Coming Distractions

If these eight risks are not on your radar screen, they will be soon.

Expect more of these Shanghai surprises coming from U.S. businesses — many triggered by the internal-controls provisions of Sarbanes-Oxley. Chinese companies listed in the United States also feel pressure to comply. “I’ve had at least three separate sessions with lawyers explaining the rules,” says Mark Keithley, senior vice president at Nasdaq-listed PCCW Global, a unit of Hong Kong’s phone company. “They emphasize a change in the way the law is being enforced.” One change involves tighter control over marketing costs. Notes Keithley: “The costs can now be looked at as a potential inducement or bribe.”

That’s one of the thrills of the FCPA: it can be interpreted in many ways. Moreover, it permits some actions that might actually be perceived as questionable. For example, gratuities given to government officials for performing essentially clerical duties (known as facilitation payments) are generally allowable. A company’s CFO must decide which payments are appropriate and which may be an attempt to influence an official. Negotiating such a gray area is never easy. Says Peter Humphrey, managing director at Shanghai-based investigative firm ChinaWhys: “It’s a very human exercise, not just a balance-sheet exercise.”

Traditional Chinese accounting practices — such as the use of fa piao, or a generic receipt — only add to the uncertainty. So, too, does a reliance on chops, or stamped signatures. Microsoft’s MacLellan is well aware of the perilous landscape. “Business practices conducted in China are tailored deal by deal,” he says. “It’s up to you to determine what’s right or wrong.”

That’s what worries CFOs. — Tom Leander

Contingent Liability Accounting: Exposing Exposures

At last count, the won-lost record of Merck & Co. for Vioxx-related lawsuits is 2-1. The company scored a big win in federal court in February when a jury in New Orleans found that the pain medication had not caused a man’s heart attack and death, as had been alleged. Says Standard & Poor’s director Arthur Wong: “The first set of cases is critical in terms of gauging what the damage awards are going to be.”

Despite the verdict, Wall Street puts Merck’s total Vioxx liability somewhere between $5 billion and $50 billion. The yawning difference in estimates is understandable: currently, there are more than 9,600 Vioxx cases pending. And yet in its latest filing, management at the $22 billion (in revenues) Merck indicated that the drugmaker has not set aside any reserves for potential liability relating to the Vioxx litigation.

That sort of guarded approach has regulators wondering if companies are giving investors enough information about their legal exposures. Under Financial Accounting Standard No. 5, public issuers must disclose the existence of any lawsuit that’s likely to cause a loss — but they don’t have to include legal liabilities on the balance sheet until a payout is “probable” and the amount can be “reasonably estimated.” At a recent conference, Financial Accounting Standards Board chief Robert Herz expressed concern about FAS 5, noting that companies often don’t disclose legal liabilities “until the doo-doo hits the fan.”

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