The movement to scale back recent financial reforms has turned into a veritable book-of-the-month club as one organization after another issues reports that call for major changes to everything from Sarbanes-Oxley to shareholders’ rights. On the heels of last fall’s report by the Committee on Capital Markets Regulation (see “Reform Effort Rebuked,” Topline, February 2007), three more reports or statements recommending Sarbanes-Oxley rollbacks and new limitations on corporate and auditor liability have appeared so far this year, from the U.S. Chamber of Commerce, Financial Executives International, and as a joint effort between New York City mayor Michael Bloomberg and Sen. Charles Schumer (D–N.Y.).
These critics have found a sympathetic ear at the Treasury Department, which has historically avoided such issues in large part because it has no direct control over the agencies that regulate financial markets. But with former Goldman Sachs boss Henry Paulson now at the helm, the Treasury Department seems eager to weigh in; in March it convened a group of heavy hitters, including General Electric CEO Jeff Immelt, Berkshire Hathaway CEO Warren Buffett, and former Securities and Exchange Commission head Arthur Levitt, to discuss whether the Unites States has, as Paulson put it, “struck the right balance between investor protections and market competitiveness.”
Balance is very much on the minds of CFOs, who hope that Sarbox does not remain a perpetually moving target. But some welcome the broad scope of recent reform efforts. “These new reports are helpful,” says James Frates, CFO of drug developer Alkermes Inc., “because they make it clear that it’s not just Sarbanes-Oxley that’s affecting the capital markets.” He expects yet more advocacy efforts to be launched once the SEC issues clarifications on two contentious issues — internal controls and Auditing Standard No. 5 — which it is expected to do next month.
If legislative remedies prove problematic, the courts may provide some relief. In Tellabs v. Makor, the U.S. Supreme Court is expected to determine what sort of threshold investors must meet in advancing securities-fraud claims. And in Stoneridge Investment v. Scientific-Atlanta, the Court will decide whether investors can sue a company’s advisers, including accountants, bankers, and lawyers. “The business community may get a lot of what it wants through judicial decisions, without ever getting a piece of legislation passed,” says Joseph Carcello, director of research at the University of Tennessee’s Corporate Governance Center. That, he says, “is ideal, because it cuts down on the dirty laundry that gets aired.” — Alix Nyberg Stuart
A Growing Chorus
November 2006: Committee on Capital Markets Regulation calls for clearer SEC guidance on Sarbox and securities-litigation reforms, including an arbitration option for shareholders, liability caps for auditors, and better indemnification for directors.
January 2007: Bloomberg/Schumer report states that the SEC should give clearer guidance on Sarbox and allow small or foreign firms to opt out of certain aspects. Also advocates accepting U.S. GAAP and IFRS in parallel in advance of convergence and addresses a number of securities-litigation issues.
March 2007: U.S. Chamber of Commerce says companies should eliminate quarterly earnings guidance and the SEC should have more authority over Sarbox so it can make exceptions as needed. Also calls for liability caps for auditors and for the SEC to make civil fines deductible from private-investor litigation demands.
FEI asks FASB to freeze accounting rules until conceptual framework is established; asks Congress to set limits on securities litigation; and creates a committee to explore principles-based accounting.
Board of Objectors
Call it the Sarbox trickle-down effect: As corporate boards have become more active in company management (see “Board Battles“), shareholders have become more eager to exercise control over boards. Of the five most common proposals put forward during this proxy season (see the list at the end of this article), four address making boards more accountable to shareholders for issues ranging from executive compensation to board membership. Indeed, says Patrick McGurn, executive vice president and special counsel with Institutional Shareholder Services, board accountability has emerged as a “central theme.”
