Risk & Compliance

SEC Implementing Sarbanes-Oxley

New rules would require companies to explain pro forma results, off-balance-sheet deals; will MD&As become novellas? Elsewhere: Fastow on the cusp,...
Stephen TaubOctober 31, 2002

The Securities and Exchange Commission took another big step toward implementing provisions of the Sarbanes-Oxley Act.

On Wednesday, the commission proposed a number of critical rules regarding pro forma results, off-balance-sheet entities, and executive stock-trading.

The commission is seeking public comment for 30 days. Then the rules will be published in the Federal Register.

Under the proposals governing pro forma results, companies that issue non-GAAP financials must explain how those numbers differ from results using generally accepted accounting principles.

In addition, pro forma results must not mislead investors.

The SEC also proposed rules that require the disclosure of all material off-balance-sheet transactions, as well as disclosure of arrangements, obligations, and relationships with unconsolidated entities. The commission wants public companies to present such information in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section of a company’s regulatory filings.

The rules, an outgrowth of the Enron scandal, would affect an estimated $3 trillion in off-balance-sheet debt, according to Bloomberg.

“While off-balance-sheet arrangements can have a legitimate business purpose, they can also be extremely complicated, can mask financial problems or the true state of a company’s financial health, and they can have drastic consequences,” said SEC commissioner Cynthia Glassman.

The proposal would require companies to present tables identifying when their obligations—including debt, leases, lines of credit, and guarantees—mature over at least the next five years, Bloomberg reported, citing SEC officials.

In addition, the SEC yesterday proposed rules that would limit the ability of executives and directors to sell stock in retirement plans such as 401(k)s. The commission would bar such sales during a blackout period—if that period lasts more than three consecutive business days and if a company temporarily suspends the ability of at least half of the plan participants to conduct any stock transactions.

Fastow Indictment Coming Soon?

Back in November, management at Enron Corp. first acknowledged that it had improperly kept more than $600 million in debt obligations off the company’s balance sheet. In what was a jaw-dropping announcement at the time, Enron management noted that financial statements from 1997 through the third quarter of 2001 “should not be relied upon, and that outside businesses run by Enron officials during that period should have been included in the company’s earnings reports.”

One of the “Enron officials” running the off-balance-sheet entities was then-CFO Andrew Fastow. Indeed, Fastow reportedly made $30 million overseeing those unconsolidated businesses—businesses that eventually forced the Houston energy company into bankruptcy.

It’s been almost a year since Enron’s stunning announcement, and Fastow still has not been indicted for his apparent role in the Enron debacle. In fact, some are wondering if Fastow will he ever be charged with a crime.

Yesterday, the 24-hour TV news channels were proclaiming that Enron’s former chief financial officer would be indicted by the end of the day. He was not.

Now the wire services are running stories predicting that Fastow is about to be indicted. Reuters reported late Wednesday that he would be indicted “soon” by a federal grand jury in Houston on fraud and other criminal charges, citing sources familiar with the case. In fact, they say the indictment will be handed down today.

As CFO.com reported, the Justice Department brought a criminal complaint against Fastow on October 2, accusing him of engaging in securities, wire, and mail fraud as well as money laundering.

But that’s just a complaint. Prosecutors have 30 days to obtain a grand jury indictment. The 30-day deadline ends today, according to reports.

Fastow is currently free on a $5 million bond.

Michael Kopper, who was a close aide to Fastow at Enron, pleaded guilty to two counts of conspiracy in U.S. District Court in Houston in August. It’s widely believed that prosecutors convinced Kopper to roll over on his former boss.

Bond Issuance Down

So much for declining interest rates buoying corporate bond issuance.

According to Standard & Poor’s rating service, the dollar volume of bond issuance for U.S. nonfinancial companies is down by one-third so far this year (to $251 billion), even though interest rates continued to decline during that period.

This comes on the heels of a blockbuster year, when a large number of companies refinanced bank debt and higher coupon public debt.

In fact, during the past two years, U.S. nonfinancial commercial paper outstanding plummeted more than 50 percent to $161 billion as many issuers refinanced and extended maturities in the bond market

“In addition to dwindling refinancing this year, high levels of issuance by telecommunications, media and entertainment, and health-care companies have been cut in half,” noted Diane Vazza, head of Standard & Poor’s global fixed-income research.

