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States to Employers: Pay Up

States press companies to provide employee health-care coverage; are two boards better than one?; rising demand for fraud examiners; the case for financial-statement insurance; Andy Fastow repents; and more.
CFO Staff, CFO Magazine
April 1, 2006

Companies that don't provide health-care insurance could soon get a wake-up call. That's because an increasing number of states — 23 at recent count, according to the National Conference of State Legislatures — are considering so-called pay-or-play bills that would force employers either to provide some coverage or pay a penalty.

One of those states, Maryland, passed the first such law in January. The Fair Share Health Care Fund Act requires companies with more than 10,000 employees in the state to dedicate at least 8 percent of their labor costs to providing employee health care, or pay the difference to the state. The act was aimed squarely at Wal-Mart Stores Inc., which has been widely criticized for its benefit practices. With more than 16,000 employees in Maryland, Wal-Mart is the most notable company affected by the law.

Other states, including New York, Tennessee, New Jersey, and California, have also introduced bills that would require employers with 10,000 or more employees to contribute at least 8 percent of payroll to employee health care, or pay the difference to the state. (Nonprofits would generally be allowed to contribute less.) Rhode Island has introduced a pay-or-play bill aimed at employers with 1,000 or more employees.

And in a move that pits small business against big companies, Massachusetts is considering health-care reform that could require employers that do not offer health insurance to pay an initial $295 per employee annually into the state's free-care pool. The proposal, which is supported by many large companies in the state, is meant to help pick up the health-care tab for the more than 500,000 uninsured individuals living in Massachusetts.

Not surprisingly, small businesses are fighting the Massachusetts proposal. "I'm all for private and public health-care coverage, but not the way they're doing it," says Chris Stone, president and CEO of StreamServe Inc., a Burlington, Mass.-based maker of enterprise document presentment software. While StreamServe does provide health insurance, Stone says the move would hurt small businesses that can't afford it. "Think of the small contractors, the welders, and the service stations," he adds.

Wal-Mart, which provides health care to less than half of its employees, took exception to being singled out. "There are 786,000 uninsured people in the state of Maryland, and less than one-half of 1 percent work for Wal-Mart," said a spokesperson in a statement. (Wal-Mart recently announced plans to expand its health coverage by shortening waiting periods for, and expanding availability of, its low-cost health plans.)

Michael L. Blau, a partner at law firm McDermott Will & Emery LLP, says employers that don't provide health-care coverage should brace for change no matter what state they do business in. "If Massachusetts does impose the $295 assessment on employers, other states are going to be watching to see how effective it is," he says. Likely, they will be ready to impose penalties of their own. — Laura DeMars



Taking Stock of SARs

Some companies are spreading SARs, and their executives couldn't be happier.

With FAS 123R making stock options increasingly unpopular, a growing number of companies are resurrecting an old form of incentives known as stock appreciation rights, or SARs. Like options, SARs reward employees based on the increase between a set strike price and current market price. The compensation vehicle gives the right to the monetary equivalent of the appreciation of share price over a specified time, but no stock or options are actually granted at the time the right is offered. Since they cover only the marginal gain, however, SARs can be fulfilled using cash or fewer shares of stock than options require, reducing dilution.

"A lot of companies are looking at [SARs] right now, up from about zero interest a few years ago," says Bruce Ellig, an executive compensation consultant. Aviall Inc., a Dallas-based parts distributor for the aerospace, defense, and marine industries, granted SARs for the first time this year. "The advantage has switched considerably from straight-up stock options to SARs because of the onerous accounting for options and the dilution factor," says David Leedy, director of investor relations. Aviall replaced its options packages with SARs that vest in equal installments over three years (except for the CEO's SARs, which vest in four years).

SARs have been around since at least 1934, says Ellig, but fell out of favor because of the variable cost accounting they required. Compensation consultancy Frederic W. Cook & Co. reports that only 3 percent of 250 large companies used stock-settled SARs in 2005, up from 1 percent in 2003. But now that 123R requires options to be expensed, and allows for stock-settled SARs to be expensed as a fixed cost, the two are much more comparable in terms of accounting and tax treatment. (Cash-settled SARs still require variable accounting.)