Through the end of March, far and away the most frequently introduced proposals were those that would require a majority vote of shareholders to elect board members. Executive pay was also hot: 64 companies heard calls to make executive compensation subject to an annual advisory vote by shareholders, while 59 companies weighed requests to link executive pay to corporate performance. (Such calls were heard in Washington, D.C., as well; in March, the “say-on-pay” bill advocated by Financial Services Committee chairman Barney Frank [D–Mass.], which would give shareholders a nonbinding advisory vote on executive compensation plans, passed a committee vote and headed to the full House.)
Also on shareholders’ minds is the concept of the “classified” (that is, staggered) board, in which only a fraction of board members face reelection in any given year. Increasingly, shareholders want to be able to replace an entire slate at once. That demand is not new, but McGurn says that while in the past shareholders found classified boards an impediment to potentially lucrative takeover bids, they now “view it as an accountability issue: if they have a problem with compensation, they want to be able to vote out the whole compensation committee.”
Charles Nathan, global co-chair of the Mergers and Acquisitions Group at law firm Latham and Watkins, says headlines about options backdating have also played a role, because they “confirm the popular belief that companies have been run for the benefit of management, not investors.” Most proposals were coming to a vote at press time; check CFO.com for updates. — Rob Garver
Proxy Season at a Glance*
140: To require a majority vote to elect directors
64: To require an annual advisory vote on executive compensation
59: To link executive pay to performance
57: To require disclosure of political contributions
53: To repeal the classified board structure
*As of March 30
Source: Institutional Shareholder Services
Helping Employees Understand Fees
Expect to see plenty of news come out of Washington, D.C., during the next few months as all three branches of government zero in on the fees that 401(k)-plan participants pay, often unknowingly.
The judicial branch is the most active thus far, with at least 14 lawsuits pending against such companies as Lockheed Martin, International Paper, and Kraft Global alleging that plan participants were not adequately informed about 401(k) fees.
On Capitol Hill, George Miller (D–Calif.), chair of the House Education and Labor Committee, held a hearing in March to “find out if hidden fees are eating into workers’ retirement-savings-account balances,” according to his statement. Members of the House Ways and Means Committee and the Senate Health, Education, Labor, and Pensions committees also have expressed concern over fees, says Jan Jacobson, director of retirement policy at the American Benefits Council. Last November, the Government Accountability Office issued a report that cited an AARP study stating that 80 percent of plan participants don’t know how much they pay in fees.
That’s not surprising, according to Trisha Brambley, president of Resources for Retirement Inc., a plan advisory firm. Fees are “all over the board,” she says, noting that investment firms that administer 401(k) plans may assess fees from a list of 70 or more potential charges. The GAO said that “piecemeal” disclosure of such fees makes it nearly impossible for the average participant to get a full picture of his or her plan.
Meanwhile, the Department of Labor intends to issue a request for information to help it determine the level of fee disclosure that participants would find most helpful. Jacobson says that the RFI will be released shortly, but won’t speculate as to whether final regulations will be issued or when they would take effect.
Companies should watch such developments closely, says Martha Priddy Patterson, director in the human-capital group of Deloitte Consulting. Given the spate of recent lawsuits, she says, “you need to be prepared to say, ‘We’ve looked at our fees and believe they are reasonable.'” — Karen M. Kroll
The 1% Dilution
As an example of how insidious even small fees can be, consider an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on the account average 7% over the next 35 years and expenses reduce the average returns by 0.5%, the account will grow to $227,000 at retirement, even if there are no further contributions. But if fees and expenses are 1.5%, the account will grow to only $163,000. Thus, a 1% difference in fees and expenses would reduce the balance at retirement by 28%.
