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PwC Off the Hook for Tyco Audit, Says Story

Report says prosecutors won't indict PwC for failing to disclose that Kozlowski got $33 million bonus from Tyco. Plus: More bad news for Global Crossing, Danaher denies charges, and big investors say governance a yawn
Stephen Taub, | US
October 15, 2002

It looks like management at PricewaterhouseCoopers won't have to sweat out an investigation into the firm's audit of Tyco International.

A member of the Big Four accounting firm told Reuters the firm was assured that PwC—as well as individual auditors—will not be hit with criminal charges stemming from New York prosecutors' investigation into Tyco International.

According to Bloomberg, Manhattan District Attorney Robert Morgenthau was apparently considering leveling criminal charges against PwC auditors who were responsible for reviewing the compensation of former Tyco chief executive L. Dennis Kozlowski.

The big question all along has been whether PwC auditors broke the law when they failed to disclose that a proxy statement didn't include a $33 million bonus paid to Kozlowski.

John Moscow, the lead prosecutor on the case, told Reuters Monday that even though charges won't be brought against PwC at this time, the "investigation is continuing."

Meanwhile, published reports say PwC has assigned additional resources, including more accountants, to conduct its annual audit of Tyco. PwC spokesman David Nestor told the AP that his firm added the auditors several months ago at Tyco's request, and not in response to a widening investigation of Tyco's accounting.

"It's not a reaction to reports of earlier in the week," Nestor told the wire service.

New Global Crossing Probe
Federal prosecutors are investigating whether Global Crossing employees used suspect accounting to boost the company's cash flow in the first half of 2001 in a bid to avoid violating critical bank covenants, which could have triggered a multi-billion-dollar default, according to the Los Angeles Times.

Top company executives reportedly cashed out more than $147 million in stock during the period in question, according to the report. In May 2001 alone, five executives or directors reportedly dumped 11.5 million shares—including chairman Gary Winnick, who apparently cashed in more than $124 million in stock.

The paper said that internal documents and E-mails it obtained show that by May 2001, the telecom giant was very close to violating a key bank requirement. Breaking the covenant would have enabled Global Crossing's banks to demand the repayment of more than $2 billion in loans, triggering a default on $3.8 billion in notes.

Had this string of events unfolded, Global Crossing could have been forced to file for bankruptcy a number of months before it filed for Chapter 11 on January 28, according to the Times.

At the very least, a default would have restricted or reduced Global Crossing's access to credit and resulted in a lower credit rating and stock price.

The paper pointed out that while much attention has been paid to the fiber-optic capacity swaps Global Crossing forged with other telecom operators, the company undertook a number of smaller actions during the second quarter of 2001.

For example, Global Crossing reclassified an 11-year rental agreement on the company's Madison, New Jersey, office building from an operating lease to a capital lease, according to theTimes report, citing internal accounting documents. The paper noted that most standard office leases don't meet the required accounting criteria to be classified as anything but operating leases.

In fact, companies typically try to avoid capitalizing leases because doing so adds interest expense and depreciation and shows up as a liability on the books, the paper added.

For Global Crossing, the apparent switch increased the company's earnings before interest, taxes, depreciation, and amortization. That's because the lease change—made retroactive to January 1, 2001—converted six months of ordinary rent expenses into interest and depreciation expenses that remain outside the EBITDA calculation, the paper elaborated.

The upshot: Global Crossing was able to lift what it called "recurring adjusted EBITDA" by $1.38 million, plus an additional amount for six months' worth of depreciation, in the second quarter.

Although these alleged maneuvers reportedly affected the company's EBITDA by less than 1 percent, such small improvements can have a huge impact on meeting bank covenants.

"It immediately smacks of an attempted manipulation of the financial results," Carr Conway, a forensic accountant with Denver-based Dickerson Financial Investigation Group Inc., told the paper. "If you enter into a lease transaction, you make the determination at the inception of the lease. You don't change it midstream."