So far, investors seem accepting of SARs. "They're no more open to abuse than stock options or restricted stock," says Paul Hodgson, senior research associate at The Corporate Library. However, he adds, "the problem with both restricted stock and SARs is that they are no more related to performance over the long term than options are." — Alix Nyberg Stuart


Double the Fun

Are two boards better than one? In light of the heightened demands on directors today due to new regulatory requirements, Yoram Wind, a professor at the Wharton School of the University of Pennsylvania, proposes a new way to think about board structure: split the responsibilities of the directors in two.

"The board is becoming more like a policeman and not really helping management strategically," says Wind. To benefit from directors' insight as well as governance oversight, he suggests that companies consider maintaining a separate board for each role. "Let's recognize that there are two functions — compliance and strategy — and that these functions require different skills and different expertise," he says.

Wind outlines a structure in which an oversight board, made up entirely of independent directors who are paid substantial salaries, would meet monthly, while a strategy board would meet less frequently, perhaps twice annually. The two boards would unite once a year to address topics such as compensation and director nominations.

CFOs are quick to raise questions about the dual-board concept. "Having two boards would be administratively quite difficult," says Bruce Nolop, CFO at Pitney Bowes Inc. in Stamford, Conn. He says the two roles are intertwined. "We could have a compliance CFO and a strategy CFO, but I don't think that would be very efficient. I think the compliance side of my job helps me with the strategy side and vice versa."

Scott Davis, finance chief at UPS Inc., says the board at the Atlanta-based shipping and logistics company has tackled additional compliance work in its committees. "Our audit and governance committees play the role of a compliance board," he says. "Then, when the entire board meets, they still have time to get into the trends of the business." Davis worries that the demands of a strictly compliance-oriented board would severely restrict the pool of available director candidates. "It's hard enough to find board members today," he says.

To date, no companies have split their boards in two, though Wind says some are considering the proposal.

Despite their arguments against the two-board theory, CFOs see a need for boards to consider new models for the current regulatory environment. "Every board should be reviewing how they do things," says Nolop. — Kate O'Sullivan


Total U.S. Tort Costs Continue to Climb

Tort costs in the United States reached a record $260 billion in 2004, or approximately $886 per person, according to a March report by Towers Perrin. The record figure is up 5.9 percent from total tort costs in 2003, but that's smaller than the 14 percent increases in 2002 and 2001. The costs include benefits paid or expected to be paid to third parties, defense costs, and administrative expenses. Asbestos claims, which totaled about $5 billion in 2004, were less of a factor than in each of the prior three years. However, medical malpractice tort costs increased from $26.5 billion in 2003 to $28.7 billion in 2004. The survey estimates that tort costs will grow at 6.5 percent over the next three years.



Pricier Premiums

If plan sponsors thought the pension landscape couldn't get any more difficult to navigate, they were wrong. New pension regulations expected to take effect in the coming months could push more companies closer to freezing their plans.

As part of the Deficit Reduction Act of 2005, which is awaiting approval by President Bush, annual premiums payable to the Pension Benefits Guaranty Corp. (PBGC) are expected to rise from $19 to $30 per capita for single-employer plans and from $2.60 to $8 for multiemployer plans.

In most cases, the premium increase is nominal compared with the size of the plan. But companies are concerned that future increases, which would be indexed to wages, could be harder to swallow. Aliya Wong, director of pension policy at the U.S. Chamber of Commerce, says future increases could put a burden on struggling plans. "Many companies believe the premium hikes are being driven by [federal] budgetary concerns when they should be driven by the overall state of the pension system."

Finance executives say the pension-premium increases rub salt in an already-open wound. Says Robert Lewis, manager of Government Affairs at Financial Executives International: "Members are concerned whether the companies left holding defined-benefit plans will be forced to pay more to compensate for the companies terminating their plans."


That's just what the PBGC plans to do, says agency spokesman Randolph Clerihue. "If companies do not fund the promises they make, the cost will get transferred to other companies in the form of higher premiums." Did someone say "domino effect"? — L.D.


