SEC Comes Down on Former Tyco Auditor

Commission bars ex-PwC partner who worked on Tyco account; also bans firm's former auditor for MicroStrategy. Plus: 401(k) admin tops HR outsourcing list, defaults drop, and Oracle of Omaha backs Arnold of California.

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It has not been a particularly good week for professional services firm PricewaterhouseCoopers, as two of its former auditing partners were barred by the Securities and Exchange Commission from practicing as accountants.

On Wednesday, the commission settled charges against Richard P. Scalzo, the former PwC engagement partner responsible for the firm’s audits of Tyco International Ltd.

Earlier in the week, the SEC settled charges and barred Warren Martin, a former PwC partner, from auditing the books of publicly traded companies. That ban stems from Martin’s audit work for MicroStrategy Inc., a company which announced a massive financial restatement in 2000.

The regulatory agency’s order again Scalzo, who audited Tyco’s financials from fiscal years 1997 through 2001, found that he recklessly violated the antifraud provisions of the federal securities laws and engaged in improper professional conduct.

“The commission’s order finds that multiple and repeated facts provided notice to Scalzo regarding the integrity of Tyco’s senior management and that Scalzo was reckless in not taking appropriate audit steps in the face of this information,” the SEC asserted.

According to the commission, those facts were sufficient that, by the end of Sept, 1998, Scalzo should have reevaluated the risk assessment of the Tyco audits and performed additional audit procedures. Among those procedures: additional audit testing of certain executive benefits, executive compensation, and related party transactions. “Scalzo did not take sufficient steps in these regards,” the SEC’s asserted in its order.

As a result, the SEC barred the one-time auditor of Tyco from practicing as an accountant.

The commission also noted that Scalzo recklessly violated the antifraud provisions of the federal securities laws because PwC had erroneously issued an audit report stating that the firm had conducted an audit of Tyco’s financial statements “in accordance with auditing standards generally accepted in the United States of America.” The SEC said Scalzo was responsible for those statements, and, at the time those statements were made, he was reckless in not knowing that the Tyco audits had not been conducted in accordance with GAAS.

“Investors rely on auditors and are betrayed when auditors fail to conduct diligent audits,” said Thomas C. Newkirk, associate director of enforcement at the SEC, in a statement. “In this case, senior management was looting the company, and Scalzo was confronted with numerous warning signs about management’s integrity. Scalzo is not being sanctioned because he did not discover the looting; he is being charged because he did not look despite these warnings.”

On Monday, the SEC settled with Martin, the PwC audit partner, for his role in the revenue recognition scandal at MicroStrategy. In April 2000, the company restated its results for the three years ended 1999.

The commission said Martin failed to develop adequate audit evidence for MicroStrategy’s revenue recognition; failed to consider properly language and dates in MicroStrategy’s contracts that conflicted with the company’s revenue recognition; failed to consider properly concerns raised by PwC personnel that should have alerted Martin to the audit failures; and relied on unprobed and untested management representations.

Martin agreed not to practice as an accountant, with a right to apply for reinstatement after two years.

In May 2001, PwC paid $55 million to settle a class-action shareholder lawsuit related to its MicroStrategy audits.

Junk Default Rate Falls

Further proof that the economy is rebounding.

Companies with lousy credit ratings are not defaulting as frequently as they did in the past.

The global speculative-grade corporate bond default rate came in at 5.8 percent in July, down from 6 percent in June, according to Moody’s Investors Service.

What’s more, the credit rating agency predicted that the default rate may decline more in 2004 than it had previously predicted.

Moody’s said it now expects the global junk bond default rate to end the year at 5.9 percent, and fall to 4.9 percent by July 2004. “July’s forecast marks a significant reduction in the forecasted default rate, which, for much of 2003, had predicted little improvement,” Moody’s noted.

The more optimistic forecast is the result of both lower actual defaults than expected over 2003 thus far, along with a marked improvement in rating activity for speculative-grade rated issuers, Moody’s said.

