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Small-town Blues

Is a small-town locale a risk factor for corporate fraud?; when work outings can result in workers' comp claims; paternity benefits are catching on; meet a CFO whistle-blower; the benefits of setting up shop in Puerto Rico; more.
CFO Staff, CFO Magazine
May 1, 2004

Does locating the headquarters of a large company in a small town increase the likelihood of fraud? Richard Breeden, the court-appointed watchdog of WorldCom-cum-MCI, thinks so. The former chairman of the Securities and Exchange Commission says that WorldCom's headquarters location in Clinton, Miss. (population: 25,000), placed added pressure on its finance staff to comply with dicey executive orders, since the nearest job alternative was "800 miles away."

"If you're in New York City and someone asks you to do something you don't feel comfortable with, you can do a dozen interviews in a 12-block radius. That gives you some bargaining power," says Breeden. "That's not going to happen if you're out in the boonies somewhere."

Perhaps none of the companies that experienced large-scale fraud was based in a more remote location than Adelphia Communications Corp. The cable-television provider, which has been in Chapter 11 bankruptcy for the past two years, had been headquartered in Coudersport, Pa., a town of 5,390 on the border between Pennsylvania and New York. It was in "Coudy" that many of the alleged wrongdoings of founder and former CEO John Rigas and his sons, Timothy (CFO) and Michael (executive vice president), took place.

Adelphia CFO Vanessa Wittman, who has been following the trial of her executive predecessors, agrees with Breeden that location was a factor in the fraud. She notes that Chris Thurner, a former accountant at Adelphia, testified that he was threatened with being fired when he questioned transactions. "In that situation, you feel that if you say no to your boss, you're out of a job with no chance to find a new one," says Wittman.

Certainly employees at Tyco International Ltd., which is incorporated in Bermuda but until recently handled U.S. operations from Portsmouth, N.H. (pop.: 21,000), didn't have a lot of options if they decided to walk. (Like Adelphia, which relocated to Denver after the scandal, Tyco's new management moved the company to an urban setting: Morristown, N.J.)

What does that mean for companies like Wal-Mart Stores Inc., based in Bentonville, Ark. (pop.: 19,730), or Maytag Corp., in Newton, Iowa (pop.: 16,000)? Experts contend that a remote location is only one contributing risk factor. Executive recruiter Peter McLean of Spencer Stuart admits that recruiting is tougher for small-town companies, but he dismisses the small-town theory. "At WorldCom, it had nothing to do with people trying to protect their jobs," he says. "It wasn't the underlings who were responsible, it was the leaders." —Ilan Mochari

Time Out

Think twice before you organize that softball game at the company picnic. Injuries sustained at work-sponsored recreational outings could result in workers' compensation claims.

A March 10 ruling by the New Jersey Supreme Court found that an employee could collect workers' compensation benefits for injuries sustained while driving a go-cart, at his employer's insistence, during a company outing. When an employer compels an employee to participate in an activity that ordinarily would be considered recreational or social, the employer renders that activity work-related, wrote Justice James Zazzali in the court's decision.

The definition of "work related injury" is a gray area subject to judicial interpretation, but the recent ruling will broaden that definition in New Jersey and could influence other state courts.

One factor used to determine whether or not a company outing can be considered work is how much official business occurs there. A pregame speech from the CEO or the inclusion of clients at a golf tourney can tilt the balance. If participation is mandatory, even implicitly, it might be considered work-related for workers' comp purposes. So don't lean too hard on the company ringer to play third base. —Joseph McCafferty

Make Room for Daddy

Now here's a different kind of bond issue. In a controversial vote in 2002, the California legislature passed SB 1661, better known as the Paid Family Leave Act. Under the legislation, both male and female employees in California can take up to six weeks of paid leave to spend time with newborn or newly adopted children or foster children. The law, which kicks in July 1, is funded by employee contributions.

Business groups, which lobbied against SB 1661, say it's a productivity killer. But researchers claim paid paternity leave could save the state's employers $89 million in employee-retention costs. And family advocates say the bill is simply an acknowledgement of the realities of child-rearing in the 21st century. "The involvement of the father is crucial to the well-being of children," asserts Roland C. Warren, president of the National Fatherhood Initiative.

