Tax Departments:Technology Review Time

Plus, Board members wanted; beware the consequences of stock-option recissions; complying with the Health Insurance Portability and Accountability Act; E-commerce barter; and more.

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Now even boardroom denizens are discovering firsthand what a tight job market feels like. As companies demand more of directors in terms of time and responsibility, it becomes increasingly difficult to find people who want to serve, says Susan F. Shultz, president of SSA Executive Search International Ltd., in Phoenix, and author of The Board Book.

Shultz estimates that for every board they serve on, executives spend 15 to 20 days a year away from their primary job responsibilities. That’s just too many for some companies. General Electric Co., for one, discourages its executives from sitting on other boards, citing the time factor as the
reason.

The job squeeze is pushing many companies to hire recruiters to help fill vacant director seats. Shultz says she has seen a “definite” increase in the number of director search requests over the past few years.

Using recruiters may actually improve the board, notes Ken Bertsch, director of corporate governance for TIAA-CREF. Doing so widens the pool of candidates and increases diversity, he explains. – Joan Urdang

TAX DEPARTMENTS

Technology Review Time

Corporate tax departments have been the forgotten stepchild of financial IT innovation–until now. According to a new survey by KPMG LLP, 70 percent of the Fortune 1,000 tax directors polled say they are currently leading radical restructuring efforts focused on using technology to reduce paper and manual data entry. “This is the type of reengineering that happened five years ago in other departments,” says Steve Martucci, a partner in KPMG’s Tax Management Solutions Practice. “Many companies are still just dealing with drawing financial accounting directly into tax software.” And few companies are even close to being able to reorganize data electronically or leverage corporate intranets for
tax purposes.

Reducing the effective tax rate (ETR) is the goal of nearly half the 273 tax directors surveyed. Increasing cash flow, tax compliance, tax deferral, and audit defense are the other top objectives. And while technology upgrades don’t directly reduce ETR, they can free up time for tax staff to focus on tax strategies. For instance, before Rich Schoenthaler, Ecolab Inc.’s manager of regulation and public affairs, implemented software programs to pull accounting data into tax programs, his 14-person department had little time to check its work for accuracy, much less plan strategically. “With regard to property tax,” he says, “we got the bill and sent the check, because the process was so time-consuming.”

One reason tax departments lag behind is that IT providers have been slow to tackle the area. For ex-ample, enterprise resource planning systems don’t ad- dress tax needs. Also, many software vendors have been scared off by the frequent product updates that tax laws demand, says Diane Tinney, information coordinator for the Association for Computers and Taxation. However, corporate IT liaisons drive technology efforts forward, says Campbell’s Soup Co. tax manager Riza Cebula, who contends the corporate link is “critical.”

Automation has its problems, though. The tax chief at one of the most sophisticated shops in the United States declined to comment for this story, for fear the IRS would start demanding additional information once it recognized how easily it could be pulled from the system. – Alix Nyberg

TAX DIRECTORS WEIGH IN

Reasons for improving tax processes

  • Effective Tax Rate 46%
  • Cash Flow 24%
  • Compliance 16%
  • Tax Deferral 10%
  • Audit Defense 4%

Source: KPMG LLP Tax Management Solutions Practice

ONLY 18% of corporate audit committee members will seek more schooling to meet new financial literacy rules, says KPMG.

EXECUTIVE COMPENSATION

Take It Back

Now you see them, now you don’t. Stock option rescissions are the worst-kept secret seeping out of corner offices. Top executives who exercised stock options and saw the price of the stock subsequently collapse are being allowed to cancel the trade altogether. This alleviates the executive-size tax bill that could be in excess of the total value of the stock, postmeltdown. What’s more, the loans the companies made to executives so they could buy the stock are also being forgiven.

The concept is a boost for executives but not for stockholders, who are often kept in the dark about option “returns.” Late last year, shareholder advocates asked the Securities and Exchange Commission to address rescission issues, such as informing shareholders when options are rescinded, and providing guidelines on how to book the rescission for accounting purposes.

Corporations beware, says Andrew Liazos, a partner and specialist in executive compensation in the Boston office of McDermott, Will & Emery. Based on new SEC conclusions, “the variable accounting consequences to the employer should be carefully considered before implementing an options exchange program,” says the attorney.

A recent SEC Staff Announcement points out that rescission of stock options triggers variable accounting, thus requiring estimated compensation expenses. As a result, the free ride–which is otherwise granted until the options are exercised–is gone. Furthermore, the company tax benefits obtained through recording rescinded options as a deferred tax asset, or as a reduction in current taxes payable, are lost.

