Adios Arthur

Arthur Levitt exits stage left. Plus: the revenue Lucent can't recognize; impairment testing gains approval; why business thinks OSHA's new rules are ''voodoo ergonomics''; a step-up in step-ups; trade war delayed, not diverted; and more.


With the arrival of a new President comes the widely anticipated end of Arthur Levitt's nearly eight-year tenure at the helm of the Securities and Exchange Commission. Serving longer as SEC chairman than anyone in history, and at a time of dramatic challenges in the financial markets, Levitt pursued an activist, investor-oriented agenda that often antagonized Wall Street players and corporate executives alike, not to mention Sen.

Phil Gramm (R-Tex.), the influential chairman of the Senate Banking Committee.

So, how well will his initiatives stand up with a new Administration in the White House?

"Levitt's legacy is a strong one," says John F. Olson, a securities lawyer at Gibson, Dunn & Crutcher LLP in Washington, D.C. "He was an effective politician in articulating priorities, moving his programs forward and getting changes made. Sometimes he could be tough on people, but after they softened, he negotiated reasonable compromises."

That was certainly true of his reforms of Nasdaq and municipal bond markets early in his tenure, as well as his recent efforts to strengthen audit committees and stop leaks of important corporate news to favored analysts and investors. And those skills were perhaps never more on display than in his pursuit of rules to enhance auditor independence.

For much of last year, the Big Five accounting firms were at odds with the SEC over its plans to severely limit the consulting work an accounting firm can do for an audit client. Both sides agreed to more lenient terms in mid-November, but Levitt dismisses the charge that he caved in by requiring only an increase in corporate reporting of consulting services and fees. "The outcome is consistent with the commission's technique of using full and fair disclosure to allow investors to make better judgments," he told CFO.

Those who clashed with Levitt are not necessarily looking to turn back the clock on his initiatives, though they would welcome a Republican-dominated SEC with more emphasis on deregulation and
private-sector solutions. "We don't need rules to tell us how to behave," says Joe Berardino, a managing partner with Arthur Andersen LLP. —Stephen Barr

Revenue Wrangling

In the course of preparing its annual financial statements in November, Lucent Technologies announced it had "identified a revenue-recognition issue" that would reduce revenue for fourth-quarter 2000 by approximately $125 million. That announcement touched off speculation that Lucent was a high-profile victim of Staff Accounting Bulletin 101, the SEC's new guidelines on revenue recognition.

Spokesman Bill Price says Lucent will not comment until a financial review is completed. However, the fact that the company also backed off its projections for the first quarter of 2001 suggests bigger problems than SAB 101 compliance.

"Lucent had a revenue issue, but we don't know whether it is directly related to SAB 101 or if it showed up because auditors were looking at revenue more closely because of SAB 101," notes Pat McConnell of Bear, Stearns & Co.

Marjorie Saint-Aime of Pittsburg Institutional, in Great Neck, N.Y., says the restatement may have more to do with the company's recent removal of CEO Richard McGinn. "I would assume that now that McGinn is gone, [CFO Debbie Hopkins] will be able to do at Lucent what she did at Boeing." —Tim Reason

Bad Old Days Return

As the rope around the neck of the junk-bond market turns into a noose, it could choke expansion
of the Internet. That's because the pathetic performance of most telecommunications companies — one force behind Internet expansion — is souring the junk-bond market, an important source of capital for those businesses.

According to Moody's Investors Service, downgrades continue to outpace upgrades in the overall market, and defaults are headed toward numbers that rival the bad old days of the early 1990s. During fourth-quarter 2000, downgrades outnumbered upgrades 4.4 to 1, up from 2.6 to 1 in the third quarter and exceeding the 2.8 to 1 ratio for the 12 months ending in September. The trend is an ominous one, already surpassing the 4 to 1 ratios run up during the junk-bond meltdown in 1990-91.

Moody's analysis is shared by Standard & Poor's. According to Diane Vazza, head of global fixed-income research at S&P, downgrades have exceeded upgrades in 10 consecutive quarters — again, a run that hasn't been seen since 1990­91.

Moody's says that a major factor driving the trend is weakening revenue growth among non-oil companies. Their year-over-year growth slowed from 10.6 percent in the first quarter of 2000 to 8.3 percent in the third. Significantly influencing those revenue trends is the performance of telecoms. Those companies have been plagued with missed revenue estimates and business plans that failed to mature.