Apparently some employers agree. A recent survey found that about 14 percent of U.S. companies grant paid paternity leave — well up from a decade ago. Most programs offer two weeks paid leave, and some offer four or more. Microsoft, IBM, Merrill Lynch, Eli Lilly, and Ikea all offer the benefit. Big Four accounting firm KPMG LLP launched a paternity-leave program in 2002, as part of the firm's ongoing work/life initiative. Joe Maiorano, KPMG executive director of human resources, says the take-up rate has been near 80 percent.


Scott Fritz, director of financial reporting at KPMG, says he never hesitated to stay at home when his daughter, Sydney, was born last year. Says Fritz: "There's a culture of understanding here that there's more to life than work."

Still, champions of work/life balance programs concede that male workers face obstacles in taking paternity leave — even if their employers offer such policies. "In most cases, it's unrealistic to think there won't be some consequences," admits Warren. "There are trade-offs."

Take SB 1661. Under the law, workers can take paid paternity leave, but employers with fewer than 50 employees are not required to hold their jobs for them while they're away. That could qualify as a pretty bad trade-off. —John Goff

Making the Grade

Which are the best-governed companies in America? According to GovernanceMetrics International, they include 3M, Intel, McDonald's, Pfizer, and Target. These heavyweights, along with 13 other, received a score of 10 out of 10 in GMI's latest report on corporate-governance practices.

The study, which analyzed 2,100 companies around the world, scored them on such criteria as executive compensation, board independence, division of leadership roles, and environmental policies.

Analysts gathered the data from publicly available sources, including Securities and Exchange Commission filings, company Websites, and government agencies. "We're trying to do an extensive nonfinancial due-diligence check," says Gavin Anderson, president and CEO of GMI.

By country, Canadian companies achieved the highest average rating at 7.6 out of 10, followed by U.S. companies at 7.0. Japanese businesses scored the lowest, with a 3.0, an average Anderson attributes in large part to poor disclosure.

Similar rankings are also published by The Corporate Library, Standard & Poor's, and Institutional Shareholder Services.

While these watchdogs hope to give investors and other constituents insight into corporate governance, some companies say the scores don't always reflect reality. "You end up with kind of a one-size-fits-all ranking," says Norman Black, spokesperson for United Parcel Service.

And while GMI cited UPS as one of the most-improved companies and upped its score from 5.5 to 7.5, Black says UPS pays little attention to the ratings.

But investors and analysts can't afford to ignore them, says Beverly Behan, a partner in the corporate-governance practice at Mercer Delta Consulting. She argues that the lists can act as warning signs. "they summarize a lot of information in one place," says Behan. "You can get a sense of where they may be a problem." GMI red-flagged Parmalat in July 2003, for example, several months before the Italian company began to unravel. Other companies that fared poorly in GMI's most-recent report include Bristol-Myers Squibb and Halliburton.—Kate O'Sullivan

Perfect 10s
U.S. companies awarded a top score by GovernanceMetrics International.

3M Co.
Air Products and Chemicals
Colgate-Palmolive Co.
Cooper Industries Ltd.
E.I. DuPont de Nemours & Co.
Entergy Corp.
Exxon Mobil Corp.
General Electric Co.
General Motors Corp.
Great Lakes Chemical Corp.
Intel Corp.
McDonald's Corp.
People's Energy Corp.
PepsiCo Inc.
Pfizer Inc.
Praxair Inc.
Target Corp.
Wisconsin Energy Corp.

Trials of a CFO Whistle-Blower

In many ways, Dave Welch is Exhibit A in the debate over how well the Sarbanes-Oxley Act of 2002 can defend conscience-stricken employees. Fired from his job as CFO of Floyd, Va.-based Cardinal Bankshares Corp. and its subsidiary, Bank of Floyd, in late 2002 after refusing to certify his company's financial statements, Welch won preliminary orders from a Department of Labor administrative law judge in January to get his job back — along with lost wages, damages, and a clean employment record — in the first whistle-blower case to go to trial since the passage of Sarbox.

"When I refused to certify, I was just trying to get the ball rolling on some improvements," says Welch. The former CFO says he raised concerns about several potential abuses to Cardinal chairman and CEO Leon Moore as early as 2001, but to no avail. Included in those concerns were improper journal entries amounting to $195,000, which led to a 14 percent net income overstatement, alleges Welch. When he escalated the concerns through a series of memos and by withholding his signature from quarterly Securities and Exchange Commission filings for the small bank and its holding company, which trades over the counter, the audit committee hired its external auditor and an outside attorney to investigate the claims. However, he says, the team blocked him from meeting with the audit committee and rigged evidence to make him look incompetent. "[They] misconstrued everything I said and never presented my memos," he argues. Within weeks, Welch was out of a job.