There have been, on average, 7.5 defaults per month — lower than the nine defaults per month Moody’s forecast at the beginning of the year.

Also, credit rating actions for speculative-grade rated issuers have shown improvement over the past year. As proof: The downgrade-to-upgrade ratio has fallen to 2.5:1 for the 12 months ended July, compared to about a 4:1 ratio at the beginning of that period.

“In addition to improving fundamental credit quality, a very receptive high-yield bond market has probably helped to lower the default rate somewhat,” said David T. Hamilton, Moody’s director of default research. “These market conditions have made high-yield refinancings easier.”

Hamilton did point out that credit challenges still exist, however. For example, he says rating reviews suggest that rating downgrades may pick up in the second half of 2003. Currently, more than five issuers are on review for downgrade for every issuer on review for upgrade as of the end of July.

And on a dollar basis, the credit climate still looks a bit bumpy.

Last month, for example, nine companies defaulted on a total of $8.7 billion of debt. That’s compared with a June total of six defaults on just $2.1 billion. The $8.7 billion in July defaults is the largest for a single month thus far in 2003.

Of note: the default rate for U.S.-domiciled issuers dropped to 5.3 percent last month, down from 5.8 percent in June. Still, U.S.-based issuers comprised seven of July’s nine global defaults. Those included defaults by Mirant Corp., which, together with Mirant Americas Generation LLC, could not make payments on over $5 billion in corporate debt.

HR Outsourcing: What and Why Companies Outsource

No shocker here: according to a new survey released by the Society for Human Resource Management (SHRM), cost savings is the most common reason companies outsource human resources functions. SHRM asked 393 randomly selected HR professionals to explain why their employers had decided to outsource some or all of their HR processes.

Besides cost savings (which was cited by 26 percent of the respondents), here are the most popular reasons for outsourcing:

  • Focus on strategy (23 percent)
  • Improve compliance (22 percent)
  • Improve accuracy (18 percent)
  • Lack experience in-house (18 percent)
  • Take advantage of technological advances (18 percent)
  • Offer services we otherwise could not (17 percent)
  • Focus on core business (15 percent)

And what are the HR functions that get outsourced the most?

  • 401(k) administration (84 percent)
  • Employee assistance/counseling (84 percent)
  • Retirement planning help (74 percent)
  • Pension administration (73 percent)
  • Temporary staffing (72 percent)
  • Background checks (68 percent)
  • Training and management development programs (57 percent)
  • Executive development and coaching (54 percent)
  • Health care benefits administration (53 percent)
  • Employee benefit administration (49 percent)
  • Payroll (49 percent)

Short Takes

  • Warren Buffett has agreed to be the senior financial and economic adviser for Arnold Schwarzenegger in his bid to become governor of California governor. This, according to Bloomberg, citing Darrel Ng, a campaign spokesman. “I have known Arnold for years and know he’ll be a great governor,” Buffett reportedly said in a statement released by the Schwarzenegger campaign. “It is critical to the rest of the nation that California’s economic crisis be solved, and I think Arnold will get that job done.” The wire service said Debbie Ray of Berkshire Hathaway confirmed the campaign statement.
  • Yesterday, Texas Capital Bancshares Inc. sold 3 million shares and shareholders sold another 3 million shares, in an initial public offering. The share price was $11 — in the middle of the expected range of $10 to $12 per share. The bank holding company raised $66 million in the IPO.
  • Bristol-Myers Squibb Co. raised $1 billion in a two-part private placement of debt, led by Goldman Sachs, J.P. Morgan and Banc of America Securities. The drug giant issued $400 million of 5-year paper priced to yield 4.01 percent, or 78 basis points above comparable Treasurys, and $600 million in 10-year paper priced to yield 5.334 percent, or 95 points over Treasurys. Both issues were rated A1 by Moody’s and A-minus by Standard & Poor’s.

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