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Proper Recognition

Guidance needed on recognizing revenue; keeping financial-printing costs in check; Reg FD and the First Amendment; the danger of deferrals; and more.
CFO Staff, CFO Magazine
April 1, 2005

On February 28, the day investors expected NCO Group Inc. to release earnings results for fourth-quarter 2004, the provider of business-process outsourcing services instead issued some bad news: it was delaying the release of its financials and changing one of its revenue-recognition policies. In January, the Horsham, Pa., firm received word that the Securities and Exchange Commission was taking issue with its policy.

NCO is not alone. The SEC has brought more enforcement actions related to revenue recognition than to any other area. In most cases, the actions have less to do with fraud than with confusion about the existing patchwork of regulations. According to a study released last summer, 76 percent of senior finance executives say there is a need for a comprehensive statement on how revenue should be recognized. "There has never been a comprehensive assessment," says Edward Nusbaum, CEO of Grant Thornton LLP and a member of the Financial Accounting Standards Board's advisory council. "There has been piecemeal guidance put together by industry."

In 2002, FASB convened a project to research the issue, but it has yet to release any formal findings. A spokesperson at FASB says only that work is ongoing and that there is no timetable for guidance. At issue: how to construct a wide-ranging policy that can be applied across the board, instead of detailed rules that govern revenue recognition across a variety of scenarios.

Instructing companies on how to determine a transaction's fair market value for sales that include multiple components is particularly complicated. Jennifer Haslip, a CPA who is the CFO of Universal Technical Institute, a for-profit technical training school based in Phoenix, says she wonders how companies will find appropriate market benchmarks for their transactions. "When you start to break apart the individual transactions of different companies, it gets complex," she says.

Greg Walker, CFO of Magma Design Automation, a software company based in Sunnyvale, Calif., says the rules need to be simplified. "They are too open to interpretation, too complicated," he explains, "and the basic outcome is that they generate a lot of unnecessary audit fees."

Nusbaum says he anticipates possible preliminary recommendations from FASB by the end of the year.—Kate O'Sullivan


Secret Rewards

Companies have always enjoyed the enticements that states dish out to lure them to relocate. What they don't like is the backlash that can occur when the public feels a company is getting a cushy deal.

A law proposed in Georgia could change that, at least in the Peach State, by keeping such incentives as state grants and tax credits secret.

Although not likely to pass, the bill raises the question of how much information about deals between states and businesses should be made public. "It comes down to the need to balance the right of the public to know how their resources are being spent and the right of taxpayers to keep their affairs private," says Don Griswold, a partner in the Washington, D.C., office of law firm McDermott Will & Emery LLP. He says that the deals are often kept pretty quiet.

However, legislation that shields details about incentives could be bad for businesses. How? It would prevent rival states from upping the ante on what Georgia offers. During negotiations, it's likely that relocation-minded companies would rather have competing states play with open hands.—Joseph McCafferty


A License to Print Money?

Are financial printers consistently exceeding the initial estimates they give clients? The answer seems to be yes—particularly for such transactions as initial public offerings, mergers, or debt offerings.

Consider a few examples. When Alibris, an Emeryville, Calif.-based online bookseller, filed an S-1 in preparation for an IPO it later withdrew, its printer estimated that the work would cost from $75,000 to $100,000. According to CFO Steve Gillan, the final bill was more than $250,000. Another company attempted to negotiate a "fixed" price with its printer of $140,000. After the job was completed, the company got an invoice for $230,000.

In yet another case, a work proposal reviewed by CFO magazine indicated that the final invoice would be in the $200,000 to $250,000 range. The actual tally: more than $770,000.

"The attitude seems to be that when you're going public, there's a huge influx of cash, so who cares about overpaying on some bill?" says one controller whose printing bill greatly exceeded the estimate. "But from my perspective, that's the shareholders' money."

These are not isolated cases, says John Wert, president of The Maverick Group Financial Print Consultants LLC, a New York­based firm that, in collaboration with the Institute of Management and Administration, advises companies on managing their financial- printing costs. "In almost every case, the issuer's bill goes well beyond the initial estimate," he says. (Three companies dominate the financial-printing market: R.R. Donnelley, Merrill, and Bowne.)


According to Wert and others, one issue is that big transactions invariably involve Securities and Exchange Commission delays and last-minute changes from issuers themselves. But the estimates from printers often don't spell out the high variable unit rates that will apply.

Printers will also sometimes rush customers to get their own documents into the system sooner than necessary. The result is an especially high number of costly changes. "They take advantage of companies' lack of understanding of the process," complains one lawyer who works on IPOs and other transactions.

Audits of printing bills also show that errors are common. In several instances, says Wert, clients have asked for supporting documents only to be told that the paperwork had been destroyed. "These bills are just rife with double charges," he says.—Don Durfee


The Right to Whisper

Executives at Siebel Systems Inc., including CFO Kenneth Goldman, are following in the footsteps of Hustler magazine publisher Larry Flynt. No, they're not going into the porn industry, but, like Flynt, they are trying to turn allegations of wrongdoing into a battle for First Amendment rights.

On March 15, a judge from the U.S. Southern District Court of New York was expected to hear arguments by Siebel Systems that the right to free speech protects its chief financial officer and an investor-relations officer against a Securities and Exchange Commission complaint that alleges the company violated Regulation Fair Disclosure. Reg FD, which took effect in 2000, bans U.S. public companies from selectively disclosing "material nonpublic" information to investors, analysts, and company outsiders.