Finally, the terms of the rescission must be disclosed in accordance with generally accepted accounting principles, such as FASB Statements 123 (Accounting for Stock-Based Compensation) and FAS 128 (Earnings per Share). The notice should be a stock option footnote in the financial disclosure statement, reflected in the earnings-per-share report and included in the statement of changes of stockholder equity. – Nikos Valance

STRIKE THREE

The AICPA is the third accounting group to fail in its attempt to create a broad, global credential for finance pros, similar to the CPA. Shot down by members, the losing label was “cognitor.”

MEDICAL PRIVACY

Stealth Impacts

If your company provides health benefits to employees, get ready to feel the compliance sting of the Health Insurance Portability and Accountability Act (HIPAA). The brunt of the burden will be shouldered by health-care plan administrators, such as hospitals, insurance companies, claim clearinghouses, and corporations large enough to self- administer plans. However, other companies will be forced to evaluate and rework internal procedures.

The law, which mandates compliance by April 2003, makes it illegal to use medical records for the purpose of employment evaluation. In practice, that means that “individually identifiable health information” is off-limits to most company employees. Such access would trigger HIPAA and a host of onerous compliance measures, says Alan C. Brown, a partner at Duane Morris LLP, in Washington, D.C. These include appointment of a privacy officer, HIPAA training for employees with access to the data, and whistleblower protection.

Most financial executives will face HIPAA compliance when they redesign or renegotiate benefits plans, says Martha Priddy Patterson, the Washington, D.C.-based director of employee benefits policy at Deloitte & Touche LLP. Benefits claims are used as a baseline to redesign fee structures. Unless those claims are “de-identified,” HIPAA will kick in, notes Patterson.

Basically, the corporate negotiating team must not be able to recognize a claimant. This gets tricky, says Patterson, because identifying claimants is unavoidable at small companies, or when the claims are unusually high. In addition, most plan providers don’t have IT systems that de-identify the data yet. The other big hurdle is shielding medical data from corporate-benefits personnel–although the enrollment process is exempt from HIPAA.

The IT problem is a systems management issue, says Henry Ringel, program director for enterprise security management at BMC Software Inc., in Houston. He predicts that installation of new “middleware,” password synchronization, and firewall construction will be key for companies affected by HIPAA. – Marie Leone

OVEREXERTION is the leading cause of worker injury, costing companies $9.8 billion in wage and medical payouts, says Liberty Mutual.

E-COMMERCE BARTER

Swap Stopper

At the height of the Internet joy ride, bartering dot-com equity for goods and services enjoyed quite a vogue. Dot-com executives assumed that equity in their companies was driving the deals. However, as New Economy stocks fall and barters continue, it’s apparent that equity was not the driver.

“Equity is just icing on the cake in dot-com barter deals,” says Kevin Dunn, general manager of Delta (Air Lines) E-Venture, in Atlanta. He explains that the arrangements are driven by core business needs, never by the promise of soaring stock values–although he notes that the value of Delta’s equity stake in Priceline.com, which is now $750 million, came as a welcome surprise. Delta also took an undisclosed equity stake in New York­based Site 59.com, which books travel packages less than six days in advance, something Delta doesn’t offer. Delta is therefore able to accommodate last-minute leisure fliers through Site59.com, says Dunn, and jettison distressed assets–unfilled seats.

Even if E-business and corporate goals align, equity barter deals will be under Securities and Exchange Commission scrutiny. Currently, SEC investigators are examining several deals–including one involving Amazon.com–that used stock as payment to partners. At issue are reporting requirements affecting investors’ risk assumptions about the companies.

Dot-com equity barters still have a role to play, says David Prose, executive vice president of Stamford, Conn.-based ICON International. E- tailers have a lot of returns, and companies that are struggling can use barter to manage their inventories, he adds. –Ray Pospisil

OPTIONS ABOUND

On average, CFOs receive stock options valued at $799,000 on a base salary of $277,000, according to Watson Wyatt’s most recent executive compensation survey.

FDIC PREMIUMS

Sliding Scale

It’s pretty much a done deal that the Federal Deposit Insurance Corp. will be changing the way it assesses premiums on deposit insurance. The key question, which will be debated during the next year, is what formula it will use. Currently, FDIC premiums are assessed on the bank’s ledger balance. The bank passes that assessment through to companies based on the size of a corporation’s deposit. This, according to Nolan North, vice president of T. Rowe Price Associates Inc., amounts to an unfair subsidy of the system by large corporations. Companies with tens of millions of dollars in deposits pay premiums on that amount but, given the FDIC insurance cap of $100,000, receive the same coverage as smaller depositors that pay lower premiums.

While bank lobbying groups are pushing to raise the cap to $200,000– and to cover certain deposits, such as those from municipals, in full– they want to keep the current maximum coverage, but assess all deposits only up to $100,000. – N.V.