Source: Department of Labor
By one measure, consumer-driven health plans (CDHPs) are booming; by another, they appear to be nearly DOA. A survey by the National Business Group on Health and Watson Wyatt Worldwide found that 38 percent of the 573 large companies studied now offer CDHPs, up from a minuscule 2 percent just five years ago. But employee acceptance is lagging: only 8 percent opted for CDHPs last year, up just one percentage point from the previous year. A recent report from The Conference Board also found that acceptance of such plans is low; it cites poor communication by employers regarding the usage and potential savings of CDHPs as a major factor in their slow acceptance. CDHPs attempt to rein in health-care costs by giving employees more responsibility for spending on health care, and, in theory at least, by giving them adequate information to shop wisely. The plans typically feature high deductibles and a tax-advantaged spending account. Experts say it’s too soon to tell whether CDHPs will succeed. — Laura DeMars
Premiums for CDHPs Are Often Much Lower*
36% substantially less
33% moderately less
17% slightly less
8% No difference
4% slightly greater
2% moderately greater
*Compared with other health plans offered at the same company
Despite all the attention given to filched credit-card numbers and other damage wrought by computer hackers, a new University of Washington study puts hard numbers to what security experts have long claimed: you have more to fear from insiders than from outsiders.
The study looked at almost 600 incidents of compromised data over the past quarter century and found that employees are to blame about 60 percent of the time. Often it’s not because they are maliciously out to steal or destroy information, but simply because they make mistakes. Lost laptops, sensitive information inadvertently forwarded via E-mail, and similar bungles are rampant. Employee education has long been seen as the key to prevention, but companies can now buy new technologies that can prevent such errors. Code Green Networks, for example, makes a security appliance (a combination of hardware and software) that will do everything from monitor the content of E-mails to “fingerprint” sensitive documents so they can be tracked or, if needed, prohibited from being forwarded. Technologies for protecting data on laptops, and for locating the machines if they are lost or stolen, are now offered by many vendors.
But companies still have plenty to fear, from both within and without. As Steve Jones, chief technology officer at Signal Financial Credit Union, notes, “Even though accidents are a more common form of inside risk, the damage done by a single malicious incident can be huge.” That holds true for hacking as well. The University of Washington researchers found that while hackers were responsible for a smaller percentage of incidents than were insiders, they walked away with more data. Even in some of those cases, researchers say, companies are often to blame. They cite the example of Acxiom Corp., which saw 1.6 billion customer records compromised in 2003. In that case, a nonemployee who had been granted a password to upload data guessed (correctly) that the same password would allow him to download data. So he did. — Scott Leibs
“Everyone was already exhausted by Enron. Then WorldCom took everyone’s breath away. It was just amazing. It pushed the Senate toward [adding Section] 404, [which was] taken from a banking statute…and superimposed on publicly traded companies.”
— Retired Congressman Michael Oxley, reflecting on the origins of the Sarbanes-Oxley Act of 2002
I’ll Keep My Remarks BriefÂ
Who do corporate boards look to for help in understanding a company’s IT strategy? Very often the CFO, according to a new survey from Deloitte and Corporate Board Member magazine. But don’t spend too much time concocting PowerPoint slides that explain your IT infrastructure: the survey also found that boards are far less interested in IT than in other issues. Their overwhelming priority? Financial performance. — S.L.
American companies have been on a buyback tear, snatching up stock with cheap capital and bulging balance sheets. Sagging share prices and new regulations have made buybacks even more alluring. But while many companies have been doling out cash to shareholders through share repurchases, some, wary of being gobbled by hungry private-equity firms, have taken a different approach.
During the first quarter, several companies, including dairy-products producer Dean Foods, hospital-management company Health Management Associates, and Domino’s Pizza, announced multibillion-dollar recapitalizations. The strategy is designed to have two effects: it rewards shareholders with fast and sizable dividends and keeps private-equity firms at bay. And while the moves required companies to absorb more debt, the companies’ share prices usually went up.
Some researchers have suggested that buybacks aren’t the magic potion they appear to be. A recent study by Guojin Gong, Henock Louis, and Amy Sun, of Penn State’s Smeal College of Business, argues that companies often use creative financial reporting to push earnings downward before buybacks, resulting in an artificially low stock price that jumps higher following a buyback. “The rules allow managers the discretion” to manipulate earnings, says Professor Louis. “I think they do it intentionally.” Other studies have found that buybacks obscure the true picture of a company’s financial health while allowing executives to reap bonuses based on share-price targets. Michael Gumport, a senior partner at MG Holdings/SIP, has argued that buybacks are often mistimed, resulting in companies paying a premium for the shares.
