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Mend the GAAP

Simplifying financial reporting; prosecuting CFOs; finding board members; gaining proxy access; regulating rating agencies; fixing Fx; social networking; and the high cost of clean data.
CFO Staff, CFO Magazine
September 1, 2007

Is there a direct link between the complexity of the current financial reporting system and the large number of restatements among public companies?

That was the major question hovering over the first meeting of a committee charged with simplifying financial reporting. The Advisory Committee on Improvements to Financial Reporting is made up of current and former CFOs, professors, securities lawyers, investor advocates, and audit-firm executives (see the list at the end of this article). It was created at the behest of the Securities and Exchange Commission and will examine a host of issues, including how the Financial Accounting Standards Board and the Public Company Accounting Oversight Board work, the debate over principles-based versus rules-based accounting, and the consequences of giving auditors more leeway to use professional judgment.

Several participants noted that 10 percent of public companies restated their financials in 2006. Robert Pozen, chairman of MFS Investment Management and of the advisory committee, recommended that a subcommittee be formed to address whether the glut of restatements stems from an overly broad definition of materiality, increasingly detailed accounting standards, or some other issue. Data from a commission formed by the U.S. Treasury may shed light on why the number of restatements has risen so dramatically; its report is expected in the first quarter of 2008.

There was also no shortage of reasons floated for the current situation, encompassing everything from management fears of being second-guessed by auditors and regulators to poorly written rules to conflicting interpretations of and guidance on those rules. Collectively, members noted, all the guidance and related bulletins, speeches, and letters amount to what Pozen described as "too much GAAP running around," adding that "we need to figure out what is and isn't GAAP and grab hold of it."

There are certainly plenty of things to figure out. In particular, FASB's rules on hedge accounting and fair-value accounting have caused widespread misunderstanding.

The members questioned whether MD&A disclosures should be improved and if earnings releases, which often include non-GAAP financials, should be included in regulatory filings. Also discussed: how the ongoing FASB — International Accounting Standards Board convergence project might affect complexity and how to advance the XBRL data-tagging system.

The committee plans to present a list of 12 recommendations to the SEC next August. Despite the premium placed on simplifying financial reporting, Joseph Grundfest, a professor at Stanford Law School, suggested that the group not go too far. "Sometimes, to describe a complicated transaction, you have to give a complicated answer," he said. If you force everyone to give "a simple yes-or-no answer to a complicated question, then you can end up forcing someone to lie." — Sarah Johnson

The CIFR Members

Fraud by the Numbers

This year marks not only the five-year anniversary of the Sarbanes-Oxley Act but the same milestone for the President's Corporate Fraud Task Force. Announced in July 2002, the task force is chaired by Deputy Attorney General Paul J. McNulty and includes senior Department of Justice officials and seven U.S. attorneys, along with heads of the departments of Treasury and Labor and of the Securities and Exchange Commission, Commodity Futures Trading Commission, Federal Energy Regulatory Commission, Federal Communications Commission, U.S. Postal Inspection Service, and the Department of Housing and Urban Development's Office of Federal Housing Enterprise Oversight.

The group celebrated the occasion by issuing a scorecard of sorts that quantified the number of senior executives convicted (see "Busted" at the end of this article). While the group noted in a report that it "has compiled a strong record of combating corporate fraud and punishing those who violate the trust of employees and investors," its primary role is to coordinate the enforcement efforts of various federal departments. Several high-profile CFOs, including Enron's Andy Fastow and WorldCom's Scott Sullivan, were not on the list, because their cases were handled by a fraud team within the U.S. Attorney's office.

The charges brought have included securities fraud, insider trading, market manipulation, false statements, stock-option backdating, conspiracy, money laundering, and violations of the Foreign Corrupt Practices Act. In addition to the convictions, the task force noted, more than $1 billion in forfeitures has been distributed to victims of corporate fraud.

The task force cited the role that Sarbox played in facilitating convictions (or, more precisely, plea deals, which occurred in more than 75 percent of cases), although only three CFOs were convicted based on direct violations of Sarbox. New securities-fraud provisions from Title 18 of the U.S. Code, Section 1348, played a role in more than 50 cases. — Kate Plourd

Among the 1,236 people convicted by the Task Force were:

* For a complete list of those convicted, click here.

Matchmaker, Matchmaker


OK, scratch that last sentence, but the first part is no fantasy. Nasdaq has unveiled a new way for companies and finance executives to hook up over open board seats and possibly make long-term commitments.