For its part, the bank claims it fired Welch because he refused to comply with the audit committee's direction to meet with its representatives without his personal attorney. Cardinal claims an outside attorney would have violated the company's need for confidentiality. "David Welch was not a whistle-blower," says Laura Effel of Flippin Densmore, an attorney for the company. "If he had come to the audit-committee investigators...he would have been protected. But that's not what he did; he said, 'I'm not going to come and tell you unless I can bring my lawyer.' "


Based on minutes from an earlier audit-committee meeting that indicated plans to fire Welch before his refusal to appear without an attorney — as well as the short time that elapsed between Welch's memos and firing — administrative law judge Stephen L. Purcell found Cardinal's argument "simply unconvincing." (A year-end restatement of the numbers that Welch had questioned in 2001 also helped make his case, although Purcell insists that whether Cardinal is actually guilty of accounting fraud "is not, and never has been, at issue in this case." He says that all Sarbox requires is that an employee "reasonably believed" such fraud was occurring.) As a result, he recommended that the DoL issue orders for Welch to return to his job at Cardinal.

Yet Welch continues to work at his new job, managing a group of physicians' practices in a town several hours from his home. Cardinal has begun a review and appeals process that allows it to delay rehiring him and could last several years. The monetary awards he stands to gain have not yet been quantified. As a result, Welch looks to the future with a certain amount of trepidation. "I would feel a responsibility to go back [if the judge's order becomes final]," he says, "but it would be difficult at best." —Alix Nyberg

Outsourcing the Handyman

Jerry Whitaker, a vice president in Eaton Corp.'s $2.3 billion electrical-products division, had reservations about outsourcing his equipment maintenance. At the time, Eaton employed on-site mechanics to tackle emergency repairs. "Our initial concern," he recalls, "was whether [the outsourcer] would be pulling people away from our plants to attend to others." Whitaker was also worried about what would happen to the current crew: would third-party administration of his machines mean he'd have to sack longtime staffers?

But in December 2000, as Whitaker contemplated the move to outsourcing, machine uptime at Eaton Electrical was only 85 percent, and he thought the division could do better. Increasing uptime to 90 percent would yield more than 100 extra man-hours annually. There was also another fiscal argument: since a new machine cost $500,000 to $2 million, better upkeep could save millions if it could extend the life of existing equipment.

So despite some apprehension, Whitaker signed with Advanced Technology Services Inc. (ATS), a Peoria, Ill.-based provider of outsourced repairs and maintenance. ATS sets an annual cost reduction goal. If the goal is met, both sides split the savings; if not, ATS covers the difference. For this, Eaton pays a fixed annual fee (based on time, material, and manpower estimates) in monthly installments.

So far, the deal has been a good one. Uptime has jumped to 95 percent, and Don Brown, an Eaton Electrical director of operations, estimates that the company's six plants save $400,000 a year through ATS's contributions.

Most of the 45 former Eaton mechanics were hired by ATS, and are now deployed at the various Eaton facilities, allaying Whitaker's concerns about manpower availability and employment for longtime workers.

In addition to ATS, other providers of outsourced repair and maintenance include The Fluor Corp., a $1 billion engineering and construction company based in Aliso Viejo, Calif., which has a maintenance division; BE&K, of Birmingham, Ala., which offers maintenance outsourcing through its industrial-services unit; and Zurich-based ABB Ltd., a $19 billion giant, which offers maintenance and field services, mostly in the utilities sector. —I.M.

Parading to Puerto Rico

In March, Tyco International Ltd. came under heavy criticism for its decision to maintain its incorporation in Bermuda. But some companies have discovered a locale that has tax advantages without the political pressure that comes with moving to non-U.S. tax havens: Puerto Rico.

While Puerto Rico's corporate income tax is similar to that of the United States — ranging from 22 to 39 percent — industries that the commonwealth's government wishes to attract to the island receive tax incentives, according to Rolando Lopez, a partner with KPMG LLP in San Juan. Those industries include manufacturing, tourism, agriculture, and exportation of goods or services. Companies in these industries, he adds, may qualify for a rate on taxable income as low as 2 percent and no distribution tax, as well as a 60 percent exemption from the tax on gross receipts.

