who abruptly resigned as head of AOL's business affairs unit two weeks ago.

As of yet, no charges have been filed against AOL TimeWarner by the SEC or DOJ.

AOL Nears Deal with AT&T
Despite the ongoing investigations, AOL could be close to buying out AT&T Corp.'s stake in Time Warner Entertainment. According to Reuters, AOL plans to repurchase the stake by offering AT&T $9 billion in cash, AOL TimeWarner stock, and shares in the company's planned cable business.

The deal would give AOL Time Warner full ownership of Warner Bros. studios and the cable networks HBO, Court TV, and Comedy Central. It could also help bolster AOL's sagging stock price by showing investors the company's management is serious about cleaning house, Reuters reported.

But Reuters also stated that the two sides were still at odds over AOL's access to AT&T's cable networks. An announcement on that issue might not come for several more days. AT&T is reportedly selling its cable business to Comcast Corp.. It's uncertain whether AOL's access deal with AT&T would also include access to Comcast's networks.

Securing a tie-in to AT&T's network is crucial to AOL's Internet strategy. Such a move would give AOL a much-needed pipeline to provide high-speed digital service, as well as broadband delivery of Time Warner's cable offerings. It might also help convince cable operators that AOL is not an adversary, the Reuters said.

Under terms of the deal, AT&T would reportedly receive about $2 billion in cash, and about $1.5 billion in AOL common stock. In return, AT&T would fork over its 27.6 percent stake in Time Warner Entertainment, which includes the Warner Bros. film studio, most of Time Warner Cable, and the three cable TV networks.

AT&T also would get a more than 20 percent stake in a new cable TV business operated by AOL. That company, which would have about 9 million subscribers, would be spun off. According to Reuters, AT&T's 20 percent stake in the spin-off would be valued at about $5.5 billion.

A deal between AOL and AT&T would conclude more than two years of often contentious negotiations. For AT&T, the deal will help the phone company cut its debt load and strengthen its balance sheet as it prepares to sell its cable TV business, AT&T Broadband, to Comcast.

The sale of AT&T's stake in Time Warner Entertainment would generate about $5.8 billion to $6.5 billion in after-tax proceeds. That influx of cash would help the combined AT&T Comcast operation maintain investment-grade debt ratings, Reuters reported, citing research from an analyst at JP Morgan. To fund the Time Warner Entertainment purchase, AOL management would issue about 136 million shares of AOL common stock and use about $2 billion from the company's existing credit facilities

Survey: U.S. Directors Will Get Tough
The accounting scandals of the past year will have a lasting effect on corporate boards of directors -- both in the U.S. and overseas, according to a survey released Monday from PricewaterhouseCoopers and BSI Global Research Inc.

Some 75 percent of the 242 CFOs and managing directors in the United States and Western Europe responding to the survey said they believe their boards will be generally more assertive identifying and managing risk, supervising a company's business structure and transactions, and supporting auditor independence. Commenting on the survey, Richard Steinber, PwC's global corporate governance leader, said: "The pendulum is swinging toward increased board activism in a number of key areas."

Steinberg continued: "There are no universal requirements for audit committees, or for how often or how long they must meet. But even before the new legal, regulatory, and listing requirements were introduced, the well-publicized scandals elevated both the importance and visibility of the audit committee."

Nearly a third of the 145 U.S. executives surveyed said they would hold audit committee meetings more frequently. About the same percentage indicated they would have longer meetings, while 26 percent said they would have additional education of audit committee members. Around 15 percent of the respondents aid they would have changes in the audit committee's composition. Fifteen percent also said they would change their audit committee's charter.

Calling All Accountants
Thanks to Congress, the SEC is getting a 77 percent increase in its budget to help enforce all the new rules that have just been passed.

But Bloomberg News reports that the agency may be hard pressed to hire enough lawyers and accountants to handle all the extra investigations.

Part of the problem: there reportedly is still a huge pay gap between the pay of SEC staffers and their private sector counterparts.

For accountants, the difference is not so sizeable. SEC accountants typically make from $65,000 to $80,000 per year, or about $10,000 less than mid-level accountants in the private sector.

But SEC staff members with a law degree are really missing out on a big payday. Inside the agency, they're on roughly the same pay scale as the accountants. Out on the street, they can make $200,000 practicing securities law.

Short Takes

Apparently, Hare is unpopular with some of the Marconi's creditors, although the article did not explain why.

As it stands, Marconi's bondholders and banks appear to disagree on whether shareholders should get any new equity in the company. Reportedly, bondholders are expected to receive the bulk of the new equity, while bank lenders are trying to secure as much as possible of the estimated $2 billion in cash left on Marconi's balance sheet. Much of the cash is believed to be tied up in working capital and contingent liabilities, however.

As you know, the FDA had requested the recall of tendon and ligament tissue because the company could not ensure that they were free of bacteria and fungus.