That's bad news for the Internet, especially since high-yield bonds are one of the major sources of capital for Internet-related businesses. "Telecoms as well as other companies related to the Internet will be searching hard for funds," observes Kamalesh Rao, an economist with Moody's. "How that's going to affect development is anyone's guess, but you will see a credit crunch applied to many of these companies." —John P. Mello Jr.

FASB's Original Vision Impaired

In the end, the Financial Accounting Standards Board (FASB) may very well eliminate pooling-of-interest accounting in business combinations, as it has planned to do all along. But it has also agreed to go along with critics who have urged it to fix the purchase method.

At a meeting on December 6, the seven-member board agreed to permit an impairment test for goodwill in the new merger accounting standard to be finalized early this year, rather than to require only an immediate write-down for the asset.

"Any time you don't have to amortize goodwill, I'm all for it," says Robert Willens, an accounting expert at Lehman Brothers Inc. Testing goodwill for impairment will not only "ease the sting" from the end of pooling, he adds, but may also make the new purchase model superior because pooling has so many restrictions.

FASB's decision follows more than a year of blistering attacks from corporate executives looking to save pooling. Their main gripe: Purchase accounting puts goodwill on the balance sheet and depresses future earnings when that asset could, in fact, be appreciating. Politicians have also shown a willingness to step in with legislation that would slow the board's progress.

Such a dramatic move may now be unnecessary. After all, at a congressional hearing held last spring, Sen. Phil Gramm (R­-Tex.), chairman of the Senate Banking Committee, advocated that FASB pursue the impairment-testing approach.

FASB chairman Edmund Jenkins acknowledged in an interview that the board's action is a response to the feedback of Gramm and others. Moreover, he said, testing for impairment will provide investors with better information about the economic value of goodwill and its impact on earnings than amortization.

"FASB has listened and responded to the extensive comments from the financial community about making the purchase method more effective," says Dennis Powell, controller of Cisco Systems Inc.

Still, says Jack Ciesielski, publisher of The Analyst's Accounting Observer newsletter, "Goodwill is a fuzzy asset, and testing a fuzzy asset is going to be a fuzzy test."

Jenkins, however, is confident that FASB is heading toward a standard that will satisfy supporters and opponents. "I'm hopeful we can come up with a package that will improve financial reporting sufficiently and bring reasonable agreement among our constituencies." —S.B.

Business to OSHA: "OUCH!"

On November 14, the Occupational Safety and Health Administration (OSHA) issued the most far-reaching set of work-related rules ever, provoking an immediate barrage of criticism that the new ergonomics regulations are too broad, overly vague, and scientifically unsound.

In response, more than 60 organizations and companies have signed on to legal actions seeking to overturn the new rules, which take effect January 16 but give businesses until October to comply.

Baruch Fellner, a lawyer in the Washington, D.C., office of Gibson, Dunn & Crutcher LLP and lead counsel of the court challenge, says, "We believe the standard is fatally flawed." He cites as examples OSHA's economic analysis and rule-making procedures, potential conflicts between certain provisions and state workers' compensation laws, and the absence of compelling medical evidence of the need for the new regulations.

In addition, with George W. Bush in the White House, the Republican-controlled Congress may "feel the pain" of OSHA's antagonists and introduce legislation to rescind the rules or withhold funds to enforce them.

Under the new guidelines, many employers may have to do little more than give workers information on ergonomics-related injuries. But if two workers complain of musculoskeletal ailments such as carpal tunnel syndrome, lower back pain, or sciatica, companies would be required to screen for causes in the workplace and take steps to reduce those hazards.

One of the harshest provisions would require companies to pay an injured worker 90 percent of his or her pay for up to 90 days, while workers' compensation insurance covers no more than 67 percent of pay. "The employer will have to pay the difference," says Bob Gibson, vice president of loss prevention at Missouri Employers Mutual Insurance Co., a workers' comp provider. Another concern is that companies would increasingly find themselves responsible for injuries that were largely caused by nonwork activities.

OSHA puts the cost of complying with its new regulations at $4.5 billion a year, and projects a benefit of $9.1 billion from improved productivity and reduced insurance claims. Business groups say the agency is way off, offering up annual estimates that range from $18 billion to $126 billion. They also insist that such heavy-handed regulations are unnecessary, since ergonomics-related injuries are on the decline nationwide.

