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Picking Up Pieces

Few alternatives to the Big Four emerging. Plus: pay increases for board members; new charges filed against former CFOs of Enron and WorldCom; how benefits communication improves employee loyalty; more.
CFO Staff, CFO Magazine
June 1, 2003

Now that the Big Eight have dwindled to four, are viable alternatives emerging from the horde of smaller accounting firms? The second-tier firms would like you to think so.

Sensing an opportunity to lure unhappy clients of the Big Four, the largest of the second-tier firms have been quietly gobbling up pieces of Arthur Andersen, along with divested operations of the remaining four. For example, Grant Thornton, the country's fifth-largest accountancy, bought parts of Andersen's practice in Florida and the Carolinas.

Accounting firms have also been merging. New Jersey­based J.H. Cohn LLP and The Videre Group LLP recently joined to create the 13th-largest accounting firm. In addition to strengthening its hold on middle-market companies, the combined firm hopes to snare some bigger clients. "Initially, Andersen clients went to the Big Four, but many are unhappy and are looking for alternatives," says J.H. Cohn COO Dom Esposito. "We want to go after clients that aren't being properly serviced by the Big Four."

But does any of the maneuvering by second-tier accounting firms create a real alternative for large companies? Probably not, says Jack Ciesielski, who writes for the Analyst's Accounting Observer. The Big Four have tens of thousands of employees and extensive overseas operations, both essential features for multinationals. And it's hard to exaggerate the yawning gap between the smallest of the Big Four and the largest of the next tier: KPMG has $3.2 billion in annual revenues compared with $433 million for Grant Thornton. "I'm not sure that the smaller firms' hopes of competing with the Big Four are much more than a pipe dream," says Ciesielski.

Still, for large companies with a regional or domestic-only business, the smaller firms may be an attractive choice. Esposito argues that these firms can offer greater attention from audit partners, deep regional expertise, and often lower prices. And "because [the] Sarbanes-Oxley [Act] requires the Big Four to choose between certain services for their clients, CFOs may want to look at the superregionals for their internal audit work," adds Arthur Bowman, editor-in-chief of Bowman's Accounting Report. "But few of these firms have the resources to start doing SEC audits for big clients." —Don Durfee

D-School

Call them "Masters of the University." In April, students enrolled in the Master of Science in Financial Engineering (MSFE) program at Kent State University began trading derivatives on a simulated trading floor, using real-time information.

"Everything is real except the profits and losses," says Michael Persico, CEO of Tekom Inc., which built the first-of-its-kind simulator.

The floor, just like those at Morgan Stanley and Goldman Sachs, gives students hands-on experience at trading derivatives, says program director Mark Holder. "Seeing the mathematical principles in action is much different than sitting and working through formulas," he notes.

The students also learn the perils of derivatives trading. A related course covers the blowups at Enron, Orange County, and Barings Bank. "There are dangers, but 'financial engineering' doesn't have to be a dirty word," says Holder.

Holder predicts the trading experience will give students an edge when they look for jobs. "The message from investment banks and the Fortune 500 was, 'We don't want quants who can't trade,'" he says. Now, the next generation of traders can make their mistakes before they make — or lose — their millions. —Joseph McCafferty

Feds Fail Again

Can you guess which recently released annual report warns readers that "amounts reported in the consolidated financial statements and related notes may not be reliable"? Hint: it isn't Tyco's.

Once again, the Financial Report of the United States Government failed to pass muster with its auditors. That news may simply add insult to injury for private-sector CFOs, who compiled their reports under a slew of new government regulations this year.

"Government should lead by example," insists U.S. comptroller general David M. Walker. "We should be as good or better than those we are regulating." Uncle Sam's books are slowly improving, but the example it sets is still mixed at best.

Of the 24 agencies required to produce audited financial statements under the Chief Financial Officers Act of 1990, 3 more managed to receive clean opinions for fiscal 2002, for a total of 21. The Department of Defense, the Small Business Administration, and the U.S. Agency for International Development didn't receive the unqualified stamp.

Many clean opinions still result from manually intensive "heroic efforts," a practice Walker predicts will end once accelerated reporting deadlines of 45 days (faster even than the new 10-K reporting deadlines) become effective in 2004. Both the Department of the Treasury and the Social Security Administration met the new deadline for fiscal 2002. "There are other areas where we are ahead of the curve," says Walker. For example, the General Accounting Office has audited in- ternal controls for several years and promulgated independence standards for auditors well in advance of the Sarbanes-Oxley Act of 2002, he notes.


Still, as CFO reported last spring, one enormous agency prohibits the government from becoming a model of financial responsibility. "The Department of Defense remains the biggest challenge," says Walker. Defense comptroller Dov Zakheim continues to modernize his department's financial practices, he says, but wars in Afghanistan and Iraq, and time spent compiling a supplemental budget request for the latter, have slowed the pace. "They are still dedicated, they have done a lot of work, but obviously they haven't had as much time to devote to it," notes Walker.

