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Please Don't Feed the Politicians

Employee campaign contributions; robots reading earnings releases; health-care cost increases slow; temporary accounting help; doing more with treasury; what backdating means for D&O insurance; how to fire someone; fixing immaterial errors; and more.
CFO Staff, CFO Magazine
November 1, 2006

Next election cycle, when an employee makes a personal political contribution, beware: it could harm a company's ability to win government contracts.

Many municipalities and some states are passing so-called pay-to-play rules that are designed to discourage contractors, and in some cases their executives, from contributing to candidates who have the authority to issue or influence government contracts. The rules set limits on contributions or exclude them outright. "For prosecutors, it's hard to show a quid pro quo between a contribution and a contract," notes Wesley Bizzell, an attorney specializing in campaign-finance law at Winston & Strawn. "Pay-to-play rules make enforcement easier and get around the burden of proof."

Illinois is currently considering legislation that would restrict campaign contributions by government vendors. New Jersey's pay-to-play law went into effect in January. And such states as California and Ohio, as well as the cities of Houston, Los Angeles, Philadelphia, San Francisco, and Oakland, Calif., have similar rules in place.

The restrictions could create potential problems for companies that lack diligence in tracking contributions from their executives and political-action committees. Robert Kelner, a partner at law firm Covington & Burling and chair of the firm's election and political law practice group, notes that more companies are starting to subject their political activities to compliance programs. And some are adding a new position — political law compliance officer — to lead the effort. The intense scrutiny comes on the heels of a number of scandals involving campaign contributions and lobbying efforts. For example, prosecutors are still investigating allegations that Mitchell Wade, founder and former CEO of San Diego defense contractor MZM Inc., made illegal campaign contributions to a number of influential lawmakers. He has pleaded guilty to making bribes to former representative Randy Cunningham (R-Calif.), who also pleaded guilty and is serving a sentence of eight years and four months.

Companies are keeping a closer eye on executives' personal political giving as well. In August, Oracle announced that it would offer executives legal assistance on the filing of such contributions. The move will help the software giant avoid running afoul of complex contribution rules. "We've begun to see corporations dedicating manpower and resources to these particular types of compliance issues and amending corporate policies because the cost of noncompliance is getting higher," says Caleb Burns, an attorney at Wiley Rein & Fielding.

Investors, too, are demanding more transparency on political giving. Last proxy season, proposals calling on companies to disclose campaign contributions accounted for nearly 18 percent of all social-policy proposals put to a shareholder vote, according to a report by Proxy Governance Inc.

It is still unclear how strictly pay-to-play rules will be enforced. "I suspect some large companies will get into trouble because they will become aware of [these laws] only when there is a big enforcement action," predicts Kelner. "It might take some time to see how much teeth they have."

Then again, given the combative political environment, it shouldn't take long for one side to demand that the rules be put to the test. — Helen Shaw

States with Pay-to-Play Laws

California, Connecticut, Florida, Hawaii, Illinois, Kentucky, Missouri, New Jersey, Ohio, South Carolina, Vermont, and West Virginia

Local Jurisdictions with Pay-to-Play Laws

Los Angeles, Oakland, San Francisco, and Culver City, Calif.; Philadelphia; Houston; and various counties in New Jersey and California

Source: Skadden, Arps, Slate, Meagher & Flom LLP


When Robots Write the News

As if having their jobs outsourced to India weren't bad enough, finance journalists now face a new threat: software programs that can write stories in less than a second.

Thomson Financial has developed a computerized system that "reads" earnings releases and produces news articles based on their contents. What used to be the job of a cub reporter is now accomplished by a complex algorithm that allows a computer to digest numbers and describe the changes in text, according to Andrew Meagher, director of content development at Thomson.

Reuters began automating some aspects of its financial reporting more than two years ago, but Tom Defoe, head of product management, news production, says the company has been cautious in its approach. So far, Reuters uses computers mostly to scan company announcements for predefined phrases.

Elizabeth Boland, CFO of Bright Horizons Family Solutions, an operator of child-care centers, says automated reporting could induce companies to try to fool the reporter bots. "You may see companies being more artful about wording their releases or making sure they have positive news in the first paragraph," she says.