Launched in June, is an online board matchmaking service available to both public and private companies. Potential candidates and firms create profiles on the site and Nasdaq initiates meetings once mutual interest is established. According to Bruce Aust, executive vice president of Nasdaq's Corporate Client Group, the service offers a new way "to harness [potential board] talent" at lower cost while providing more-direct access between companies and candidates.

As of July, some 1,500 potential candidates had signed on — 60 percent of whom had prior board experience. Betsy Atkins, CEO of venture-capital firm Baja LLC (and a member of four public-company boards), says the service will be a great way to assess new opportunities. But Russell Lavoie, CFO of Framingham, Mass.-based Computer Corp. of America, notes that the service may not be right for some sectors, such as high-tech start-ups, where board recruitment "depends very much on word of mouth" and is based more on candidates who have access to capital or contacts.

Peter Gleason, COO and director of research for the National Association of Corporate Directors, believes there is a place for it, especially since traditional search firms tend to seek out candidates only in the "upper echelons" of Corporate America. (The NACD offers a similar — and free — service for its members.) He cautions, however, that companies must be prepared to vet candidates closely — something that search firms routinely handle for their typical $125,000+ fee. Nasdaq charges a one-search fee of $10,000 or an unlimited annual subscription of $15,000, plus a contingency fee of $20,000 for each introduction that results in a placement. — Lori Calabro

Battling for the Boardroom

The debate over so-called proxy access is intensifying as shareholder activists and pension funds push for the right to nominate directors even as business lobbyists counter that granting that right could create boards that are beholden to special-interest groups.

The tension was obvious during a July Securities and Exchange Commission meeting that ended with the commissioners voting to put forth two different rules for public comment. It was the first time since Christopher Cox became chairman that the commissioners have been divided. Members of the Senate Committee on Banking, Housing, and Finance later criticized the SEC for releasing what Sen. Jack Reed (D–R.I.) called "diametrically opposed" proposals.

The commission's two Republican members, together with Cox, voted to propose a rule that essentially restates the SEC's existing position, which is that companies may exclude any shareholder proposals pertaining to director nominations.

In an unusual move, Cox also voted with the two Democrats on the commission to put forth a new rule that would allow shareholders or groups of shareholders who have held more than 5 percent of a company's stock for a year to recommend changes to company bylaws allowing shareholders to nominate director candidates.

Shareholder activists may not cheer, however. Many say a 5 percent stake in a large public company could be a prohibitively high threshold. Still, says Stanley Keller, a partner with Edwards Angell Palmer & Dodge, "my guess is people will be happy to have that, as opposed to no access. If there's enough dissatisfaction, I think there are enough blocks of stock that could [collectively] reach the 5 percent threshold."

Cox wants a rule in place in time for the 2008 proxy season and cited that timetable as the reason for releasing two divergent proposals. With the commission divided, his vote is likely to determine which rule will win. — Kate O'Sullivan

The Sense of Recognition

Even as the final rules contained in the Credit Agency Reform Act of 2006 were being adopted in June, the subprime-mortgage meltdown was under way, offering an Enronesque reminder of how credit-rating agencies sometimes fail to sound adequate alarms. Ironic, then, that the Securities and Exchange Commission was in the midst of implementing a new registration process requiring all credit-rating agencies to reapply for official status as NRSROs (nationally recognized statistical rating organizations). The process is expected to foster more competition and transparency in the clubby world of rating agencies, but some question if that is enough.

"Having more rating agencies is critical," says James Kaitz, CEO of the Association for Financial Professionals, which vigorously lobbied for the act, "but even more critical is that the SEC play a more active role."

The reform act, passed in 2006 and modified in 2007, gives the SEC authority to grant the NRSRO designation and to oversee how NRSROs operate. In applying for the NRSRO seal of approval, agencies must now furnish information on how they address potential conflicts of interest, such as getting paid by companies they rate, helping underwriters structure securities, or other activities that could presumably affect the agencies' ratings.

The larger question is whether the SEC will use its increased powers to head off a repeat of the subprime situation. At a Senate Banking Committee hearing on July 31, Sen. Jim Bunning (R–Ky.) asked SEC chairman Christopher Cox pointblank about the subprime debacle, saying, "I am trying to get to the bottom of this." Asked by committee chairman Christopher Dodd (D–Conn.) if the SEC has enough authority over the credit agencies, Cox said yes.