Insuring the Books

Would auditors do a better job if they weren't paid by the companies they audit? Joshua Ronen, a professor at New York University's Stern School of Business, thinks so. He proposes that companies buy insurance to cover shareholders for losses caused by financial-statement fraud and misrepresentation. That would shift the job of hiring auditors to the insurers. "As long as auditors are paid by corporations," he says, "a conflict of interest exists."

Financial-statement insurance, claims Ronen, would eliminate this conflict. And differences in premiums would, for the first time, give investors a way to compare financial-statement quality. That quality would skyrocket, he argues, if insurers were doling out the work, since a botched audit would cost an auditor not one engagement, but hundreds. "There is a built-in, very heavy market penalty for any audit firm that doesn't do its job correctly," he says.

Is financial-statement insurance feasible? "There's no way of doing this in bite-size fashion," says Alan Williamson, CEO of Marsh Risk Consulting for Europe and the Middle East, who is deeply skeptical of Ronen's idea. He says the insurance industry "has nowhere near enough know-how to carry out such a thing. It would take a gargantuan effort."

Stephen Hodge, former CFO of Royal Dutch/Shell, says financial-statement insurance "strikes me more as a message from the world of fantasy than a practical proposal." Now a nonexecutive member of the franchise board at Lloyd's of London, Hodge notes that the insurance industry has difficulty pricing relatively rare events like financial-statement fraud. Still, Ronen claims that two major insurance companies are studying the idea. — Tim Reason


Need More Time to File Taxes?

As part of its efforts to streamline business taxation, the Internal Revenue Service announced in February that it was simplifying the process by consolidating all requests for an extension to one form. Businesses that formerly needed to file extension forms 8800, 8736, 7004, and 2758 will now need to file only the revised form 7004.

The change, effective for the 2005 tax period, will make it easier for partnerships, trusts, and other noncorporate structures to get an automatic extension of six months. Previously, only corporations could request such an extension.

The IRS is also showing sympathy for taxpayers in areas hit by Hurricane Katrina. Businesses and individuals in parts of Louisiana and Mississippi will have until August 28 of this year to file returns and make payments that were due on or after August 29, 2005. — Joseph McCafferty


Congress, Your Best ROI?

Looking for a good investment? Try your member of Congress.

A study of political donations found that when companies or their executives gave money to the tax-writing members of Congress, the returns were impressive: $1,616 for every dollar spent. The study, conducted by researchers at Arizona State University and the University of Southern California, looked specifically at the feeding frenzy surrounding the Deficit Reduction Act of 1984. But it found other examples of enviable returns: $2,500 in ethanol tax credits for Archer Daniels Midland Co. for every PAC (political action committee) dollar spent and a 1,000-to-1 return for Alliance Bernstein LP in exchange for its own donations. The study didn't examine the gains from the tax changes contained in The American Jobs Creation Act of 2004, but they were no doubt similarly dramatic.

When companies stand to gain from tax laws, executives and directors also emerge as heavy contributors. "The punch line of the paper is that not only do the firm's tax benefits influence giving by company PACs, but the effect [corporate tax legislation] has on a manager's own wealth encourages individual contributions," says co-author Sanjay Gupta, an accounting professor at the W.P. Carey School of Business at Arizona State University. He says he was surprised that the return was so high. "There is a huge disconnect between the tax benefits and political giving. It's remarkable that such a small contribution can have such a huge benefit."

Of course, this finding comes at a time when many corporate chiefs say there simply aren't enough good investments for their swelling cash balances. But given the antilobbying climate on Capitol Hill in the wake of the Jack Abramoff scandal, returns might not be as tantalizing. — Don Durfee


CPA or CFE?

Green eyeshade, or magnifying glass and fingerprint dust? That question faces an increasing number of accountants as they consider bypassing the certified public accountant route in favor of becoming a certified fraud examiner, or CFE.


While demand for both certifications is strong, increasing pressure at accounting firms to find fraud and greater scrutiny by regulators have put additional emphasis on the CFE certification. The Association of Certified Fraud Examiners (ACFE), which administers the certification, currently counts 36,000 global members.