One concern is that the computerized process could increase volatility, as traders react to the automated reports ahead of the broader release of earnings news. Since companies are required to report GAAP earnings first and then back out extraordinary items, in many cases earnings releases require close analysis to find the meaningful news.

Meagher says the automated system has a human control. "If a company is reporting an abnormal item, we hold off on producing the story until we've talked to an analyst," he says.

Automated financial reporters probably won't render their human counterparts obsolete just yet. "The computer only tells you what's happening," admits Meagher. "It doesn't tell you why." — Kate O'Sullivan


In Stable Condition?

First, the good news: In 2007, employers could enjoy the smallest health-care cost increase since 2000. Now the bad news: that increase is still likely to be much higher than the rate of inflation.

Health-care premiums rose just 7.7 percent in 2006, compared to 9.2 percent in 2005 and 13.9 percent in 2003, according to the Kaiser Family Foundation. A number of experts expect the slowdown in cost growth to continue into next year.

"There's no doubt the trend is toward smaller increases," says Paul Fronstin, a director at the Employee Benefit Research Institute. He says the slowdown is partly due to companies shifting more of the health-care burden to employees. "Costs are also moderating because we haven't seen a lot of new technologies hit the market recently," he adds.

A decline in the cost of prescription drugs has also contributed to smaller price spikes. According to a recent survey from The Segal Co., a benefits consultancy, pharmaceutical costs have declined about 40 percent since 2003.

Given Imaging in Atlanta has enjoyed a slowdown in health-care cost increases over the past five years. Vice president of finance Ed Cordell says Given's costs rose just 5 percent in 2005. But the medical-devices company is still working to contain costs; it offers rewards for nonsmokers and recently adopted a wellness program. "We are trying to help our employees live healthier lifestyles, which could increase savings on our health plan," says Cordell.

But don't pop the cork on the soy milk just yet. Cordell predicts that prices will start to creep up again over the next few years as providers launch new high-tech products. Tom Billet, a consultant at Watson Wyatt Worldwide, says baby boomers could also push health-care costs back into double-digit growth. "We have yet to feel the full effects of the aging population," he warns. — Laura DeMars


Accountants: Going Once, Going Twice

What if companies could bid for temporary accounting help on the Web as easily as Bruce Springsteen fans chase concert tickets on eBay? Now they can.

Slated to launch this month, GreenBrim.com provides an auction service for companies looking for temporary finance and IT help. "Usually, companies call up a staffing firm, take whomever they can get, and pay fees to both the person and the agency," says Robert Stewart, a former auditor and founder of GreenBrim.com. "Now they can pick the person they want and save money."

The site lets companies view profiles of finance professionals, including the prospect's job history, certifications, and education. Companies can also solicit bids for specific projects, such as Sarbanes-Oxley compliance work or a financial-software installation. As on eBay, both parties can provide feedback on the transaction, so workers and companies can build a reputation for reliability. While companies can search free of charge, finance professionals looking for jobs pay a monthly membership fee of $20 to $40 to search and bid for positions.

Last year the demand for temporary accounting and finance staff jumped 23 percent, according to Staffing Industry Analysts, a research firm that follows the temporary-staffing industry. Barry Asin, executive vice president of SIA, estimates that companies will spend about $9.1 billion on temporary finance staff this year.

Nonetheless, job auctions will be a tough sell. "It's a chicken-and-egg problem," claims Asin. "Site membership needs to hit critical mass before many staff seekers will use it." And, he explains, many companies do not have time to sift through profiles to find the right person for the job. "That's why they hire staffing agencies." — L.D.


Backdating Fallout: D&O Coverage

The wave of scandals involving stock-option backdating threatens to push directors' and officers' insurance premiums higher in anticipation of a surge in class-action suits.

So far, restatements related to backdating have led to 19 shareholder suits, with many more expected over the next year. (At recent count, the Securities and Exchange Commission was investigating more than 100 companies for backdating.) Class actions are extremely expensive to defend, notes John Rafferty, manager of the D&O liability practice at The Hartford Financial Services Group.


