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Delayed Reactions

Late filings and restatements soar as companies continue to grapple with Sarbanes-Oxley; are the Feds bugging your boardroom?; why XBRL will soon be the language of financial reporting; Atlanta versus New York; and more.
CFO Staff, CFO Magazine
May 8, 2006

More than three years after taking effect, Sarbanes-Oxley is still wreaking havoc on corporate reporting.

In 2005, accounting restatements nearly doubled to a record 1,195, according to research firm Glass Lewis & Co. This year, scores of companies — among them General Motors, Nortel Networks, Bausch & Lomb, and Bally Total Fitness — announced that they would miss the Securities and Exchange Commission's March 16 deadline to file their annual reports.

While substantive problems have not disappeared, today a company is more likely to revise or delay its results simply to play it safe. Companies are using extreme caution as they continue to work on internal controls, says Ed Nusbaum, CEO of accounting firm Grant Thornton LLP, so they are handling minor errors differently than they have in the past. "Before, if something was borderline, there was a tendency to say, 'We'll fix it next year,'" he says. "Today if something is wrong, you fix it now."

Tardy 10-Ks stem from a variety of causes. HealthSouth Corp. announced it would postpone its annual report as it continues to deal with fallout from a massive accounting scandal. GM says it will be late due to accounting errors related to cash flows from a subsidiary of GMAC.

No matter the reason, regulators and investors don't take kindly to late filings, says James Duncan, accounting professor at Ball State University and former controller at fast-food chain KFC Corp. "If you delay the 10-K, the SEC is going to ask questions," he says. Late filings can also precipitate stock declines, securities suits, and loan defaults if they are prohibited in loan covenants. Bally Total Fitness, which was forced to delay filing its 2005 annual report because of complications with restatements of prior years, solicited waivers from creditors to avoid defaulting on loans due to the filing delay. The waivers were granted, but at a price: Bally paid $10 in cash or equivalent shares for each $1,000 in principal to obtain the one-time consent.

The current avalanche of do-overs suggests a variety of causes, including accounting for derivatives, leases, pensions, revenue recognition, and asset retirement obligations (FIN 47). In many cases, restatements arise from new guidance from regulators or from trying to force complex transactions into a one-size-fits-all rule, says Baruch College accounting professor Steven Lilien.

So far, the surge of restatements shows few signs of abating. Tenet Healthcare already announced plans to revise earnings on two separate occasions this year. Clearly, companies continue to struggle with Sarbox. What's less clear, says Lilien, is whether executives are going to give back the hefty compensation they received based on numbers that were later revised. — Joseph McCafferty


Total Number of Accounting Restatements
2005 1,195
2004 619
2003 514
Source: Glass Lewis & Co.

A Hotter Shade of Pink

Faced with rising compliance costs and a thinly traded stock, Southern Energy Homes Inc. voluntarily delisted from Nasdaq in January 2004. The manufactured-home builder instead moved to Pink Sheets LLC, a quotation service for over-the-counter stocks. Southern Energy, which continues to produce annually audited financial statements, is just the type of company Pink Sheets CEO R. Cromwell Coulson had in mind when he decided to launch a new premium service to highlight the best of the Pink Sheets.

The over-the-counter segment of the market includes all securities not listed on the major U.S. stock exchanges. Those quoted on the OTC Bulletin Board (OTCBB), operated by Nasdaq, must be registered with the Securities and Exchange Commission, but Pink Sheets includes many unregistered securities, giving it a reputation for hosting what Coulson calls "dark and dodgy" businesses.

In March, however, Coulson introduced the OTCQX, or "over-the-counter-quality exchange," a quotation service designed for reputable businesses, targeting the top 25 percent of Pink Sheets and OTCBB firms. "By limiting entry to operating companies with audited financials, we're going to clean out a lot of the dreck in the space," says Coulson.