Eventually Global Crossing's lenders did force the company into bankruptcy, after reportedly granting a temporary waiver of the covenants in late 2001.

The Times article included excerpts of E-mail exchanges among finance executives.

In one apparently sent by chief financial officer Dan Cohrs dated May 12, 2001, and titled "Debt covenants and capacity sales," the CFO wrote that current projections for adjusted EBITDA indicate "that we will be tight on our bank covenant as we go through this year," according to the report. Cohrs added: "We need to make our numbers."

Four days later, Hank Millner, head of Global Crossing's structured finance department, apparently sent an E-mail to the top financial executives and the general counsel warning of "the very serious impact" if first-quarter numbers forced the company out of compliance with the banks, according to theTimes account.

Danaher Defends Accounting
On Monday, Danaher Corp., a maker of process and environmental controls and tools, issued a press release defending its accounting practices in response to a published report that questioned the quality of the company's earnings.

Danaher's share price dropped more than 7 percent on Monday—apparently due to the report. Monday speculated whether the industrial conglomerate used "acquisition adjustments" to artificially boost the company's earnings and cash flows.

The Web site also tried to explain big balance-sheet changes, suggesting that they reflect "substantial amounts of merger-related costs that Danaher may not have adequately disclosed." The manipulation of an acquisition's assets and liabilities to create phantom profits is known as "spring-loading."

In response to the story, Danaher management said: "Danaher does not spring-load its earnings and cash flows in any way."

The company's management said it does not write down assets of acquired businesses to create artificial profits. "Such write-downs are not permitted under purchase accounting principles," Danaher's management noted in its statement. "Danaher complies with the letter and spirit of these and all other generally accepted accounting principles."

(Editor's note: Danaher fares very well in cost management compared with its industry peers, according to the CFO PeerMetrix interactive scorecards.)

CFO Sentenced for Embezzlement
In what has become a near weekly event, a federal judge has sent yet another former CFO to prison. This time, Gary Schultz, a longtime executive for Genmar Holdings Inc.'s Lund Boats, was sentenced to 63 months in jail for stealing about $14 million from his former employer. Schultz, 52, perpetrated the scheme over a period of 18 years.

"I will continue to pay for this for the rest of my life and will take it to the grave when I die," he told the court last Friday, according to Dow Jones.

Schultz pleaded guilty to looting Lund and helping finance a licensed firearms dealership on the side. The onetime CFO also bankrolled extensive stock-market activities, subsidized a family embroidery operation and coffee shop, and paid hundreds of thousands of dollars of credit-card and other personal bills, according to Dow Jones.

Schultz was ordered to repay the stolen money to Lund and Genmar. So far, however, he has returned less than $2 million of the $14 million he skimmed.

Genmar has sued a bank, an outside auditor, and a brokerage house in an effort to retrieve more of the missing funds, the wire service reported.

Institutions Blase about Governance Issues
It appears that if institutional investors are mad as hell at the rash of corporate-governance scandals, they don't plan to do much about it.

About 71 percent of 35 professional investors polled by Thomson Financial indicated they don't anticipate their funds will become more proactive in dealing with corporate-governance issues.

Only 21 percent said they expected their groups to be more proactive.

Coincidentally, the number of institutional investors that consider themselves proactive is equal to the number that say they aren't proactive: more than 43 percent for each. Just 8.7 percent said they were "newly active."

When asked if a company's corporate-governance structure affects their research and investing decisions, more than 68 percent said yes. They noted that governance was a secondary factor, however, after company fundamental and macro indicators.

The most popular governance issue among the institutional investors: executive compensation.

And how do the investors feel about the new requirement that CEOs and CFOs certify the results of their companies?

Well, more than 19 percent said it is a "PR thing" designed to inspire investor confidence. In addition, 17 percent said the requirement will have no impact, since they believe rogue execs would sign erroneous statements anyway.

Would it make a difference to their investment decisions if a company hired a chief governance officer? Interestingly, three out of four of the respondents said they wouldn't favor a company just because it hired a CGO.

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