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Rising tensions between the U.S. and EU could lead to more trade restrictions. Plus: visas harder to come by, Nader rides again, and ten signs your finance department is second rate.
CFO Staff, CFO Magazine
May 1, 2003
With members of Congress feasting on "freedom fries" and French protesters defacing McDonald's restaurants, you might think that transatlantic trade relations are in bad shape. And so they are. But it's not because of the war with Iraq -- not yet, that is.
"Even before Iraq, trade tensions were as bad as at any time I've seen in my 30-year career," says Gary C. Hufbauer, senior fellow at the Institute for International Economics, in Washington, D.C. The United States and the European Union remain "at fundamental loggerheads" on a range of economic issues, says Hufbauer, in areas from agriculture and airlines to pharmaceuticals, steel, and E-commerce.
The EU is still waiting for Congress to craft acceptable replacement legislation for the foreign sales corporation (FSC) tax provisions, which the World Trade Organization deemed an illegal export subsidy in 2000. (The FSC's successor, the Extraterritorial Income Exclusion Act, was also rejected by the WTO.) Meanwhile, U.S. farmers are upset that Europe is keeping its doors shut against genetically modified food products.
This past March, the United States lost another significant trade dispute with the EU. A WTO panel ruled in an interim decision that the steel tariffs imposed last year by President Bush are illegal. The Bush Administration said it would appeal the decision, which was expected to be made final in April.
Officially, U.S. and European Commission trade representatives continue to profess allegiance to open markets. "The present geopolitical circumstances make it even more necessary that the EC-U.S. trade agenda is handled with care and with a lot of cooperation," said EU trade commissioner Pascal Lamy at a press conference in March. Meanwhile, a spokesman for the EC delegation to the United States pooh-poohs any connection between tensions over the war and trade disputes. "Put it in perspective," he says. "A few years ago, we said that transatlantic relations were in great shape but were jeopardized by a few trade conflicts. Now, one can say that trade is the glue."
If that's so, it may be time to worry. A test of the glue could come in June, when the leaders of the G8 industrial nations hold their annual summit, in Evian-les-Bains, France. Will Bush, Chirac, Schroeder, and the rest make a genuine commitment to strengthening mutual economic relations, despite their deep disagreements on security policy?
In this context, the Iraqi war does matter. Says Hufbauer, it will provide "a very strong rhetorical edge" to those who don't want to liberalize trade-on either side of the Atlantic. — Edward Teach
Work Visas: Not Going Anywhere for Awhile?
Homeland security efforts are complicating business travel to the United States. Hypervigilance on the part of U.S. consulates in various areas of the world, particularly China, Russia, and India, has delayed visa processing from 15 days to up to six months (the average is four months) for would-be foreign business partners, say industry associations. Customers, suppliers, and even employees on H-1B visas are getting frozen out.
"These lengthy delays in getting a visa for potential partners or employees have caused very substantial problems for companies," says Edmund Rice, chair of the Working Group on Visa Policy, which has been lobbying Congress to better fund the agencies involved in the visa security clearances.
The delays stem from two initiatives introduced last year ordering heightened checks, such as in-person interviews and reference calls, for all adult males from predominantly Muslim countries, as well as for anyone trying to enter the country to work with technologies linked to national security. A new Web site, www.unitedstatesvisas.gov, details the policies and advises businesses to plan for delays.
"We're not arguing [the regulations] should be changed, but they'll need to add some resources" to speed up the background checks, says Rice.
Motorola, for example, reportedly stood to lose a $10 million contract from the government of Vietnam when visa delays prevented decision-makers from coming to the United States on schedule. And for employees on H-1B visas, "it has gotten so bad that some companies are prohibiting them from going home" because of the risk of getting stuck there, says Thom Stohler, vice president of workforce policy for the American Electronics Association. At least two U.S. companies have lost senior researchers who were unable to renew their work visas to reenter the United States after traveling to their home countries, he says.
Some companies are holding meetings and conferences in Canada, where visa policies are less strict, says Rice. Others say they are leveraging overseas joint-venture partners or offshore outsourcing to avoid the need for travel to the United States. — Alix Nyberg
Accounting: Ralph Rides Again
Ralph Nader is taking on the accounting regulators. The consumer advocate and former Presidential candidate wants to help restore integrity to an accounting profession that he says has been compromised by scandal. In early March, he announced the formation of the Association for Integrity in Accounting (AIA), a public-interest group that intends to keep a close eye on the Securities and Exchange Commission and other regulatory agencies. The industry watchdogs, he says, need watching themselves.