To qualify for the "premier" tier of the OTCQX, companies must meet certain requirements, including maintaining a minimum bid price of $1, holding annual shareholders' meetings, and publishing audited financials. Companies whose shares trade for less than $1 but meet all other requirements will qualify for the second, or "prime," tier. Pink Sheets will continue to quote the companies that fail to meet these requirements on its regular service.


But will the new designations amount to more than window dressing? "I'm fairly skeptical about the service," says Peter Falvey, co-founder of Revolution Partners, a boutique investment bank. "I think the pink sheets stigma will remain." It certainly could, since the premium listing service will not require SEC registration.

James Stariha, finance chief at Southern Energy Homes, hopes Falvey is wrong. "We're hoping this premium service will provide a level of visibility that will get more people interested in our stock." — Kate O'Sullivan


Pensions Spark Credit Ratings Debate

Within the next few months, some companies may see their debt rise unexpectedly. The cause? Credit-ratings agency Moody's Investors Service plans to revamp the way it views the shadowy long-term obligations associated with multi-employer pension plans for public companies and add those figures to overall debt loads when it considers credit ratings.

Multi-employer plans, popular in unionized industries, allow itinerant employees to keep their pension plans as they switch employers. Under current accounting rules, companies treat the contributions as an annual expense and do not have to disclose projections of their long-term obligations, which can fluctuate significantly.

Moody's worries that the plans — which according to its study are 23 percent underfunded on average — may soon saddle companies with higher payments to avoid a funding deficiency. "Just because the contribution is driven by union negotiations does not imply to us that there's no long-term liability," says Greg Jonas, managing director at Moody's. The ratings agency plans to construct industry-based debt multipliers using information from the Department of Labor and apply them to rated companies by midyear.

Not surprisingly, rated companies strongly oppose the change. "We very much believe we can help Moody's see the error of its ways," says Norman Black, spokesperson for United Parcel Service. The shipping company, by far the top contributor to such plans according to the Moody's study, paid nearly $1.2 billion in 2004. UPS makes no internal projections for its long-term exposure, says Black. "We do not view it as long-term debt; it is the cost of labor, which is short-term." Based on the change in methodology, UPS could lose its triple-A rating with Moody's.

Meanwhile, Standard & Poor's has no plans to follow suit. Claiming the DoL data isn't always reliable, S&P says it already gets current information from issuers and will ask for more going forward. "We're quantifying the debt; we don't want to rely on such imprecise measures," says Neri Bukspan, chief accountant for S&P.

For its part, Moody's is standing by the plan. "We admit that our approach is a very rough calculation, but we believe it's a better number than zero," Jonas says. "If companies are willing to provide us with more company-specific facts, we will consider those numbers." — Alix Nyberg Stuart


Not Yet Rated:
Top 5 contributors to multi-employer pension plans, ranked by size of contribution
Moody's Rating
(As of 1/06)
2004 Contribution
(In $ Millions)
Contribution
As % of Debt
United Parcel Service Aaa $1,163 26.1%
Yellow Roadway Ba1 $378 57.5%
Safeway Baa2 $196.8 2.9%
Kroger Baa2 $180 2.3%
EMCOR Group Ba1 $133.7 162.8%
Source: Moody's Investors Service

What Board Members Want from the CFO


Finance chiefs are spending endless hours in the boardroom these days — not all of it quality time. As CFO and treasurer of shipping company Hub Group Inc. and as a director at two other public companies, Tom White has experienced the interaction between CFOs and boards from both sides. According to White's informal survey of dozens of directors, these are the top things board members want from their CFOs:

1) More interaction. Most of the audit-committee members White surveyed say they don't hear from the CFO enough. They want questions and answers from the CFO whenever an issue comes up, they say, not just at a board meeting.

2) Someone who can handle pressure. Board members want a CFO who is receptive to challenges and doesn't get defensive when pushed. Directors cite problems with CFOs who hold back information or don't give candid answers.

3) Insightful and timely meeting materials. Directors report receiving "phone books" of documents with lists of backward-looking numbers. One says he sometimes receives board packages on the night before the meeting.