For the most part, in fact, major corporations are already on the ergonomics bandwagon. SuperValu Inc., based in Eden Prairie, Minn., spent $160,000 at one of its warehouses on a new exercise machine that isolates and strengthens the muscles along the spine. Workers who spend their days lifting heavy boxes use the device 10 minutes a week; if back-strain injuries are down after a year, SuperValu will consider putting the machine in each of its 38 food distribution centers.

"I'm frustrated that OSHA thinks that if it were not for OSHA, no one would care about ergonomics," says James Koskan, corporate risk-control manager at SuperValu, who estimates that it would cost the company a minimum of $17 million to comply with the OSHA rules, based on a study by Food Distributors International, a trade association in Falls Church, Va.

Yet it is likely that companies with a few hundred employees or less will feel the greatest burden. "Small businesses are going to have a harder time than large ones," says Phyllis King, an ergonomics expert at the University of Wisconsin, Milwaukee. They have fewer resources to spend on ergonomics programs, she notes, and would reap fewer benefits from the money they can invest. —S.B.

School of Hard Time

No business school has had more students go to jail than the University of Maryland's Robert H. Smith School of Business. Fortunately, they go for only half a day.

Each year, about 200 full-time MBA students from the school visit federal prisons in small groups, where they hear from inmates serving time for white-collar crimes. More important, says professor Stephen E. Loeb, they also "tour the prison and see what it's like to be a prisoner. It is a really sobering experience."

Loeb, 60, has taught accounting ethics since 1970, and was inspired by the 1987 "Treadway Commission Report on Fraudulent Financial Reporting," which emphasized the importance of education in combating fraud. When university officials decided the MBA program needed more real-world experiences, Loeb hit upon the idea of taking students to the slammer. After some discussion with both faculty and prison officials, he took his first class to prison in 1996.

The result, he says, is an experience that students will remember when they encounter legal or ethical challenges in their careers. "I hope they will say, 'Hmmm, if I make the wrong decision and get prosecuted, that's where I'm going to be for a few years.'"

That's truer today than ever before: the U.S. Attorney's office has been quick to follow up actions by the Securities and Exchange Commission with criminal prosecutions. And according to David Levine, special adviser to the SEC's director of enforcement, initial numbers for the year 2000 show that of 500 SEC enforcement actions, 100 were financial fraud and reporting cases. That's 10 percent more cases than were brought in 1999, which in turn exceeded the number of cases in 1998 by 15 percent.

"Those numbers cry out for continuing professional education in ethics," responds Loeb. "Not only do we need ethics education at the university; we need it throughout a financial professional's career." —T.R.

Step Lightly

There's a step-up in step-ups, it seems. By early December, 18 investment-grade companies had attached step-ups to their bond issues in 2000, according to MCM CorporateWatch, far outpacing the three such issues that included the provision in 1999. At least 5 of the 18 covenants stipulated that a company would increase its coupon rate if it was downgraded by a major ratings agency within a specified time.

Half of the bonds using step-ups were issued by European-based companies in 2000. But, while "it's a European phenomenon at this point, there's downward pressure on the U.S. as well," says Bob Konefal, head of Moody's Investors Service's telecommunications, media, and technology group. He notes that AT&T is being reviewed for a possible downgrade and that companies in other volatile sectors, like retail and energy, are likely to be hit up for step-ups. For example, Southern California Edison Corp. and Pacific Gas & Electric both included step-ups in their fall 2000 bond issues. —Alix Nyberg

Showdown in Alabama

When the U.S. Supreme Court pronounced Alabama's foreign franchise tax unconstitutional in March 1999, companies across the nation smelled refunds. Big ones. For years, they had paid millions of dollars under the tax, which assessed out-of-state firms based on the value of their capital in the state, while in-state companies' assessments were based on the par value of their stock, which firms can set at levels well below their book or market value.

In September, however, the plaintiff, South Central Bell, now known as BellSouth of Atlanta, settled for a $40 million refund — a mere 19 percent of what the state had collected. While the state's governor has been encouraging other companies to do likewise, many are willing to take the state to court to get their money back. Bruce Ely, an attorney with Tuscaloosa, Ala.-based Tanner & Guin LLC, for example, is handling a class-action lawsuit by Gladwin Corp. "We're teeing it up for a long, arduous battle in the courts," says Ely, whose 2,500-plus clients are collectively owed more than $700 million.