How long will it take to clean up the DoD? "It is one of my goals to make sure we get a clean opinion before I go," says Walker. His term expires in October 2013. —Tim Reason

The Directors Cut

Board members, especially those serving on audit committees, have taken on new risks and responsibilities. Now they're getting paid more, too.

That's the conclusion of a recent survey by Sibson Consulting. Of the 69 companies that took part in the survey, about two-thirds are either making or planning material changes to their directors' compensation by upping per-meeting fees and retainers and altering the cash and equity mix for their directors. And where committee service is involved, all of the companies planning to make changes to committee pay say they plan to increase compensation for audit-committee service.

Committee Pay

"Everybody has been reevaluating," says Susan Shultz, president of Phoenix-based SSA Executive Search International Ltd., as well as the author of The Board Book (Amacom, 2000). "Sizable companies now see that directors are worth more money."

That's because they're doing more work. Shultz estimates that committed board members currently work an average of 300 hours a year for each board they sit on. And, she says, they are taking a more strategic role in the company.

Arthur J. Gallagher & Co., an Itasca, Ill.-based insurance brokerage and risk-management firm, is increasing fees for all of its outside directors, says CEO Pat Gallagher. In May, the company, which lets board members choose whether they want their compensation in options or in a combination of cash and options, raised per-meeting fees from $500 to $1,000, and retainers from $20,000 to $30,000. "Board members are doing more work because of [the] Sarbanes-Oxley [Act]," he says. "There's now a heightened chance of an increase in their personal liability, and they're taking their responsibilities seriously." —Joan Urdang

Error and Trial

In April and May, new charges were brought against Scott Sullivan and Andrew Fastow, as prosecutors continued to build cases against the former CFOs of WorldCom and Enron for their alleged roles in massive accounting scandals.

Sullivan was hit with two counts of bank fraud and two counts of making false statements in connection with loan and credit applications. His trial was also delayed from September to early 2004, to give the defense more time to examine new documents. Fastow faces 31 new charges, bringing his total to 109 counts of money laundering, conspiracy, and other frauds. Both executives pleaded not guilty to the charges.

While it might appear to outsiders that the cases are moving slowly, legal experts say the reverse is true. "There has been a sea change in the speed at which the Department of Justice is moving with these cases," says Ronald H. Levine, a partner with the Philadelphia law firm Post & Schell PC and a former federal prosecutor. He says he's seen it take as long as two and a half years to put together similar cases, but that political pressure is causing the DoJ to move more rapidly.

Levine says that getting convictions in both cases won't be easy for prosecutors. "To convict someone of fraud, you have to convince 12 members of the jury beyond a reasonable doubt that the defendant intended to cheat," says Levine. "You have to get inside the defendant's head."

Robert A. Mintz, an attorney with Newark, N.J., law firm McCarter & English LLP and a former federal prosecutor, adds that the Enron case could prove particularly tricky for prosecutors since, so far, not many defendants are cooperating. Of the 19 individuals facing charges in the case, only 6 have pleaded guilty and are expected to help prosecutors. "There hasn't been a domino effect of people rushing to strike deals with the prosecution in exchange for leniency," says Mintz. —Joe McCafferty

Accounting's Most Wanted
Andrew Fastow
Enron
10/02
Not guilty
109 charges, incl. securities fraud, money laundering, and mail and wire fraud.Released on $5M bond; awaiting trial. Money laundering alone could net a 20-year sentence.
Scott Sullivan
WorldCom
8/02
Not guilty
Charges incl. bank fraud, securities fraud, tax evasion, and other charges.Released on $10M bail; trial scheduled for early 2004.
Mark Swartz
Tyco Int'l
9/02
Not guilty
Conspiracy, bank fraud, securities fraud, tax evasion, and other charges.Posted $5m bail using Tyco stock. Faces up to 25 yrs. in prison. Tax-. evasion case goes to trial July 8.
Weston Smith &
William Owens
HealthSouth
Charged
3/03
Guilty
Conspiracy, wire fraud, securities fraud, insider trading, and other charges.Cooperating with authorities in investigation of former CEO Richard Scrushy.
Timothy Rigas
Adelphia Comm.
9/02
Not guilty
24 counts, incl. conspiracy, wire fraud, and bank fraud.Could face up to 30 years in prison. Trial to start in 2004.
Sources: Various published reports




Boning Up on Benefits Communication

When it comes to creating loyal employees, could communication about benefits be as important as offering them? A new study by Aon Consulting Inc. says it is.