The tax enticements have lured a number of pharmaceutical, medical-equipment, and biotech companies. Sixteen of the 20 top-selling drugs in the United States are made on the island, as are 50 percent of all pacemakers and defibrillators. More than $2 billion worth of investment in facility development and construction for the manufacture of biotech bulk active ingredients is currently under way, according to the Puerto Rico Industrial Development Co. (PRIDCO).

Companies should be cautious about chasing tax benefits to reduce costs, warns Brian E. Andreoli, a partner with Duane Morris LLP in New York. "Tax benefits can disappear overnight," he says. Smart companies should open shop in a location because it makes business sense to do so, and treat tax benefits as a bonus, he observes.

Apart from the tax break, there are other advantages to making capital investments in Puerto Rico, according to PRIDCO senior financial analyst David M. Press. There's no currency-exchange risk, he notes, and it's a U.S. custom zone, so it is less difficult to move products into markets on the mainland. The capital, San Juan, was also recently named by KPMG as the least-expensive place to do business among 24 U.S. and affiliated cities with populations exceeding 1.5 million. —John P. Mello Jr.


It's Better (and Worse) Than You Think

It's been a long two-and-a-half years since Enron's spectacular collapse. Arthur Andersen has vanished, other success stories of the 1990s have been exposed as frauds, and Congress has passed a big, expensive law to keep it all from happening again.

Now, at long last, prospects are improving. Corporate profits are increasing. CFOs are more optimistic about the economy than they have been in years. And the first wave of scandals is coming to a resolution — Andrew Fastow of Enron has received his sentence, Scott Sullivan of WorldCom has pleaded guilty, and prosecutors are pursuing the CEOs of both companies.

So has life eased for beleaguered finance professionals? The short answer would seem to be no, although there is cause for optimism, according to a survey of 179 finance executives CFO magazine conducted this past March at its annual CFO Rising conference.

Consider the signs of trouble. First, it is alarmingly common for executives to lean on finance employees to "make the numbers work." Nearly half — 47 percent — report they still feel pressure from their superiors to use aggressive accounting to make results look better. This helps explain how finance executives think about the scandals — respondents identified personal greed, weak boards of directors, and overbearing CEOs as top causes. What is worrisome is that the pressure to make the numbers hasn't abated much. Of those who have felt pressure in the past, only 38 percent think there is less pressure today than there was three years ago, and 20 percent say there is more.

A second, related worry is that few finance executives have much confidence in the numbers their colleagues are reporting. Only 27 percent say that if they were investing their own money, they would feel "very confident" about the quality and completeness of information available about public companies. (The rest were either "somewhat confident" or "not confident.") CFOs know better than anyone how companies assemble their numbers — such a lukewarm endorsement should make investors uneasy.

Then there is the toll exacted by the Sarbanes-Oxley Act of 2002 and heightened regulatory scrutiny. Three-quarters of the respondents report that the scandals have made their jobs harder. In response to a question asking what CFOs would like to say to Fastow, Sullivan, and Mark Swartz one wrote: "Your missteps have tarnished the image of all CFOs and have burdened corporations with unnecessary costs related to Sarbanes-Oxley."

But every cloud has a silver lining. The upheaval of the past few years may have created more work for the CFO, but it has also brought new prominence. Ninety-eight percent of respondents say the scandals have elevated the profile of corporate finance with CEOs and corporate boards.

And most concede that while costly, the much-loathed Sarbox is doing some good. Seventy-seven percent say the law makes it easier to resist pressure from a superior to misrepresent results. That is positive news. If it's true that the scandals originated with some overbearing CEOs, then it's up to ethical finance employees to stand up to them. Greed will not go away, and neither will scandals. But next time, maybe fewer CFOs will feel the need to ask the question that many respondents did on this survey: "What were they thinking?" —Don Durfee

The Causes of Scandal
Percentage responding "very important."

Personal greed
79%
Weak board of directors
58%
Overbearing CEOs
45%
Unrealistic shareholder expectations
34%
Poor internal controls
33%
Unrealistic budget targets
29%



Still Feeling the Heat
Have you ever felt pressure from your superiors to use aggressive accounting techniques?

Yes
47%
No
53%


A Lukewarm Endorsement
Confidence in the quality/completeness of information available on public companies.

Very confident
27%
Somewhat confident
66%
Not confident
8%






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