Race to Reform

CFO Bob Davis and his cohorts have nine months left to clean up Computer Associates.
Alix StuartJanuary 3, 2006

Trapped for four hours on a flight packed with irritable travelers waiting for takeoff in Washington, D.C., Bob Davis couldn’t help but wonder if the delay was an omen. He was on his way to a job interview. Even before the flight he’d had qualms, but as he sat on the runway as the hours ticked by, he really started to worry. Forty-five years old at the time, Davis had nimbly scaled the corporate ladder to win the job of chief accounting officer at Dell Inc. Then came a call from a headhunter asking him if he would consider going to Computer Associates International Inc., the Islandia, New York–based software giant rocked by an accounting scandal. Part of the allure was a chance to work with Jeff Clarke, CFO of Computer Associates, whom he had met years earlier when Clarke was CFO of Compaq Computer Corp. But taking the post would mean joining the cleanup crew at a very messy corporate crime scene.

As he fretted about the risks of the new job, things got worse. Bad weather forced the aircraft to divert to Syracuse, New York, for several hours before finally landing at New York’s LaGuardia Airport. At 3 A.M., Davis arrived at his hotel to find no room at the inn. Sent across town to a fleabag motel, he had time for only a half-hour nap before showering and shaving for a full day of interviews. But despite the rocky start, Davis was intrigued by the opportunities at CA, as the company is now officially known. Three months later, lured by a pay package that could be worth $2.3 million or more over the next two years, he joined the company.

As chief financial officer, Davis is a key member of the team working to resurrect the $3.5 billion company. Once one of the stars of the software industry, CA crashed in 2002 when federal regulators charged certain top executives with falsifying financial records in a $3.3 billion fraud that began in 1998. Now operating under an innovative legal deal called a deferred-prosecution agreement, or DPA, CA’s executives are racing to complete reforms while bolstering the company’s core business in an increasingly competitive software market.

Davis has joined a group of heavy hitters. CA’s CEO is John A. Swainson, 51, a 26-year veteran of IBM Corp., where he had held key product-development and sales jobs. CA’s chief operating officer is Clarke, 44, who became executive vice president of global operations for Hewlett-Packard Co. after it acquired Compaq in 2002. Of CA’s top 35 executives, half were recruited within the past two years. “It’s definitely a new CA,” says Jean-Pierre Garbani, a vice president at Forrester Research Inc., a technology- and market-research firm in Cambridge, Massachusetts. “But the company’s success depends on how well they execute, and it’s too soon to know that yet.”

The Watchful Overseer

The deadline looms. By September 30, CA will have had to fulfill a host of obligations or else face charges of fraud and obstruction of justice under terms of the DPA. Some $80 million worth of financial-reporting software has to be installed and functioning adequately. CA’s finance department must be reorganized and strengthened. Although CA has met many of the terms of the DPA, such as hiring a chief compliance officer and controllers for each of its five business units, much work remains to be done.

Meanwhile, CA is laboring under the watchful eye of an overseer. The DPA specifies that CA’s rehabilitation is subject to the scrutiny of a court-appointed independent examiner, Lee S. Richards. A partner in the law firm of Richards Spears Kibbe & Orbe LLP in New York, Richards, who declined to be interviewed for this article, maintains an office at CA’s headquarters. His reports to the board, the court, and federal agencies are confidential. CA would not disclose what, if any, recommendations he has made to the new executive team.

CA also must mend its reputation with customers, shareholders, and Wall Street. One of its largest institutional investors is Private Capital Management LP, a unit of Legg Mason, which holds 11.6 percent of CA and has been accumulating shares since 2000. The money manager made headlines recently by forcing Knight Ridder, the newspaper chain, to put itself up for sale. Through a spokesman, PCM declined to comment on CA. CA still faces the wrath of other angry shareholders who have filed lawsuits against the company, among them Texas billionaire Sam Wyly.

So the job is a risky bet for Davis. After all, the finance department was the scene of the crime — and the cover-up — at CA. Much of the work of rehabilitation rests squarely on his shoulders. If successful, the financial payoff could be big. CA lured Davis with a signing bonus of $275,000. His base annual salary is $525,000. If he meets certain targets, he will earn a bonus in his first year of $525,000. CA also has promised him $2.2 million in long-term incentives such as stock options and restricted stock. But Davis says the move wasn’t just about the money. “It was frankly about the opportunity,” he says. “There was limited opportunity to move up at Dell.”