Still, don’t expect buybacks to fall from favor any time soon. Regulation National Market System, which took effect in February, is expected to amplify the impact of buybacks by pushing more trades onto electronic exchanges. The greater efficiency and improved cost transparency provided by electronic trading could make buybacks even more appealing. — Alan Rappeport
For global companies, taxation offers a strong dose of good news/bad news. “Complexity and asymmetry across jurisdictions,” says a recent report from Ernst & Young, present “problems for an increasing number of companies and can result in traps for both the wary and the unwary.” That’s the bad news. The good news is that the United States is one of only four countries now active in every major effort to reform global tax laws. While the specific goals and charters of these efforts vary, in the aggregate they promise to bring more simplicity, transparency, and cooperation to bear, eliminating problems such as double taxation, inconsistent enforcement, and tax-shelter abuse. Participation in these efforts should bear fruit by year-end, says Michael Mundaca, principal of international tax services at E&Y. The Joint International Tax Shelter Information Centre, in particular, has already helped the Internal Revenue Service identify what it calls “abusive transactions” that otherwise would have escaped its notice. Some companies won’t see that as a victory, of course, but most will benefit as tax enforcement migrates from a wildly inconsistent local affair to a more normalized product of international cooperation. — Kayleigh Karutis
A Big Leap for Web Conferencing?
Cisco Systems’s $3.2 billion purchase of Web-conferencing leader WebEx was more than just another deal for the acquisition-mad networking giant. In shelling out so much for an established Web-services firm, Cisco made it clear that it intends to move beyond its base in networking hardware and take on rival Microsoft in the nascent “unified messaging” market. That could lead to more innovation and lower prices for a range of customers, from the small and midsize businesses that drove WebEx’s early success to the large enterprises that are Cisco’s primary domain.
Web conferencing is a service that allows multiple people to hold a conference from their respective desktops by logging in to a shared Web space and sharing documents, text messages, and other types of information, much as a teleconference allows multiple people to participate in a conversation.
The acquisition was unusual for Cisco, says analyst Roopam Jain of Frost & Sullivan, because it deviated from the company’s usual strategy of paying relatively little for start-ups or firms with promising technologies. Instead, Cisco paid a premium for a market leader with a sizable customer base and an established distribution channel.
Jan Dawson, vice president of the U.S. Enterprise Practice at tech advisory firm Ovum, says this deal “will contribute to the growth of Web conferencing, especially in the large-business market and internationally, where Cisco has a strong presence.” Cisco’s director of business development, Charles Carmel, says the deal is also a major part of the company’s overall strategy of combining E-mail, phones, text messaging, instant messaging, and Web conferencing into a single unified-messaging service.
The purchase was also seen as a shot across Microsoft’s bow; Microsoft’s Live Meeting platform plays number two to WebEx, but it leads in other portions of the unified-messaging market. “These two are gearing up for a big fight,” Dawson says, adding that the true test for Cisco will lie in how fast it can integrate Web conferencing into its other platforms. Jain predicts the Web-conferencing market will triple, to $21 billion, by 2011 and expects Cisco to make other sizable acquisitions as it attempts to dominate the space. — L.D.
Even as Cisco Systems moved to expand its unified-messaging product line, a major competitive threat emerged in the form of Google. In February, it announced a partnership with communications company Avaya that would combine Google’s subscription-based E-mail, instant messaging, calendaring, and other collaboration offerings (known collectively as Google Apps Premier Edition) with Avaya’s networking services. Aimed primarily at smaller companies, the integrated product line is expected to be rolled out later this year, and offers further evidence of the intense interest in combining various communications technologies into a single platform. — S.L.