But so far the SEC has not flexed that newly won muscle. And to date, the only companies applying for NRSRO status under the new rules are those that enjoyed that status under the previous system, with one exception: Egan-Jones Ratings Inc., which has long sought NRSRO status, is now pursuing the designation. Unlike the other big players in the field, it earns fees from investors rather than the companies it rates. — Avital Louria-Hahn

Survey Says Fix Fx

You might expect that as U.S. corporations become increasingly global, they quickly develop effective systems to manage foreign currency exposure. They don't, at least according to Fx software vendor FIREapps. Foreign exchange (Fx) is a complicated area that few companies understand or manage well. A reliance on manual systems is just one part of the problem.

In a survey of more than 100 U.S.-based multinational corporations, FIREapps found that fully 98 percent had significant errors in their Fx spreadsheets, errors that ran the gamut from missing entities and income to incomplete calculations. Worse, says Andrew Gage, director of marketing at FIREapps, is that in 13 percent of the cases companies inverted numbers on a hedge. That means they were short where they should have been long and vice versa.

This probably wouldn't surprise most of the respondents: the majority of the Fx managers surveyed said they don't trust their own data or the systems that supply it. Assumptions underlying the numbers were also suspect.

In addition to the risk of mistakes and failure to meet FAS 52 requirements (which govern foreign currency translation), companies can pay in other ways as well. For example, the study found that companies that don't fully understand their exposure end up buying 30 percent more derivatives than they need. Lack of experience and high turnover within the Fx community contribute to the challenge of developing more-effective Fx systems. — A.L.-H.

The High Cost of Clean Data

With several studies over the past three years showing that chief information officers regard business intelligence as their top priority, you might expect a stronger CFO-CIO relationship to be close at hand. But a recent Accenture survey found that CIOs regard funding limits as one of the top obstacles to pursuing ambitious information-management projects. The goal of information management is to provide more workers with access to higher-quality data that is more secure and better governed, and can help power the nascent move toward analytics (the linking of various metrics to drive business performance).

Seventy-five percent of the 160 CIOs in North America and Europe who were surveyed said they aim to develop an overall information-management strategy in the next three years, versus 25 percent focused on such a strategy today. But the CIOs ranked a lack of funding, along with poor data quality, as the top barriers to their plans.

The two hurdles are closely related. "Across any industry, the number of people needed to transform, aggregate, and cleanse data is much higher than companies realize," says Greg Todd, senior executive with Accenture's Information Management Services group. Further complicating the equation is that, while the cost of the ERP systems that provide much of the data that business intelligence and analytics efforts need is high, at least it's quantifiable. These newer information-management efforts are, according to Forrester Research analyst Boris Evelson, multilayered and far from commoditized. "It's an art, not a science," he says. Worse, perhaps, from a CFO's point of view is his warning that information management "is not a finite project." Todd says attacking it piecemeal drives up the cost. — Allan Richter

Correction: The print version of the article "Social Studies," which appeared in the September 2007 print edition of CFO magazine, incorrectly states the number of clients surveyed by SelectMinds. The correct number, 60, appears below.

Social Studies

Social networking sites aren't just for Generation Y anymore. Increasingly, companies are finding them invaluable for recruitment, retention, and even for landing new business.

Many companies already use such popular social networks as Linked In, inCircle Pro, and QuietAgent to recruit new hires. A new twist is the rise of internal social networks designed to help employees connect with co-workers, alumni, and potential clients. Offered by vendors including SelectMinds and Visible Path, these networks are "all the rage," according to Jason Corsello, vice president of the Center of Excellence at HR consultancy Knowledge Infusion. Employees create personal profiles that include education, work history, current projects, personal interests, and other data, and can then link to those who share something in common. Such communication takes place over a closed network, ensuring that, for example, sensitive information about job openings or business plans is restricted to approved parties.

Such networks can help companies "on-board" new hires, Corsello says, by providing them with a quick way to learn about their co-workers and the company's goals and culture. Social networks can also help remote, part-time, and field workers feel more connected to the organization. And access to such networks can be expanded to include customers.

Law firm Goodwin Procter's use of SelectMind's alumni tracking network helps it stay connected to successful alumni such as Massachusetts Attorney General Martha Coakley, who recently returned to the firm to give a well-received presentation. Director of professional development Scott Westfahl says that by highlighting the subsequent careers of former associates, the network has aided new-associate retention.

Of course, former employees can do more than just return for a pep talk. One accounting firm says its use of SelectMinds to stay connected to former employees helped it pull in $180 million in new business. SelectMinds says a survey of 60 of its clients revealed an average 11.7 percent increase in new business from the use of social networks. Cost for the software varies depending on a company's size and type of network. A small company could pay a $15,000 start-up fee with an $8,000 monthly subscription. — K.P.

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