Still, colleagues were surprised when he took the job. James Schneider, CFO of Dell and his former boss, admits he was baffled when Davis announced he was leaving Dell for CA. Davis is “a good, solid guy,” says Schneider, “but I wouldn’t have thought of him as a risk-taker.” (Dell had been very generous with Davis. He made approximately $3.1 million by cashing in his stock options in 2003 and 2004.)

Building a Strong Team

Known for his technical accounting skills, Davis began his career at PricewaterhouseCoopers LLP in 1980, working on audit and regulatory matters in Washington, D.C. After getting his MBA at Columbia Business School, he joined MCI as senior manager in the corporate controller’s group in 1994. Schneider, who was also at MCI at the time, says that he would often pull Davis in to work on projects for him, although Davis did not report directly to him. Schneider left to join Dell in 1996. Several months later, Davis, in pursuit of fresh challenges, joined Dell as vice president of worldwide finance and planning for the enterprise systems group.

At Dell, Davis rose through the ranks to become chief accounting officer in part by contributing to the company’s famously disciplined growth strategy. “When I look at who really helped us get to where we are, Bob is one of the core guys,” says Schneider. Among other things, Davis installed sophisticated software systems that provided top executives with detailed financial data so they could make better strategic decisions for Dell.

At CA, Davis is focusing on building a strong team and improving internal systems. One top priority: clearing up the three material weaknesses that stand in the way of a clean 404 opinion. With cash flow of about $1 billion a year, Davis says, CA is in a strong financial position. But, he adds, “there’s plenty of opportunity to get the company growing and more profitable.”

Davis is working closely with Clarke, who had championed Davis at CA. Clarke joined CA as CFO in 2004 and is experienced in complex corporate-restructuring projects. He led the team overseeing one of the biggest mergers in the history of the computer industry: Hewlett-Packard’s $19 billion acquisition of Compaq Computer. Like Davis, Clarke has a hefty pay package from CA that could be worth $4.5 million over the next two years.

Indeed, CA’s generosity to its new executive team is stirring controversy among shareholders and corporate watchdogs. CEO Swainson could earn as much as $12.8 million over the next five years. “CA’s board has not yet learned either restraint or resistance” when it comes to compensation, says Nell Minow, co-founder of The Corporate Library, in Portland, Maine, a research firm that rates companies based on corporate-governance practices. Christopher Lofgren, a CA board member and president and CEO of Schneider National, a transportation and logistics company in Green Bay, Wisconsin, defends the company’s pay packages. Seasoned executives with impeccable reputations command a high price in today’s market, he says.

In his one-year tenure as CA’s CFO, Clarke began cleaning up the finance department while working with the board to negotiate the deferred-prosecution agreement with the SEC and the Department of Justice. He restated financial results for fiscal years 2000 and 2001 and began to clamp down on sloppy internal financial procedures. He also helped craft a restructuring plan that involved cutting 5 percent of the workforce and oversaw the $439 million acquisition of Netegrity, a network security software company in Waltham, Massachusetts. Clarke relinquished the title of CFO after Davis came on board in early 2005, and remains COO, a title he garnered in April 2004.

With the independent examiner looking over his shoulder these days, Davis says there’s a heightened “sense of urgency and momentum” on often-tedious compliance work. Richards and the team he has hired to review finances at CA “don’t pull any punches if they see issues,” says Davis. Most of their inquiries, he notes, involve matters that are now part of the routine at CA. “The DPA is basic blocking and tackling for finance,” he says. “If we can’t comply with the DPA, we’ve got bigger issues.”

Imperial Court of China

CA has formed a review group that circulates drafts of quarterly reports to 70 senior managers in its finance, legal, and sales departments before the documents are filed with the SEC. Controllers now oversee the finances of the company’s five business units. The executive roster includes a controller, a chief accounting officer, a new head of internal audit, and a new separate office for financial planning and analysis. Within the finance department, there are 100 subcertifiers for financial statements, which “drives down accountability,” says Davis.

Changing CA’s culture is another priority. Under Charles Wang, who founded the company in 1976, CA was run like the Imperial Court of China. Only a few top executives held decision-making power and there was no effective enterprisewide data system. In fact, CA was a breeding ground for fraud in part because its management and technology couldn’t keep pace with its rapid growth in the 1990s.

Federal investigators say the fraud began in 1998 when company executives started backdating sales contracts to boost their bonuses. Wang resigned as chief executive in 2000 but remained as chairman until his resignation in 2002. He was not charged with any wrongdoing in connection with the scandal.

