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FASB Slowly Coming Back to Life

After scads of scandals, standards board takes a peek in the mirror. Also: Fed governor slams accounting industry; SEC probing Schering-Plough for Reg FD violations; and more.
Stephen Taub, | US
October 9, 2002

One year after Enron finally unraveled, touching off scores of scandals, restatements, and indictments, the Financial Accounting Standards Board is slowly showing signs of life.

FASB is looking to change a number of long-standing practices, Bob Herz, the chairman of the rulemaking body, told Reuters yesterday. "We've been looking top to bottom at virtually everything we do, " he said.

FASB wants to put together a new advisory group comprised of representatives from top mutual fund companies and the biggest Wall Street companies, says Herz, who became chairman back in July. The group will offer advice on a number of the board's projects.

In fact, FASB has already received nominations for the group after sending out letters to the CEOs of the top 25 financial-services companies, Herz added.

The chairman also says FASB plans to play a more active role in its Emerging Issues Task Force, which consists of members from corporations and accounting firms and looks at pressing accounting issues.

Herz noted that it's important to have representatives from people who work at corporations and accounting firms, since they're able to deal with real-world issues.

"It's inevitable that if you believe you need those kind of people at the table that some or all of the issues discussed are going to touch upon things that they do, " Herz told Reuters. "But I'm very sensitive to the perception and potential fact of conflict of interests. "

The result is that FASB's board plans to play a role in setting the agenda at the group and have a final say on rules it institutes, Herz said.

Fed Governor Blasts Accounting Industry

Herz's public promise to play a more aggressive role came the same day that Susan Bies, a Federal Reserve governor, blamed the U.S. accounting industry for not doing enough to restore badly shaken investor confidence.

"One of the things I find the saddest in this whole episode is that the groups who should be leading the charge to strengthen the focus of their responsibility, namely the outside and internal accounting and auditing profession, have generally been very silent, " Bies told wire services in response to questions after a speech on corporate governance.

Bies singled out the American Institute of Certified Public Accountants (AICPA) and said the work of accountants was "the core foundation of the American capitalist system."

"The whole AICPA profession is just focused on cross-selling, cross-selling, cross-selling, and not the core values," Bies reportedly said. "And until we get back to the core values, I worry about how we're going to restore confidence. "

Speaking at the Annual International Symposium on Derivatives and Risk Management at Fordham University School of Law, Bies said "governance involves many players, each with specific assigned responsibilities to ensure that the system as a whole is sufficient to support the business strategy and ensure the effectiveness of the systems of internal control. "

On this point, she criticized corporate boards of directors for failing to hire honest executives. "They also have the responsibility to hire individuals who they believe have integrity and can exercise a high level of judgment and competence," she added. "Directors have the further responsibility to periodically determine whether their initial assessment of management's integrity was correct."

Bies added that boards of directors and managers of all firms should periodically test where they stand on ethical business practices. She said they should ask questions like: "Are we getting by on technicalities, adhering to the letter but not the spirit of the law? Are we compensating ourselves and others on the basis of contribution, or are we taking advantage of our positions?"

"Boards of directors are responsible for ensuring that their organizations have an effective audit process and that internal controls are adequate for the nature and scope of their businesses," she added. "The reporting lines of the internal audit function should be such that the information that directors receive is impartial and not unduly influenced by management. Internal audit is a key element of management's responsibility to validate the strength of internal controls."

Bies went on to say that internal controls are the responsibility of line management. She added that it's up to line managers to determine the levels of risk they need to accept to run their businesses and to assure themselves that the combination of earnings, capital, and internal controls is enough to compensate for the risk exposures.

Supporting functions such as accounting, internal audit, risk management, credit review, compliance, and legal should independently monitor the control processes to ensure that they are effective and that risks are measured appropriately, Bies added. She said the results of these independent reviews should be routinely reported to executive management and boards of directors, who in turn should be sufficiently engaged in the process to determine whether these reviews are in fact independent of the operating areas under review and whether the officers conducting the reviews can, indeed, speak freely.

"In many of the recent corporate and audit firm failures that have received public attention, basic tenets of internal control, particularly those pertaining to operating risks, were not followed," she added. "Recent events should remind boards of directors, management, and auditors that internal controls and sound governance become even more important when firms' operations move into higher-risk areas."

Did Schering-Plough Violate Reg FD?
Now it's Schering-Plough's turn to tell it to the Feds.

The pharmaceutical company said it is being investigated by the Securities and Exchange Commission for possible violations of Regulation Fair Disclosure (Reg FD).

The company said it received a request from the regulatory agency for information relating to its meetings with investors and other communications last week, adding it "welcomes the opportunity to cooperate with the commission in answering any questions."

Last Thursday, Schering-Plough issued an earnings warning after its stock dropped 20 percent in a three-day period. "It seems pretty darn clear that someone knew something about Schering-Plough and sold their position," Tim Anderson, an analyst at Prudential Securities, told Reuters last week.

This is why investors and obviously the SEC are questioning Schering-Plough:

If anything, it sure doesn't pass the smell test.

Tyco Files Arbitration Claim Against Swartz
It's official.

As we anticipated yesterday, Tyco International Ltd. Tuesday filed an arbitration request against Mark H. Swartz, the company's former CFO and director, seeking repayment of tens of millions of dollars in severance and other compensation.

"The company alleges that Swartz breached his fiduciary duties and otherwise engaged in wrongful conduct relating to his employment by the company and misappropriated company funds and other assets," Tyco stated in an SEC filing.

Tyco said it is seeking to recover from Swartz all damages suffered by the company "as a result of such breach, wrongful conduct and misappropriation."

The arbitration demand was filed with the American Arbitration Association in New York City.

Swartz got $45 million from Tyco as part of a severance deal reached in August when company executives attempted to get him to resign. It was an arrangement that at the time was heavily criticized by Manhattan District Attorney Robert Morgenthau. Under the severance agreement between Tyco and Swartz, the conglomerate can't sue the former CFO, but must instead file any claim against him with an arbitrator, according to the report.

Bank Loans Are Deteriorating
The quality of large syndicated bank loans continued to deteriorate this year, but at a slower rate than in 2001, according to the 2002 Shared National Credit (SNC) review, released Tuesday by the Federal Reserve, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corp.

Total loan commitments classified as either substandard, doubtful, or loss rose in 2002 by $39.4 billion, or 34 percent, from the previous year, compared with a net increase of $54.3 billion, or 86 percent, the year before.

At the same time, commitments rated special mention rose $3.6 billion, or 5 percent, compared with $39.1 billion, or 108 percent, the year before.

Adversely rated credits are the total of loans classified substandard, doubtful, and loss, and loans rated special mention. Under the agencies' Uniform Loan Classification Standards, classified loans have well-defined weaknesses, including default in some cases, while special mention loans exhibit potential weaknesses, which may result in further deterioration if left uncorrected.

Deterioration since the middle of last year was largely driven by the pronounced problems in the telecommunications industry, alleged corporate fraud, weakness from the recent recession, and the aftereffects of September 11, according to the report.

And like last year, deterioration has been particularly evident for credits to leveraged and speculative-grade borrowers that are facing difficulty generating enough cash flow to service their debts because of overcapacity, weaker pricing, or slower-than-anticipated growth, according to the report.

Even so, a number of segments showed moderate improvement, with the professional, scientific, financial, insurance, and other service sectors showing lower classification levels relative to 2001.