John Challenger, CEO of Chicago-based recruiting firm Challenger, Gray & Christmas Inc., says there are increasing requests for candidates with a CFE. "We are in a period where major litigation is threatening companies, and that exposure is going to require people who can really tackle fraud," says Challenger.

While auditors focus on the effectiveness of controls, fraud examiners look for misconduct, says Kathy Lavinder, executive director of SI Placement, a financial investigation and CSO recruiting firm in Bethesda, Md. Auditors look for compliance with, say, procurement policies and practices, while fraud examiners go a step further and look for potential issues such as hidden relationships with suppliers, she says.

The certification can be lucrative. According to the ACFE, an internal auditor who is a CFE draws an average salary of $91,058, compared with $73,248 for a noncertified internal examiner. The association also reports that in 2004, CFEs earned an average of 26 percent more than non-CFEs in comparable positions. — Esther Shein


Shareholders Push Majority Rule

As proxy season heats up, board configuration is the number-one issue for shareholders. Some 141 proposals calling for majority-voting policies have been submitted so far, up from 80 last year. "This is the flavor of the moment in terms of shareholder activism," says Cliff Neimeth, a New York–based attorney with Greenberg Traurig LLP.

The proposals aim to eliminate the current plurality system, in which a director receiving just one vote could be elected even if all other votes are withheld. Instead, shareholders are demanding that directors receive an affirmative majority to serve. "Today there is no meaningful way to object to the election of a director-nominee," notes Neimeth.

Among the companies responding to the shareholder pressure are Intel Corp., Dell Inc., and Motorola Inc., which have all adopted new director-election processes this year, changing the voting requirements in their bylaws and instituting director-resignation processes. "These are the companies that have really pushed the envelope on this issue," says Patrick McGurn, executive vice president at Institutional Shareholder Services, a firm that advises shareholders on how to vote their proxies.

A majority voting proposal received support from 41 percent of shareholders at Dell last year. This past January, the company's board instituted a new procedure. Under Dell's new rules, if a director does not receive a majority vote for reelection, he or she must resign. The board can then choose to accept or reject the resignation. Motorola and Intel adopted the same procedure, which governance experts have dubbed "majority plus."

With last year's proposals receiving an average of 44 percent voter support, other companies may soon follow Dell's lead. "It seems likely that, if shareholder support is similar to last year, many companies will be making changes to their voting standards," says Motorola CFO David Devonshire. In turn, speculates McGurn, boards "are going to be more demanding of senior management on issues ranging from acquisitions to accounting treatments, because these rules mean board members could fail to be elected." — K.O'S.


Hot Topics
Shareholder activists have highlighted nine key issues for the 2006 proxy season.
Proposal Type Number Submitted
Majority director elections 141
Repeal of classified boards 76
Pay for performance 57
Independent chair 42
Simple majority voting 36
Golden parachutes 28
Cumulative voting 25
Poison pills 25
Cap pay 12
Source: International Shareholder Services

The Katrina Effect


Many risk managers who are dealing with the insurance impact of last year's three devastating hurricanes whisper a phrase that few people would utter about the storms themselves: "It could have been worse."

The three ugly sisters — as insurance-industry insiders refer to hurricanes Katrina, Rita, and Wilma — and other hurricanes of 2005 inflicted an estimated $58 billion in losses on the insurance industry. Property-insurance rates have increased, but not as much as some risk managers had feared. The impact on other lines of insurance has been minimal.

According to a survey sponsored by the Risk and Insurance Management Society and conducted by research firm Advisen, prices for commercial-property insurance increased by a median of 8 percent in the fourth quarter of 2005. Despite the fourth-quarter rate hike, overall property insurance prices declined 2 percent in 2005, following a 6 percent drop in 2004.

Why? As large as the hurricane losses were, they represent just a dent in the insurance industry's $414 billion in claims-paying surpluses. Furthermore, insurers have been able to raise fresh capital quickly. By December, investors had formed 12 new insurers and reinsurers (11 of them in Bermuda), with a start-up capitalization totaling $8.7 billion. In all, says Robert Hartwig, senior vice president and chief economist of the Insurance Information Institute, the industry will have raised about $23 billion in post-Katrina capital by the end of February. — David M. Katz




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