What’s more, new issuance doesn’t figure to pick up due to diminishing expectations for a recovery in capital spending. The reasons for these lower expectations? Weak demand, a continued capacity glut, and corporations’ attempts to eke out productivity gains.

“Even though inventory levels are likely to be rebuilt from extremely low levels, the appetite for new business capital spending still appears minuscule, judging from weak nonresidential fixed-investment spending and depressed capacity utilization levels,” added Vazza.

She also predicted that U.S. corporate credit quality will remain constrained by earnings pressure due to the lackluster global economic environment, the likelihood that more companies will become embroiled in questionable accounting practices, and renewed concern about the strength of the underlying economic fundamentals.

What’s more, lackluster growth has depressed corporate cash flow, limiting the ability of companies to reduce their indebtedness.

S&P pointed out that about 35 percent of U.S. nonfinancial companies have either a negative outlook or are on credit watch with negative implications. Last year that figure was closer to 30 percent. As a result, downgrades will continue to outpace upgrades.

The most credit-challenged sectors: capital goods, metals and mining, aerospace and defense, transportation, media and entertainment, high technology, automotive, retailing, and—surprise—telecommunications.

Another Round of Layoffs

While the recent stock market rally seems to indicate that the economy might be in recovery, a number of companies are still in siege mode.

Yesterday, several high-profile companies announced substantial layoffs.

Management at EDS said it will can as many as 5,500 employees, or 4 percent of the company’s total workforce.

Corning also said it will cut another 2,200 jobs as that company closes more production facilities due to weak demand. Corning had already eliminated 4,600 jobs this year. In 2001, the company eliminated 12,000 jobs.

Boeing Co.’s shared-services division plans to trim 1,200 to 1,500 jobs in the next six months through layoffs, attrition, and elimination of contract workers. The cuts account for 9 percent of the total workforce of the division, which handles computing, telecommunications, building maintenance, and other in-house jobs.

Also yesterday: Earthlink indicated it will cut 250 jobs in an effort to consolidate operations and cut costs.

Good Time to Sign a New Lease

If your company is looking to move, lower its rent, or improve its lease, now would be the time.

According to Colliers International, a global commercial real-estate company, incentives are once again readily available as the nationwide office vacancy rate climbed to 16.2 percent during the third quarter of 2002.

Colliers found in a survey of eight markets nationwide that tenant incentives actually returned to the market six to nine months ago.

Incentives are being offered for both new and sublease space, according to Colliers.

“Between 60 percent and 100 percent of lease transactions now include some sort of tenant incentive,” said Ross Moore, vice president and director of research at the company.

The most popular inducement: free rent or partial free rent. The no-payment plans usually last for three to six months. In some cases, however, landlords are offering free office space for up to a year on a five-year lease. Other inducements include above-standard tenant improvement allowances and, in some cases, free parking.

Brokers are also once again receiving incentives, according to Colliers.

The most common offerings are accelerated commissions, such as 125 to 150 percent of a standard commission. Free trips, prepaid car leases, bonuses for showing properties, and faster payouts on commissions are also being offered.

SEC Settles with Controller

The SEC yesterday settled civil charges against Stephen R. Becker, a regional controller at EA Engineering, Science, and Technology Inc. Becker was charged with violating the antifraud, periodic reporting, and corporate record-keeping provisions of the federal securities laws.

The commission alleged that during the fiscal year ended August 31, 1999, Becker concealed project contract losses at EA Engineering by intentionally recording fictitious revenue in the form of unbilled accounts receivable on the company’s books. Becker was thereby able to conceal the losses from management at EA.

According to the SEC, EA management had emphasized the importance of the company hitting its projected earnings targets.

As a result of the phony entries, EA overstated its unbilled accounts receivable at the end of the May 31, 1999, quarter by about $1.4 million, and by nearly $1.5 million at the end of its 1999 fiscal year.

As part of the settlement, Becker agreed to pay a $20,000 civil penalty.

EA Engineering, an energy, environmental, and health and safety consulting company, went private through a management buyout in 2001.

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