Sunk Costs

The only thing worse than holding hopelessly underwater stock options is paying administration fees on them.

Almost by definition, fees on worthless stock options add up fastest when companies can least afford them. Little surprise, then, that some issuers are trying to void the options to avoid paying the expense. In March, Delta Air Lines won bankruptcy court approval to void roughly 93 million underwater stock options. The move could prompt plenty of copycats among companies in similar straits.

Bankruptcy court offers the most-effective venue, says Richard Alpern, a principal at executive-compensation consulting firm Frederick W. Cook. Only a bankruptcy judge can authorize the cancellation of vested options, which represent a legal obligation for companies. Delta expects to save $305,000 in administrative costs related to managing the options and an undisclosed sum in what it calls "costly" accounting procedures to expense them.

Companies that are not in bankruptcy can cancel worthless options by offering other options or equity in exchange, although recent repricing rules have made the shareholder-approval process for such a move more burdensome. Companies can also pay cash for the options, trading a recurring cost for a one-time payout. — Allan Richter


Bugs in the Boardroom

Government wiretapping isn't just for the Mafia anymore. A provision in the newly updated Patriot Act, passed in March, makes it easier for federal agencies to conduct secret surveillance on corporations.

Section 113 of the U.S.A. Patriot Improvement and Reauthorization Act now allows federal prosecutors to request permission from a judge to wiretap businesses suspected of antitrust violations, including price-fixing, bid rigging, or setting up illegal trade monopolies or distribution arrangements.

"The government is taking a hard-nosed approach toward antitrust crimes in general," says Michael Kendall, a partner at McDermott Will & Emery. He says the controversial provision was added to the Patriot Act, which is primarily aimed at combating terrorism, as a way to ensure passage quickly.

Some business groups are outraged by the change. "Granting the Antitrust Division the unrestricted power to spy on every business in America has nothing to do with fighting terrorism," says Skip Oliva, president of the Voluntary Trade Council, a free-market advocacy group. "Instead, it hands unelected, unaccountable prosecutors the power to terrorize the American economy." Opponents of the provision are concerned that trade secrets could be revealed to the public through recordings, even if no wrongdoing is found.

Stephen Huggard, a partner at Edwards Angell Palmer & Dodge, says the law is part of the recent regulatory wave against white-collar crime. "Fifteen years ago [Congress] had a hard time believing executives were committing crimes," he says. "The law is finally catching up with reality."

Despite the crackdown on antitrust crime, Kendall believes the government will use the provision to spy on companies only in extreme cases. He says it's more likely that the Department of Justice will continue using cooperators or whistle-blowers to gather information. The department already wins about 95 percent of the antitrust cases it pursues, according to Oliva. — Laura DeMars


Stock Ownership Declines

Stock ownership among families decreased for the first time since 1989, when the Federal Reserve first began tracking it. The number of households that own stocks either directly or through retirement accounts and mutual funds dipped to 48.6 percent in 2004 from 51.9 percent in 2001. Many factors — from terrorism to the tech bubble to baby boomers moving savings into less-risky bond and money-market vehicles as they approach retirement — contributed to the decline.



Behind the Numbers


If the Securities and Exchange Commission has its way, companies will soon be filing their financial reports in a new language.

No deadline has been set yet, but the SEC is expected to require companies to use extensible business reporting language (XBRL) to file financial statements as early as this year. On March 29, the commission announced that 17 companies, including Dow Chemical and Pfizer, had signed on to participate in a pilot program to file all financials using the protocol. The new method, which tags data with standardized codes, would make it easier for investors and analysts to examine a company's reports and compare results.

While XBRL has been on the table for some time, the SEC has promised to accelerate adoption of what it calls its "interactive data project." Chairman Christopher Cox has been a vocal advocate of moving to XBRL. "We are on the threshold of a revolution in corporate reporting," he told participants of a conference on the topic last fall.

"We're talking about months now, instead of years," says Greg Adams, CFO and COO of Edgar Online Inc., which provides software to convert filings into XBRL. The financial-information firm is banking on the adoption of the standard. "We bet the house on this," says Adams.

