How much does any CEO know about his company’s finances? How much should he know?
Those are the central questions in the trials of several chief executives accused of masterminding their companies’ massive accounting scandals. These CEOs claim they knew nothing of the financial machinations that rocked their companies. In each case, they insist, a manipulative and conniving CFO acted alone.
But the amiable-dunce defense has failed spectacularly at least once. This past March, former WorldCom CEO Bernard J. Ebbers was found guilty of conspiracy, false regulatory filings, and securities fraud in connection with the 2002 demise of the telecom giant—convicted despite his insistence that former CFO Scott Sullivan unilaterally cooked the books. (Sullivan, the prosecution’s star witness, admitted to the cooking, but testified that his former boss held the frying pan, a scenario the jury found more plausible than Ebbers’s version.) Similarly, Richard Scrushy, former CEO of HealthSouth, maintains in his ongoing trial that conspiring executives, including five former CFOs, committed the $2.7 billion fraud there. And Kenneth Lay, former Enron chairman and CEO, is widely expected to employ the ignorance defense when his first case gets under way, perhaps as early as next month.
So what gives? All these top executives insist they didn’t possess the knowledge necessary to execute the frauds in question.
But is it really possible for a CEO to be clueless about the financial condition of his own company? To find out, CFO magazine asked CFOs (who presumably know more about their bosses’ financial acumen than anyone else) whether it would be possible for their CEOs to legitimately claim ignorance.
The answer, to our surprise, is maybe. A full 31 percent of public-company CFOs said that before the passage of the Sarbanes-Oxley Act in 2002, their CEOs might have been ignorant of major financial fraud in their companies. Only 49 percent said that would have been impossible. Twenty percent were unsure.
The fact that so many public-company CEOs could plead ignorance of their companies’ finances makes a powerful case for the new government safeguards. Says Michael Short, CFO of Universal Orlando: “Sarbox did a lot to debunk the ‘Sergeant Schultz defense.’” (Schultz, as some may recall, was a Nazi guard in the 1960s TV show “Hogan’s Heroes,” whose stock response to every question was, “I know NUSS-ing.”) “Companies now have so many people telling the CEO what’s going on,” Short adds, “that the chances of him (or her) saying ‘I didn’t know’ with any credibility are greatly diminished.”
Indeed, new penalties for false filings, certification requirements, and internal-control assessments offer powerful incentives for CEOs to pay attention to their companies’ financials. According to our survey, they do. CFOs report that today, in 95 percent of public companies, CEOs are either moderately or deeply involved in significant corporate-finance decisions. Fully 80 percent of public-company CEOs understand financial issues very well or extremely well, and another 18 percent understand them moderately well. No longer, for example, can a CEO claim just a rudimentary knowledge of cash flow. “Five years ago,” says Bob Davis, CFO of Computer Associates (CA) and former chief accounting officer at Dell Inc., “a lot of CEOs would have been primarily focused on income statements,” but not the cash-flow statement. “I’m certain that won’t be the case in the future. As we move more toward fair-value accounting, the cash-flow statement has become more and more important.”