VENTURE FUNDING

Back to Basics

Where’s the beef? For venture capital funding, it’s in information technology. Last year, venture fund investment reached a recordbreaking $69 billion, doubling the 1999 mark, according to VentureOne Corp., in San Francisco. More than $41 billion of the total went to IT-based companies. And while IT remains a hot investment, venture capital investors are returning to basics as they canvass for new opportunities.

Fund manager François Gaouette, vice president of Telsoft Ventures Inc., in Quebec, says his firm is interested only in investments that have a solid business model, a huge market, and an impressive management team. In other words, exactly the kinds of companies it used to seek out before the dot-com boom encouraged the company to pursue quick returns via overvalued initial public offerings.

Telsoft found these solid qualities in Recruitsoft, which produces software for online recruiting. The quick return is there, too, but via profits rather than public offering. “The fast return on investment was important to us,” says Gaouette. “Usually you expect an investment like this to break even in 18 months. Recruitsoft broke even in 6 months.”

The lion’s share of venture capital is going to companies whose products and technologies can support the capital investment, says VentureOne spokesperson Staci Carney. That includes communications technology, Internet infrastructure, and biopharmaceuticals–all areas that are critical to other companies and have the potential of long- term profitability. – N.V.

MONEY TRAIL

Venture capital investments by sector (in millions).

  • Information Technology: 41,332
  • Products and Services: 20,922
  • Health Care: 6,133
  • Other: 369

Sources: VentureOne Corp., PricewaterhouseCoopers

WATCHING YOU: The IRS will hire about 567 new agents for its criminal-investigation division by 2002, bringing the G-man total to 2,912.

LAW

AlliedSignal Dodges Bullet

Did AlliedSignal Inc. use improper accounting practices to meet Wall Street expectations and trigger executive bonuses? Those bombshell allegations by Douglas Boe, a former division controller, will never be tested in court.

On February 15, Judge G. Thomas Van Bebber, in Kansas City, Kans., threw out all the counts related to Boe’s claim that he was a whistleblower who was fired after reporting accounting improprieties in the $600 million avionics division. That left only the claim that Allied- Signal violated the Americans with Disabilities Act when it dismissed Boe, who is manic-depressive. The parties settled that accusation for an undisclosed amount.

“The settlement was satisfactory, or I wouldn’t have taken it,” says Boe, who agreed not to comment on the matter.

Boe’s accounting-related charges, along with troubling details related to his status as a whistleblower, were outlined in a feature story in CFO in February (“Shadow of a Doubt”). In it, Boe described the pressure allegedly exerted by superiors to find favorable bookkeeping adjustments when quarterly-earnings targets were out of reach.

While Boe complained to others in his division, the CFO story also documented that he did nothing to take his concerns up the chain of command, including remaining silent about the practices that troubled him during a private meeting with CFO Richard Wallman. In dismissing the guts of the case, the judge ruled that Boe was “merely voicing his disagreement,” and “was not whistleblowing.”

Left unresolved by Van Bebber’s decision, however, is whether Boe’s allegations of improper accounting have any merit. Although those allegations were dismissed by AlliedSignal’s internal auditors after an investigation, their report also noted that a number of judgmental estimates lacked underlying analysis. “I’m not going to get into that,” says Patrick McGovern, in-house counsel for Honeywell International Inc., which acquired AlliedSignal in December 1999. – Stephen Barr

TEST BAN

Citing privacy violations, the U.S. EEOC filed a lawsuit challenging genetic testing of employees
at Burlington Northern Santa Fe, which halted the tests and called the claims erroneous.

CREDIT RISK

The Next Big Thing?

E-marketplaces may yet become the thriving hubs that Internet pundits predict. Several online financial firms are introducing cybertools to handle credit risk, in hopes of pushing B2B online bazaars to the next level: exchanges that have low barriers to entry and a liquid market.

These vendors have an uphill battle though, as most companies that participate in E-marketplaces refuse to break with tradition. Chemical giant The DuPont Co., for example, participates in a dozen E- marketplaces, but uses a combination of offline and online systems for settlements, says Bruce Evancho, who heads the company’s E-finance team.

Basically, the industry-specific, consortium-based marketplaces– such as auto-parts exchanges or bulk chemical Web sites–are a new way to connect with old partners, says Richard deMoll, a vice president with Cap Gemini Ernst & Young in New York. Credit risk is generally a nonissue, because business is driven by large creditworthy buyers and their established partners, he adds.

In response, credit-tool providers say their products will make a splash on sites that use reverse auctions, in which buyers and sellers are anonymous. “When you don’t know who the buyer is, it’s difficult to accept credit risk based on a screen name,” says Patrick Ogden, senior vice president of InterLink Capital Inc., in La Jolla, Calif. InterLink has developed a trade credit solution that transfers credit risk, as well as credit responsibility.