"CFOs should welcome it," says Nader, who made his name taking on the American automobile industry and now has Wall Street fixed in his crosshairs. "Inside a corporation, people are subjected to a lot of pressures. It's very important for them to feel they have people outside supporting their decisions."
Comprised of accountants and accounting professors, the AIA will stake out positions on stock-option expensing and other accounting issues, present them before Congress and the SEC, write editorial opinions, and, says Nader, "encourage more fearless publication of what's on the minds of accountants around the country."
The AIA proposes to monitor the Public Company Accounting Oversight Board (PCAOB), which Congress created last summer following Enron's collapse. Nader's group also says it will turn up the heat on the Financial Accounting Standards Board. "FASB has fine pretensions, but it doesn't deliver," says Nader. "It has allowed itself to be browbeaten by Congress and corporate officials when it has tried to do the right thing." A spokesperson for FASB declined comment.
AIA founding member Tony Tinker, an accounting professor at CUNY Baruch College, says the appointed watchdogs have conflicts of interest, especially in how they are funded. "The SEC is funded on an annual appropriation by Congress and is vulnerable to congressional pressures," he says. "FASB is funded by the Financial Accounting Foundation, and the FAF is financed by large clients of the Big Four and by the Big Four itself. In effect, the auditees are appointing the auditors."
SEC spokeswoman Christi Harlan says the SEC is an independent body funded through stock-transaction fees and fines. As far as funding, she says, all Congress does is tell the SEC how much it can collect.
Mary McCue, spokeswoman for the PCAOB, says the board has proposed rules for registration of public auditing firms and accounting support fees that will be the principal sources for its funding, and says it will carefully consider the views of "all who can help the board carry out its mission." — David Campbell
Health Care: Malpractice Insurance Rift
If swelling costs aren't enough to prove that something is wrong with health care, then the sight of doctors on a picket line certainly is. But while physicians are finally making headway in their fight against escalating medical-malpractice insurance, it's unlikely to have much of an impact on out-of-control health costs.
Physicians in West Virginia, Pennsylvania, and Idaho have recently pushed for and won tort reform legislation that caps what courts can award for noneconomic damages, like pain and suffering.
The caps are likely to ease the wild escalation of malpractice premiums in those states if they hold up in the courts. "The caps will reduce what providers pay out in malpractice premiums," says Dean Harris, clinical associate professor at the University of North Carolina School of Public Health, "but I'm not convinced that will lead to lower health-care costs."
First, the premiums that physicians pay represent a small portion of the overall cost of health care. Edward Kaplan, health-practice leader at Segal Co., an employee-benefits consultancy, estimates that a third of health-care costs are related to physicians.
Second, the hope that caps would reduce the amount of "defensive medicine" that doctors practice-that they'd cut back on the excessive tests and procedures they order only to protect against lawsuits-is unfounded, says Harris. "Doctors still don't want to get sued, so they'll continue to take measures to protect themselves."
Rick Wade, senior vice president of the American Hospital Association, agrees that health providers will have a limited ability to pass on insurance savings while "one-third of hospitals are losing money." He says it would, however, improve the quality of care. "It's not good when you see physicians closing trauma units because they can't afford to run them anymore." — Joseph McCafferty.
Worst Practices: Ten Signs Your Finance Department Is Second Rate
To bowdlerize Tolstoy, good finance departments are not alike, but all poor performers are the same in certain ways. Avoiding these worst practices doesn't guarantee success, but committing them practically guarantees its opposite. (To read an expanded version of "Ten Sure Signs Your Finance Department is Second Rate," click here).
1. Slow Closes
A properly skilled staff at all but the smallest companies should be able to produce a complete financial statement within 10 days of the month's end, says Miles Stover, president of Turnaround Inc., in Gig Harbor, Wash. Dave Peralta, CFO of software provider Arbortext, in Ann Arbor, Mich., doesn't hold to such a strict rule of thumb, but agrees that "the longer it takes to close, the more inefficient the department becomes."