According to Aon's Workforce Commitment Index, which measures a company's success in building and maintaining employee trust, good communication of benefits has a higher correlation with commitment (.38) than health plans (.22) or employer-paid pensions (.26). In general, the more closely benefits meet employees' expectations, the less likely employees are to pursue other employment opportunities, says Patricia Zar, senior vice president at Chicago-based Aon. Talking about benefits shows that employers care about their employees, she adds.

Indeed, benefits communication trumps even employee pay, says Zar. When bonuses and raises are scarce, managers need to remind employees what their benefits are worth, she says.

Charles Elson, director of the Center for Corporate Governance at the University of Delaware, concedes that employees whose benefits meet their expectations may feel more highly valued. But if the economic basics aren't being met, he says, no amount of positive spin can keep someone at a job. Pay and the benefits plans themselves — not talk about them — are what retain employees, says Elson. "In the long term, you cannot make a plan look better than it is in reality."

Nonetheless, it's important that employees understand and appreciate what their benefits plans are worth, argues Dan Ryterband, New York­based managing director at compensation consultancy Frederic W. Cook & Co. Perception is what drives employee behavior when it comes to benefits, he says. And frequent, honest, and direct communication can improve that perception. "You can have the best benefits plan in the world," adds Ryterband, "but if employees perceive it as a poor plan, it doesn't do much for the bottom line." —David Campbell

Cash-balance Barriers

When the Treasury Department and the Internal Revenue Service released proposed regulations last year that would make it easier to convert to cash-balance plans, pension plan sponsors breathed a sigh of relief — until they read the fine print. The new rules, it turns out, could actually make it harder to switch to such plans. Now the agencies have scrapped one of the problematic regulations, but experts say unintended barriers to cash-balance plans still lurk in the remaining rules.

The proposed rules were intended to clear up ambiguity around age discrimination in pension plans. But critics soon pointed out that the rules would render illegal a number of current pension plan practices — even some that are considered friendly to older workers.

Most of the controversy centered on changes to the so-called comparability rule. The American Benefits Council (ABC), which represents large corporate plan sponsors, pointed out that changes to the rule, intended to prohibit benefits plans from being weighted in favor of highly compensated employees, might also block other, more praiseworthy practices — such as offering "transition credits" to older workers whose benefits would be diminished if an employer switches from a defined-benefit to a cash-balance plan. The rule change could also prohibit grandfathering older employees into an existing pension plan.

The proposed regulations would have prevented these practices because older employees are often more highly compensated than others, thanks to their (usually) longer tenure. "Plans that employed such practices were virtually an automatic fail under the proposed rules," says Eric Lofgren, director of benefits consulting at Watson Wyatt.

After receiving nearly 5,000 comment letters on the proposed regulations, Treasury announced on April 7 that it was withdrawing the new comparability rule. That's good news for companies that want to convert to cash-balance plans, but it may not be enough. Another provision in the proposed regulations, an age-discrimination test for pension plans, would have the side effect of prohibiting long-standing pension practices. "They've proposed a quantitative age-discrimination test that's unworkable," charges John Scott, director of retirement policy at the ABC. "Perhaps they created more problems than they solved."

Critics of cash-balance plans aren't happy with the regulation, either. Eva T. Cantarella, an attorney at Hertz, Schram & Saretsky, in Bloomfield Hills, Mich., says she doesn't believe the regulations are helpful to the age-discrimination debate. "I don't think all these proposed regulations are necessary," she says. —Kris Frieswick

Tapping Retail Creditors

Companies are finding a new outlet for bond issues: retail investors. Programs that sell bonds directly to individual investors through brokers are gaining momentum, with participants that include IBM, Caterpillar, and GE Capital.

The retail market has responded. Last year, individuals snapped up $21 billion in so-called direct access notes (DANs), up from $2 billion in 1999. Patrick Kelly, managing director of LaSalle Broker Dealer Services, which offers the programs, expects the market to top $40 billion this year. "The fixed-income market at the retail level has remained very strong," says Kelly. With equity markets closed to many companies and credit standards tightening at some banks, the direct-to-investor bond programs offer companies another capital-raising option, he says.


United Parcel Service Inc. offers DANs to retail investors on a weekly basis. "This is one more financing option for us," says Gary Barth, UPS assistant treasurer. He says the relatively small weekly offerings, which average around $6 million, allow the company flexibility to fine-tune its ongoing cash needs.

The program also enables UPS to diversify its fixed-income investors. "It distributes the bonds into more hands," says Barth. Most of the buyers of DANs, whose maturities range from nine months to 30 years, are individual investors. "They're holders, not flippers," adds Barth. UPS now has $450 million outstanding in direct notes, and Barth expects the program to finish the year with from $500 million to $700 million outstanding.

Since LaSalle's parent company, ABN AMRO, pioneered DANs in 1996, Bank of America, Merrill Lynch, and Lehman Brothers have all launched similar programs. Most of them offer investors simplified fixed-income instruments, usually issued at par and in $1,000 increments. —J.McC.




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