With roughly 2,500 claims pending against the state, nearly $850 million in refunds are being sought. Because litigation is so "impractical," however, says Donald Griswold, national partner of KPMG's state and local tax technical services, the consultancy is organizing a coalition of claimants to negotiate with the state as a block, as an alternative.

Still, concerns abound about how other states will structure taxes if Alabama is not forced to pay full refunds. "States could be tempted to push the boundaries of the tax laws if they know they won't have to give it all back when it's found illegal," says Douglas Lindholm of the Committee on State Taxation. —Paul Merolli

It's the When, Not the Way

As the Securities and Exchange Commission considers a proposal requiring electronic filing for insider transactions, rancor is building over the possible change. But the frustration isn't coming from the corporate world; it's coming from investors, who claim it's the wrong rule to change.

"The real issue for insider filing is not which way it's done, but how much time executives have to make these trades public," says Mitch Zacks, vice president of Zacks Investment Research, in Chicago. "Investors see insider news well after a transaction occurs. What the SEC needs to do is narrow the window for filing this information."

Currently, paperwork for insider stock deals, known as Form 4s, must be filed with the SEC within 10 days of the end of the month in which the deal occurred. Technically, this means corporate executives and officers have up to 40 days to formally notify the commission that they have bought or sold their company's stock.

The investment world considers insider trades an indication of fundamental company or market changes, such as potential mergers, stock splits, or industry weakness. The filing delay for these trades puts outside shareholders at a disadvantage, according to Zacks, because they cannot make timely decisions that could dramatically affect the value of their own portfolios.

"The regulations regarding insider trades should be totally revamped," says Zacks. "As things stand now, junior-level managers and individual investors are getting hurt by delayed news." In droves, it seems. According to First Call/Thomson Financial, such trades are up 20 percent from a year ago.

Nevertheless, it's unlikely that rules regarding the timing for Form 4 filings will change soon. Even mandated electronic filing of the forms via the government's EDGAR system may be a long time coming, according to John Heine, a spokesperson for the SEC. The filing method was a mere footnote to other EDGAR rulemaking changes published by the SEC in April, and even then the commission noted only that it "anticipated" a proposal on the matter. As for changing the window for filing, Heine notes that that is a matter of statutory language found in the Securities Exchange Act of 1934, and that only Congress can change it.

And, as we now know all too well, the wheels of government grind slowly. — Leslie Schultz

WTO Battle Rages On

On November 17, 2000, the European Union filed a claim with the World Trade Organization for $4.04 billion in trade damages against the United States, setting in motion a new round of trade conflicts that could yet erupt in a trade war between the two regions. The move came just days after lawmakers on Capitol Hill finally managed to pass a bill repealing the foreign sales corporation (FSC) export tax break and replacing it with another tax break, which President Clinton signed into law on November 15.

The conflict continues, despite more than a yearlong effort by the U.S. Treasury and the U.S. Trade Representative's office to put in place an export incentive that would satisfy the EU. But the EU has remained adamant that the FSC-type subsidies are illegal under WTO rules.

"Whilst wishing to de-escalate this dispute, our aim is to see the WTO-incompatible FSC export subsidies removed," said Pascal Lamy, an EU trade commissioner, in a statement. "Although we believe the FSC replacement legislation does not solve the problem, the EU will leave it to the WTO to rule on this question."

Officials and business groups in the United States strongly believe that the new legislation should pass muster with the WTO, but may not for political reasons. "The WTO found problems with the form of our tax incentive, not the substance. The replacement legislation avoids the form problems and should be found legal," says Kimberly Pinter, director of corporate finance and tax issues at the National Association of Manufacturers. "But within the WTO, this is not going to be a strictly legal question. So, we think this has a 50-50 shot of being found in compliance."

The process could take another six months. Should the United States lose all the way through, the EU intends to ask for compensation, says an EU delegation source, meaning lower tariffs on EU imports. If the U.S. won't grant that, says the source, "the EU would retaliate with higher tariffs on U.S. products." —Ian Springsteel


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