2. Outrageous Audit Fees
Rick Fumo, senior vice president of practices at Parson Consulting, in Chicago, insists that high fees, including those for nonaudit services, can be traced to an underperforming finance department that requires an abnormal amount of "cleanup." Fumo warns executives to keep tabs on the fix-it bills for such things as slow shipments, bloated inventory, and out-of-control receivables.
3. High Days Sales Outstanding
An increase in DSO often stems from a lapse in accounts receivable. Collection calls, for example, might not begin until 30 days after the past-due date. Another headache, high customer adjustments, can lead to higher DSO and hinder the usefulness of forecasts. When the number of adjustments creeps up month after month, something's amiss, says Fumo.
4. Multiple Payments
Are your vendors seeing double? When they bill you once and you pay them twice, your credit may be better than your cash flow.
5. Earnings Restatements
When restatements aren't a harbinger of outright fraud, they are the result of common accounting errors or oversight. When they slip by, says James Owers, a finance professor at the J. Mack Robinson College of Business at Georgia State University, it's a strong indication that the accounting and financial functions are having a problem with accounting judgments such as revenue recognition.
6. Manual Entries
Spreadsheets are great for running "what-if" scenarios as well as budgeting exercises. But when the subject is financial controls, notes Turnaround's Stover, relying on stand-alone spreadsheets instead of financial systems "violates the audit trail."
7. Lack of Transparency
The department must respond to questions with timely and logical answers, says Arbortext's Peralta. When the mechanisms that deliver reports are too confusing, or spitting out incorrect or incomplete information, a red flag should go up.
8. Dubious Structures
If your internal audit team reports to the CFO, there's not a regulator who wouldn't bristle at the potential conflicts of interest. Another crack in the structural foundation is no division of duties. For example, internal audit rules usually require that the employee who receives checks doesn't post them, and that the employee who prepares checks doesn't sign them.
9. Overly Cozy with Sales
In a good organization, say many CFOs, the accounting department should lend a hand to sales and marketing when it can do so appropriately and educate the sales force on revenue-recognition policies. But when "lending a hand" leads to postponing sales problems-or even straying from GAAP-a company might pass "second rate" and drop to the bottom of the barrel.
10. Staff Turnover
Where there's churn, there's trouble, says Stover, and it's usually associated with burnout or poor management. Procedures that aren't sharply defined, processes with too much wiggle room, and systems that don't support job functions are all incentives for employees to walk-and reasons you could get your walking papers. — Marie Leone
Stock Indexes: In & Out
Nothing lasts forever, not even the venerable members of the S&P 500 index.
In fact, only 243 of the companies that were on the list in January 1990 remain. S&P estimates that M&A activity accounts for 70 to 80 percent of turn-over on the index, which had $854 billion invested in it at the end of 2002. Compaq, Salomon Brothers, Seagram's, and Pharmacia have been merged out.
Impending bankruptcy has also taken its toll, especially during the past two years. Such S&P 500 club members as Enron, WorldCom, and Kmart are no longer welcome. "It's a function of what's going on in the market," says Srikant Dash, index officer at S&P.
Some companies are removed by the S&P committee because "they are no longer representative of the large-cap equity market," says Dash. The company with the shortest time on the list? BroadVision Inc., with just over 10 months basking in the S&P 500 sun.
Companies that have hung on since the list was expanded to 500 in 1957 include Boeing, GM, GE, and Ford. "The companies that have been able to last on the index establish a place in the economy, not just the market," says Dash. "They build on their strengths year after year." — Joseph McCafferty
Reg G: No Good Deed Goes Unpunished
During a fourth-quarter conference call in January, R.R. Donnelley CFO Gregory Stoklosa alerted analysts that the accompanying earnings release reflected the Chicago-based printer's early adoption of the Securities and Exchange Commission's new rules on proforma disclosure, known as Regulation G.
The next day, the Chicago Tribune reported that Donnelley missed analyst estimates by 8 cents, when, in fact, it beat First Call's consensus estimate of 50 cents by 5 cents.
Why the confusion? Historically, the company's releases have led with earnings per share excluding restructuring and impairment charges, which is the number analysts use to calculate the estimates that end up in First Call. This time, Donnelley included the charges in the EPS number it disclosed in the first paragraph, as Reg G requires. It detailed the charges in the following paragraph and left analysts to subtract them — a step the Tribune reporter didn't take when comparing the results with First Call's.