The defendants argue in court documents that Reg FD is "an unprecedented and remarkably sweeping infringement of corporate speech in violation of the First Amendment."

Siebel paid a $250,000 civil penalty and agreed to a cease-and-desist order against further Reg FD violations in a 2002 SEC settlement. But six weeks after Siebel agreed to the cease-and-desist, the SEC claims the company violated Reg FD again. This time, Siebel will put up a fight in court (see "The Limits of Mercy").

To date, there have been only six enforcement actions charging violations of Reg FD, two of which have been against Siebel. And this case is the first contested action ever brought by the SEC seeking to enforce Reg FD.

Securities lawyers give the First Amendment argument little if any chance of helping Siebel's case, let alone killing Reg FD. "Free speech only goes so far," says Daniel Posin, a law professor at Tulane University.

And Treazure Johnson, the SEC's senior assistant chief litigation counsel, says she is "very confident" the commission will prevail.

If other constitutional challenges to recent securities law are any indication, Siebel's chances don't look good. "Just ask Richard Scrushy, currently being prosecuted for fraud at HealthSouth Corp.," says Posin. "He challenged the constitutionality of the Sarbanes-Oxley Act and got his head handed to him on a plate by the Federal District Court judge."—Craig Schneider


Light Up and You're Fired!

It's not just Donald Trump who's throwing around the "F" word these days. It seems that Corporate America is adding to the list of fireable offenses. In recent months, workers have been fired, or threatened with termination, at companies for blogging, tobacco use, weight gain, and—in the high-profile case of Boeing Co. CEO Harry Stonecipher—office romance.

"Employers are getting braver at exercising their right to terminate workers who are considered 'at will' employees for a variety of reasons," says Linda Doyle, a partner in the Chicago office of law firm McDermott Will & Emery LLP. Employees of Delta Air Lines and Wells Fargo say they were fired for keeping online journals known as blogs. In February, the Borgata Hotel Casino and Spa threatened to fire cocktail servers who gained more than 7 percent of their total body weight.

Weyco Inc. raised eyebrows for its policy of requiring employees to be tobacco free not only in the workplace, but also at home. The Okemos, Mich.-based employee-benefits company began conducting random tobacco Breathalyzer tests in January. "We're not saying you can't smoke. We're saying you can't smoke and work here," says CFO Gary Climes. He says the goal of the policy is to cut health-care costs and to help workers live healthier lives. Three employees were forced to leave the company because of their habit. Climes says another 18 to 20 were successful at quitting, with the help of programs Weyco began 15 months before the smoke-free policy went into effect.

Weyco's policy is legal in Michigan, but not everywhere. At least 28 states, including California, New York, and New Jersey, have drafted lifestyle statutes that protect workers from termination for certain legal behavior outside the workplace. While each state is different, most include protections for smoking and drinking off the clock, says Mark Pomfret, a partner at law firm Kirkpatrick & Lockhart Nicholson Graham LLP. He adds that all employers should be careful if they consider following Weyco's lead, since it's conceivable that smoking could be considered an addiction with protections under the Americans with Disabilities Act.


The law currently prevents employers from discriminating against those with an alcohol or drug addiction. Those who have a habit of updating their blogs on company time, or even on their own time, however, are still fair game.—J.McC.


The Danger of Deferrals

Deferred-compensation plans could soon become more trouble than they're worth. To comply with new federal rules, most large U.S. companies will have to change their plans by the end of 2005. And since many companies make customized deferral arrangements with individual executives, they could have to reexamine every plan to make sure it is up to snuff.

The new laws feature a host of restrictions on the plans. First, executives or their heirs can dip into deferral plans only in the case of employment termination, death, or disability. In the past, executives could tap a deferral account for certain large expenses, such as college tuition. (Sam Sheth, a managing director at Clark Consulting, wrote in to add that participants can still take planned distributions according to a preestablished schedule, upon hardship, change in control, or retirement. Executives will simply have less flexibility in the timing of these distributions.) Second, any of a company's top 50 officers must now wait six months after leaving the company before withdrawing money. Third, the rules eliminate so-called haircut provisions, which used to allow executives to access deferral accounts early if they paid a 10 percent penalty. Finally, plan participants must make their deferral elections earlier: before the end of the prior year to defer base salary and six months before the end of the year in which performance-based pay is earned.

Some CFOs say the new restrictions can render the plans impractical. At Chelton Microwave Corp., a technology company based in Bolton, Mass., CFO David Fuller says executives will no longer be able to defer bonus payments, since it is too difficult to determine six months in advance whether to defer the income. "By June, you can't know how well you are going to do for the year," he says. If a plan is found to improperly defer compensation, the full amount becomes immediately taxable and the employee is subject to a 20 percent penalty.

Although the Treasury Department's final version of the rules is not expected until this summer, large companies in particular are beginning to revisit their plans now. Says David Johnson, a partner in the human-capital practice at Ernst & Young LLP: "If an employee has concern about the ability to draw on these funds, the appeal of these programs may be meaningfully reduced." Johnson adds that some companies are wondering if the programs are worth the governance risk. "Deferred comp has been a lightning-rod issue in terms of shareholder disclosure," he says. "This is a legitimate time for companies to reevaluate it." —K.O'S.




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