Davis and his colleagues are trying to push accountability deep down into the organization. “We want a team that’s empowered,” he says. Toward that end, Davis says he has hired close to 150 staffers. A new employee “ethics hotline” has received 22 calls since it was established in April. Meanwhile, Davis encourages staffers to E-mail him directly, and holds informal monthly breakfast meetings with small groups of them.

CA is also working to fortify its product line and integrate the companies it has acquired recently. In the past two years, CA has spent $1.2 billion to snap up eight software businesses, including Netegrity; iLumin, a storage-management software company; Niku, an IT-management software company; and Concord Communications, which makes network-monitoring products.

In November, CA introduced a new version of Unicenter, its popular suite of integrated software modules, a move that the company hopes will help propel growth. For the six months ended September 30, 2005, CA’s revenues increased 8 percent, to $1.8 billion, though $73 million was due to currency gains and its two most recent acquisitions. Net income was $135 million, compared with a $51 million loss in the six-month period last year.

Despite the strong results at CA, many industry analysts are reserving judgment. Some are concerned about a slowdown in the market for mainframe software, CA’s primary market. Others are concerned that the product line is dated and lacks true innovation. “It’s wait-and-see,” says Kim Caughey, an equity analyst covering software companies for Fort Pitt Capital Group, in Pittsburgh, which holds a stake worth $11.5 million in CA.

Davis, however, takes such skepticism as a spur to put the overhaul into overdrive. In fact, he says the most stressful part of the job for him is “making sure the urgent doesn’t drive out the important,” such as his long-term goal of creating a training, mentoring, and development program for his finance staff similar to the popular ones at Dell, Cargill, and GE. “When someone graduates from college, I want CA to be on their short list for employment,” says Davis. And so long as the candidates don’t have the travel nightmares Davis faced on his first trip to CA, he’s confident he can win them over. “We may be hitting on only three or four of six cylinders right now,” he says, “but we’re starting to move things in the right direction.”

Alix Nyberg Stuart is senior writer at CFO.

Test Case for DPAs

CA was one of the first companies to be allowed to restructure under a deferred-prosecution agreement (DPA). Since CA’s DPA in 2004, about a dozen more companies have cut similar deals, including the accounting firm KPMG and insurance giant American International Group Inc. Under a DPA, the feds achieve a kind of coerced cooperation. To avoid prosecution, companies admit wrongdoing, promise reform, and help prosecutors convict the insiders responsible for the illegal activity. As one of the first to negotiate a DPA, CA is being watched closely by the financial and legal communities.

DPAs could “achieve a host of beneficial results — admission of guilt, restitution for victims, a disciplined process of internal reform — without causing the adverse consequences that come along with a full prosecution and conviction,” says David Pitofsky. Pitofsky was the lead federal prosecutor who helped broker the deal with CA, and is now a partner in the New York office of law firm Goodwin Procter LLP. “The consequences of failing are horrific for a company,” says Pitofsky. “They’ll move heaven and earth to fix problems” reported by the independent examiner. For CA, the stakes are high because it is one of the most prominent companies to negotiate such a deal. Federal regulators will use the company as a test of the DPA’s effectiveness. — A.N.S.

Some other companies that have avoided trials thanks to deferred-prosecution agreements.
Date Brokered Company Key Terms and Deadline
3/04 WorldCom (now MCI) Accused of a massive accounting fraud, MCI will pay shareholders $750 million in 2006, and must add 1,600 jobs to its Oklahoma workforce by 2014.
4/04 Adelphia Accused of a massive fraud, Adelphia agreed to pay shareholders $715 million when it emerges from Chapter 11.
11/04 AIG Accused of fraud, AIG agreed to pay shareholders $46 million and $80 million in fines by December 2005.
12/04 Time Warner Accused of fraud, the AOL unit must pay its former shareholders $150 million and $60 million in fines by December 2006.
1/05 AEP Accused of manipulating energy markets, AEP will pay $81 million in fines by March 2006.
1/05 Monsanto Accused of bribing foreign officials, Monsanto will pay $1 million in fines and retain an independent compliance expert to boost controls by January 2008.
3/05 Micrus Accused of bribing foreign doctors to tout its medical devices, Micrus must pay $450,000 and strengthen internal controls by March 2007.
6/05 Bristol-Myers Squibb Accused of fraud and conspiracy, BMS must pay shareholders $839 million and endow a chair in ethics at Seton Hall Law School by June 2007.
8/05 KPMG Accused of selling fraudulent tax shelters, KPMG paid $456 million in fines and restitution, and must strengthen controls by December 2006.
Sources: Department of Justice; companies