The scandals could reverse a trend toward fewer class-action securities lawsuits. Just 61 cases were filed in the first half of 2006, the lowest number for a six month period since 1996, according to data from Stanford Law School. It's too soon to tell, though, if the expected uptick in lawsuits will increase D&O premiums across the board. Currently, insurers say they are taking a case-by-case approach, so D&O rates are likely to remain in check for companies with no backdating exposure.

But they'll have to prove it. "Insurers are going to drill down on companies' practices and could look as far back as 10 years," says Steve Shappell, of Aon's financial services group. "If you can't show documentation or explain your practices in detail, you're going to get hit."

The backdating scandal is expected to widen in the coming months. Sen. Charles Grassley (R-Iowa), chairman of the Senate Banking Committee, has vowed to pursue advisers, including lawyers, accountants, and consultants, who promoted backdating as a strategy.

Should the number of backdating cases continue to grow, pressure to raise D&O premiums for all executives will increase. "I think carriers may be downplaying the significance of these investigations, and it could prove more costly than they expected," says Shappell. — L.D.


Beyond Cash Management

Companies are calling on treasury departments to do more than analyze cash and manage risk. In a survey conducted by the Association for Financial Professionals, 91 percent of respondents said the role of the treasury department is expanding. Some of the tasks treasury is assuming include assisting in mergers and acquisitions, SEC compliance, business continuity planning, and management of employee benefits other than pension plans. More than a third (37 percent) of the companies surveyed say they have expanded treasury staffing to take on the additional workload, and another 27 percent have increased the use of outsourcing. The expansion has changed the view of treasury as a cost center at some organizations: 45 percent of the finance executives polled say the treasury department is expected to earn revenues for the company.


Verbatim

"We are at a crossroads where malfeasance in Corporate America has reached an all-time high. This type of conduct simply cannot be tolerated in our society."

— U.S. District Judge Sam Cummings, upon sentencing Jonathan Nelson, former CFO of Patterson-UTI Energy Inc., to 25 years in prison for embezzlement


You're Fired! But Why?

Donald Trump may be good at firing his apprentices, but most companies do a poor job of terminating employees.

A recent survey by The Five O'clock Club, a New York–based job-outplacement firm, found that in many cases, employees don't understand why they are being let go. While 94 percent of human-resource managers say they gave reasons for dismissals, only 74 percent of employees say they received an explanation.

Richard Bayer, COO of The Five O'clock Club, says that often employees are so shocked to hear the bad news that they don't listen to the rest of the conversation. He advises HR managers to call employees the next day to explain the situation and outline their benefits in detail. And, he says, words of encouragement — that their hard work was appreciated, for example — can go a long way toward discouraging a lawsuit. Managers are often afraid to say anything positive, explains Bayer, fearing a wrongful termination suit. "The opposite is true," he says. "Failure to say a kind word is more likely to create a disgruntled former employee."

HR managers agree that they don't do a good job on terminations; 63 percent say they could handle them better. — Gareth Goh

So You Say
HR managers and former employees disagree about dismissal practices.
Was the employee informed of reasons for dismissal?
HR managers who said yes 94%
Employees who said yes 74%
Could the dismissal have been handled better?
HR managers who said yes 63%
Employees who said yes 74%
Would the employee recommend the organization in the future?
HR managers who said yes 50%
Employees who said yes 31%
Source: The Five O'clock Club

Material Whirl


The Securities and Exchange Commission has issued guidance on how to correct errors that have built up on the books over time. In the past, companies dealt with such errors — ones that are too small to fix in any given time period but cumulatively can have a material effect on the balance sheet — in a number of ways. Now, Staff Accounting Bulletin No. 108 explains how to determine if the cumulative errors are material and how to fix them.

Issued in September, SAB 108 could make for larger restatements when a reporting mistake is considered material. That's because companies must now take into account both the cumulative impact of the error on the balance sheet and its effect on the income statement in a given year. In the past, they have generally adjusted the errors on one statement or the other.

Here's an example that the SEC provided with the ruling: a company discovers an improper warranty expense accrual that overstates a warranty liability by $100, accumulated over five years at $20 a year. In each of those previous years, the company considered the misstatement immaterial. In the fifth year, it is quantified as a $20 overstatement of expenses. Typically, a company handles the misstatement in one of two ways. Under the "rollover" approach, the error of $20 would be corrected. Under the "iron curtain" view, it is considered a $100 misstatement based on the balance sheet at the end of the fifth year, and the correction would be to reduce the liability by $100 and to decrease the current year's warranty expense by $100.