"We were an early adopter, so I think we took people by surprise," says Christopher Curtis, director of investor relations. The new SEC rules, which became effective March 28, "will require the media to step up its analytical abilities," he says.
In fact, the rules mean more work for companies, too. Under Reg G, any publicly released non-GAAP financial measure (essentially, any number that is not itself GAAP, but modifies or includes a reported GAAP figure) must be accompanied by, and reconciled to, relevant GAAP numbers. CFOs who mention such numbers in a phone call or Webcast must refer listeners to a Web site where they can view the required reconciliation and GAAP figures. Under certain circumstances, such disclosures must also be furnished to the SEC in an 8K. — Tim Reason
Chart: Reg G Spells Glitch for Early Adopter
Disclosure in G Major
Public disclosure of non-GAAP numbers must include:
• the most directly comparable GAAP measure
• reconciliation between non-GAAP and GAAP measures
SEC filings including non-GAAP numbers must:
• give equal or greater prominence to the GAAP measure
• state why non-GAAP numbers are used
• disclose any material internal use of the number
FASB: Hidden Agenda?
In the past seven months, the Financial Accounting Standards Board has changed accounting for special-purpose entities, energy-trading contracts, and guarantees. Now the board has officially added the explosive topic of employee stock-option expensing to an already overflowing agenda. Could FASB be any busier? Apparently it could. Reforms to lease accounting might also be on the table.
Outlining the agenda in a speech last December, FASB chairman Robert H. Herz noted, "I believe there are also a number of other areas, like lease accountingÉthat warrant our attention." Why? "My personal view," Herz later told CFO, "is that lease-accounting rules provide the ability to make sure no leases go on the balance sheet. Yet you have the asset and an obligation to pay money that you can't get out of." If companies don't want to capitalize the assets on their balance sheets, he declared, "then something's wrong."
Yet in congressional testimony in March, Herz neglected to mention lease accounting, which has survived without an overhaul since 1976. That's small comfort to Michael Fleming, president of the Arlington, Va.-based Equipment Leasing Association. "In the long run, I do expect lease accounting to change," he says. And that uncertainty is beginning to have an impact. For the first time this year, says Fleming, lessees have begun to request indemnities or guarantees that allow them to unwind leases if the rules are changed.
An outright elimination of operating leases is unlikely, though. Instead, CFOs can expect small changes by FASB that begin to restrict the number of transactions that qualify as operating, rather than capital, leases. The cumulative effect, predicts Fleming, is "they're going to raise the cost of capital." — Tim Reason
Ratings: Singing the Moody's Blues
Since Enron declared bankruptcy, there's been no end of criticism about how effectively credit-rating agencies are doing their jobs. Moody's Investors Service recently drew fire from an unusual corner, though — one of its own clients. In January, $1.7 billion software firm Compuware Corp. sued Moody's for downgrading its $500 million credit facility last August by two notches, to junk status.
"I don't think they did the proper due diligence," says Compuware CFO and treasurer Laura Fournier. Not only did the firm have a strong balance sheet and more than $400 million in cash and investments on hand, she notes, but Moody's analysts dragged out the review for nine months with infrequent communication. It later offered little justification for the move, which caused a 14 percent drop in share price and drew calls from rattled analysts. "They could not give us a single example from the past of another company that had positive revenue growth, positive net income, cash flow from operations, and no debt, that they downgraded two levels," says Fournier.
The suit also alleges that the downgrade was motivated by a bias toward IBM, which is rated by the same analysts who handle Compuware. (Compuware sued IBM — a customer and competitor — last year, alleging copyright infringement.)
In a motion to dismiss the case, Moody's called the charges "bare, illogical speculation." It says the strain on Compuware's relationship with IBM, and other market trends, put its future prospects in jeopardy. The company was successful in getting a similar case dismissed in 1999.
Most experts are doubtful the case will change the way ratings are handled. "It makes complete sense to have analysts working multiple companies in the same industry," says Jim Lilly, an attorney at Womble Carlyle Sandridge & Rice.
Compuware is seeking only the return of its $245,000 in ratings fees, but the firm says its reputation is worth the fight. "I think a lot of this is a response to the current climate, after Enron and WorldCom," says Fournier. "They overreacted, and we became the poster child." — Alix Nyberg