Sony Music, Eastman Chemical, Wal-Mart, and Siemens use online credit certificates provided by Amsterdam-based eCredible. The certificates assign a variable spending limit to online buyers. The limit is automatically reduced when a purchase is made, and restored whenever an invoice is paid. And to smooth out volatile price swings, Waltham, Mass.-based onExchange offers a derivatives product to help marketplace participants master risk. – Steve Bergsman

50% OF EXECUTIVES believe their industry’s growth won’t slow; 70% are unprepared for economic slowdown, says a Bain & Co.

DIVIDEND CUTS

Spoonful of Sugar

What’s all the fuss about dividend cuts? Some of the most successful companies of the New Economy, including Microsoft Corp. and Cisco Systems Inc., have never paid out a dividend. And some analysts and investors say that hard-to-swallow dividend reductions are often the first step toward healthier stock prices. Share prices of AT&T Corp., American Greetings Corp., and Hasbro Inc. rose in the quarter following their end-of-year announcements of diminished dividends. And Polaroid Corp. shares barely moved on its February announcement that it would break a more-than-30-year tradition of shareholder payouts.

Investors tolerate the bitter pill for a few reasons. For one, tax structures favor stock price gains over cash payouts. Dividends are taxed regularly, at up to 39.6 percent, while the capital gains tax rate is only 20 percent.

The information pipeline is another reason for investor poise. “A dividend, by itself, is irrelevant,” says Andrew Berger, a securities analyst with Value Line Publishing Inc., in New York. With all the financial information available today, he adds, dividend cuts are less of a surprise and more of a validation of a company’s market value. Witness Polaroid, which struggled for years with cost trimming and restructuring. The company’s most recent dividend omission was already priced in the stock, says Ulysses A. Yannas, an analyst with Buckman, Buckman and Reid, in Red Bank, N.J.

Access to information also means that investors aren’t easily fooled by propped-up dividend payouts. Xerox’s policy of maintaining a reduced 5-cents-per-share payout is “like putting lipstick on a pig,” says Harry DeAngelo, a professor of finance at the University of Southern California. “Keeping that last nickel does a little bit on the margin to make Xerox look stronger financially.”

Despite investor coolness, cuts to AT&T’s and Polaroid’s sacrosanct dividends still carry a stigma. Slashed pay-outs create a negative shift in corporate psychology, and often draw the wrath of tax- exempt investors. To calm the storm, experts say, companies should provide specifics on how the extra cash will be used. Stock buybacks, which are popular with investors, are one option. When San Antonio­based Ultramar Diamond Shamrock Corp. announced its dividend cut would fund a stock buyback, share prices went up 4 percent. – A.N.

FINANCIAL THEORY

Click for Cheaper Capital

A pair of professors at the Smeal School of Business Administration at Penn State University are supplying more ammunition to the forces lobbying for greater automation of stock trading. The duo, Ian Domowitz and Benn Steil, have studied the impact of transaction fees on the cost of capital for firms, and conclude that automated trading reduces capital costs substantially.

The prevailing wisdom is that high expectations for the market drive up price/earnings ratios, thereby reducing the cost of capital, says Domowitz. “But to us, that’s only half the story.”

The researchers discovered that when automated trading is used on the major exchanges, transaction costs–including fees and market impact–drop by as much as one-third. Those savings can be directly translated into lower capital costs, the two assert. For every 10 percent decline in trading costs, the cost of equity capital to blue- chip listed companies slips 1.5 percent, they say. From 1996 to 1998, trading costs dipped 53 percent in the United States, which resulted in an 8 percent tumble in the cost of capital for S&P 500 companies.

Why do the transaction and capital costs fall together? “If a company’s fundamentals remain constant, you’ll see a lower cost of capital for a liquid stock,” says Domowitz. “To me, a more liquid stock is one I can trade more cheaply.”

Fully automating the major exchanges, however, is still only a utopian dream. “The exchanges have tried to enhance floor trading by incorporating electronic solutions, but they still have a lot to do,” says Dorit Zeevi-Farrington, vice president of trading research for New York­based Instinet, an electronic communication network for stock trading. “You have constituents there, you have traditional specialists making money off these trades, so that makes it hard to move off floor- based trading to complete automation. As this is a zero sum game, a lot of people have a lot to lose by doing that.” – John P. Mello Jr.

THE BOTTOM LINE:

Savings derived from automated trading often translate into lower capital costs.

INFO RANSOM

The FBI reports that at least 40 businesses in 20 U.S. states fell victim to Russian hackers who steal customer credit card information and then blackmail the companies.

A SHOCKING 24% of National Investor Relations Institute members are providing less information since the SEC passed Reg FD.

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