The problem? The rollover approach leaves the balance sheet misstated, while the iron-curtain approach misstates the current-year expense. "Neither approach is necessarily going to provide a result that's more satisfyingly right than the other in all circumstances," notes accounting expert Jack T. Ciesielski. "Worse, in practice, firms may use one approach or the other," or at least they could do so in the past.

Starting with fiscal years ending after November 15, 2006, SAB 108 says companies must use both approaches to fix misstatements. In the example, if the $100 error is considered material to the financial statements, adjustment would be required. But if the $100 correction would materially misstate the current year warranty expense, the firm would have to consider restating the prior financial statements for the $80 error. — Ronald Fink


Back Office for Sale

Companies that have opted to build wholly owned shared-service centers instead of outsourcing back-office functions may be sitting on gold mines.

Eager to gain scale in a consolidating industry, service providers are searching for sellers. In September, Capgemini bought 51 percent of Unilever's Indian captive. Earlier this year, the Worldwide Securities Services division of JPMorgan Chase snapped up the back-office operations of the U.S. hedge fund Paloma Partners Management Co. in order to build its own hedge fund services business. Sensing an opportunity for profit, private-equity firms and hedge funds are also on the prowl.

Many companies have a strong incentive to sell, says Chaz Foster of outsourcing advisory firm TPI. As service providers in China, India, and Indonesia expand, workers are increasingly less interested in sticking with the smaller captives. "Experienced employees want to go somewhere bigger because there's more opportunity," he explains.

Companies typically retain a stake in the operation after selling, which could mean extra profit if the commercial venture makes money. For example, GE still owns 40 percent of the successful shared-services operation (Genpact) that it sold for $500 million to two private-equity firms. Sellers typically hire the new owners to continue to provide services to them, often at a reduced cost.

Clearly, a sale isn't always appropriate, particularly if there are security worries or if the work involved differentiates a company in the market. (For these reasons, many financial-services firms are establishing more, not fewer, captives.) But John Halvey, a partner with Milbank Tweed, foresees many more such deals in the coming years. "There are 400 captive entities in India — at least 100 will get spun out," he predicts. "There's economic value in these operations, and at the end of the day, someone will want to unlock it." — Don Durfee


Rule Britannia

Sarbanes-Oxley is one American creation the British are taking pains not to import. UK Economic Secretary to the Treasury Ed Balls made that point clear when he recently proposed granting new powers to Britain's financial regulator, the Financial Services Authority. In an effort to preserve Britain's regulatory authority, the new legislation would enable the regulator to veto any major rule changes proposed by stock exchanges.

Given the New York Stock Exchange's pending $10 billion merger with European exchange operator Euronext and Nasdaq's purchase of a 25.3 percent stake in the London Stock Exchange, many in London's financial markets are concerned that Sarbanes-Oxley could make its way across the Atlantic.

"The government's interest in this area is specific and clear: to safeguard the light touch and proportionate regulatory regime that has made London a magnet for international business," Balls said in a September speech at the Hong Kong General Chamber of Commerce. He has, however, rejected the idea of an outright ban on foreign ownership of the LSE.


Officials at the NYSE and Nasdaq have met with British authorities to confirm that they have no plans to bring Sarbox to England. But the exchanges are not the target of British regulators' concerns. "The question is whether [U.S.] legislation, current or future, will mandate that companies on any American-owned exchange must follow Sarbanes-Oxley," says Julian Franks, professor of finance at London Business School.

Parliament has put the proposal on the fast track by attaching it to an existing bill. The change could become law within a year. For U.S. companies listing overseas to avoid Sarbox, the added protection can't come soon enough. — K.O'S.


Work/Life: Please Don't Thank Me

A recent survey found that 81% of executives say they are connected to work through mobile devices (cell phone, PDA, laptop, or pager) all of the time. The survey, conducted by Korn/Ferry International, also found that 38% of executives say they spend too much time connected to communication devices. One way to cut down on a small portion of E-mails: encourage co-workers not to send messages that just say "Thanks."




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