So far companies have been supportive of the idea. "It's a natural evolution of technology," says John Stantial, director of financial reporting at United Technologies Corp., another participant in the pilot program. "HTML is a snapshot, a picture with no context. XBRL has taken it to a whole new level, where you can see the context behind the numbers."

The cost of converting to XBRL is expected to be minimal, and most companies will rely on their financial printer to handle the conversion. Adams estimates the cost at an extra $2,000 per filing. — Matt Lynch


Filling the Gap

Consumer-directed health plans that offer high deductibles and tax-advantaged savings accounts have taken off over the past few years. Now, at least one insurer is looking to expand the concept to dental plans. In April, The Principal Financial Group announced it was rolling out dental plans designed to focus on preventive care and increased individual involvement in purchase decisions.

The need for new plans stems directly from the increase in consumer-driven health plans, says Theresa McConeghey, dental product director for Principal. Since health savings accounts (HSAs) can be used to pay for dental care, "there is some concern in the dental industry that employers could get rid of the dental plan." If that happens, she says, employees could neglect dental care in order to preserve their fund balances.

One plan offered by Principal covers only preventive care like checkups and cleanings, while employees could use an HSA to cover the rest or pay for full coverage out of their pockets. The Principal also offers a Website to educate employees, including a dental-cost estimator that lists a range of typical costs for specific dental procedures by zip code.

Whether or not employers will develop an appetite for consumer-driven dental plans remains to be seen. The price of dental coverage actually declined slightly in 2005, according to a study by Mercer, to about $600 per employee. — J.McC.


A Georgia Peach Bests the Big Apple

Looking for an inexpensive place to locate a business? Try Atlanta.

The Georgia capital ranked first in a KPMG survey of the least expensive U.S. cities in which to do business. Tampa and Indianapolis followed closely behind. New York claimed the distinction of being the most expensive city for companies.

The study ranked 23 of the country's largest cities based on 27 cost components, including labor, facility, transportation, and utility costs, as well as income taxes. Atlanta, which boasts competitive labor costs and favorable state tax incentives, was on top with costs 3.6 percent below the national average. Business costs in Tampa beat the average by 3.5 percent. Indianapolis ranked high due to its competitive land and construction costs, as well as favorable transportation costs associated with its central location.

New York, on the other hand, showed high labor and facilities costs, placing its business costs 12.6 percent above the national average. San Jose, Calif.'s high labor costs placed the tech city 8.5 percent above the average and second to last on the list. George Tobjy, senior manager in the Strategic Relocation and Expansion Services practice of KPMG, says high business costs are characteristic of Northeast and West Coast cities. (Boston and Newark were also near the bottom.) But despite their high costs, don't expect a mass exodus. "Cost is one aspect, but many times it's not the most important," he says. "It could depend on access to talent or international airports." — L.D.



Dummy Text

The latest topic in the For Dummies series promises to offer practical advice for CFOs that will take the pain out of Sarbanes-Oxley. While you probably don't want to base your Sarbox compliance on a book that insults your intelligence in the title, Sarbanes-Oxley for Dummies, from Wiley Publishing, does offer some plain-language tips on dealing with the regulations.


Perhaps most helpful are the appendixes that contain sample certifications and a sample audit-committee report. The book does a good job of breaking the act down into bite-size pieces and explaining what each section requires businesses to do. There are also plenty of anecdotes, a list of famous CEOs and CFOs behind bars, and war stories from Enron and WorldCom. Typical of the series, Sarbanes-Oxley includes a good dose of humor. Finance executives will love the cartoons that poke fun at the profession.

Most CFOs will find the book too dumbed down for their needs — it includes a definition of a fiscal year and a description of what board members do — but it would make a great gift for any CEO who wants to know why you've been putting in so many hours.

If this volume fails to impress, finance executives might consider another title in the series that might provide real help: Stress Management for Dummies. — J.McC.




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