Bolting from the Big Four

Smaller firms are picking up audit clients at the expense of the Big Four. Also: stock options fall out of favor; a proposal to synchronize accounting and tax reporting; analysts say good-bye to stock ratings; more.


When it comes to auditors, many companies are apparently deciding that bigger is not necessarily better. Auditor-Trak, a database that follows corporate-auditor changes, reported that in 2003 each of the Big Four accounting firms lost more public-company audit clients than it gained.

PricewaterhouseCoopers took the biggest hit, with a net loss of 91 audit clients. Ernst & Young finished 2003 with 76 fewer audit clients, while Deloitte & Touche suffered a net loss of 65 and KPMG lost 51.

More than half of those clients migrated to smaller auditors. Second-tier firms like Grant Thornton and BDO Seidman nabbed more than 21 percent of the clients that left Big Four firms, according to Auditor-Trak. Another 34 percent went with regional or local firms, and the rest moved within the Big Four.

Edward Nusbaum, CEO of Grant Thornton, says the world's fifth-largest accounting firm has picked up more than 1,000 new clients in the past year, including many defectors from the Big Four. "CFOs want more-personalized attention from their audit partners," says Nusbaum. He argues that firms like his can give midsize companies more attention at a better price than the Big Four, which, he claims, specialize in service to large caps.

Ace Comm Corp., an $18 million telecom-equipment provider based in Gaithersburg, Md., recently left Ernst & Young for Grant Thornton. CFO Steven Delmar says that price was the main consideration. "Grant Thornton's fees are lowered to meet customer demands," he says. "Big Four firms aren't going to reduce their fees below a certain level."

Apart from price, another impetus to move to a second-tier firm is that the Sarbanes-Oxley Act of 2002 prohibits companies from using the same firm for auditing and consulting services. Auditor-Trak publisher Richard Ossoff adds that the intense regulatory environment is causing many companies to reevaluate their relationship with their auditors. "Some audit committees will feel compelled to change auditors," he says, "even in the absence of any concerns about existing audit relationships." That could yield a bounty for smaller accounting firms.

Still, most large companies with global operations require the services of a Big Four auditor to handle their complex financial statements. Royal Bank of Canada recently named Deloitte & Touche as its sole auditor. "D&T has in-depth knowledge of securities and industry regulators in many international jurisdictions," says the bank's CFO, Peter Currie. He says that only Big Four firms were invited to submit proposals. —Lisa Yoon

Thanks, SEC

It's rare that companies welcome a ruling from the Securities and Exchange Commission. But recent news that the SEC was extending the deadline for companies to complete audited assessments of their internal financial controls nearly had CFOs dancing in the street.

Most companies now have until their first fiscal year ending on or after November 15, 2004, to comply with Section 404 of the Sarbanes-Oxley Act. The original deadline was June 15. Companies with a market cap under $75 million have until at least July 15, 2005.

"You could have heard us cheering for miles," says Scott Youngstrom, CFO of Compex Technologies Inc., a New Brighton, Minn.-based maker of medical devices. He says the deadline for his company now moves back a year, to June 2005. "This gives us the flexibility to use more of our own resources instead of relying on consultants to rush through it," he says.

Not everyone is cheering. The new deadlines don't affect microchip-design software firm Magma Design Automation Inc., for instance, which has its year-end on March 31. "We were kind of hoping to see it in action before we had to comply with it," says CFO Gregory Walker. —Joseph McCafferty

Down to a Trickle

Four years after the new economy ran out of gas, are companies finally ready to abandon fixed-price stock options? The impact of expensing, underwater options, and shareholder attempts to block companies from issuing new shares appear to be driving many to do so.

A new survey conducted by Deloitte & Touche found that three-quarters of the 165 S&P 500 companies surveyed plan to shift away from stock options, and 17 percent have already dropped them entirely. Companies that have announced such intentions include Dell; Microsoft, which now emphasizes restricted stock; and IBM, which will give its top executives options that vest only if the company's shares rise by 10 percent or more. In place of these options, companies are considering alternatives such as cash, restricted stock, and phantom stock (bonuses tied to an increase in stock price).

"As the economy began to slow, stock options became less of a motivation for employees, so we have had to look at other ways to incentivize," says Mike Maher, a spokesman for Dell, which has cut the number of options it grants by about half for two years in a row.

Many companies are decreasing their reliance on options because they believe they will have to start expensing them in 2005. More immediate pressure is coming from shareholders. Last year the New York Stock Exchange and Nasdaq altered their listing requirements to require companies to seek shareholder approval for changes to equity compensation plans, including the issuing of new shares to cover upcoming grants. (Formerly, such plans required only board approval.) The D&T study shows that two-thirds of companies will run out of shares within 24 months.

Big institutional investors—which worry about dilution from large options grants—are using their new power to oppose excessive compensation. According to Peter Clapman, chief counsel, corporate governance, at TIAA-CREF, his organization has recently voted against roughly 35 percent of compensation plans and will likely oppose a similar number in the future. "Plans should be performance-based, not just a reward for a general rise in the stock market," he says.

Whether the move away from stock options will survive the market's upswing is anyone's guess. Michael Kesner, a D&T principal in Chicago, believes that independent compensation committees and determined investors make a return to the excesses of the 1990s unlikely. And who knows? If overhauling compensation plans helps drive better corporate performance, boards may find they prefer having fewer options but more choices. —Don Durfee

Matched Sets

Companies keep two sets of books—one for financial accounting and one for tax filing. But a new proposal from the Internal Revenue Service would make them synchronize the two sets of numbers.

The proposed form, known as Schedule M-3, would force corporate taxpayers with assets of more than $10 million to disclose additional information about the difference between financial accounting and taxable income, and reconcile net income or loss in the income statement to taxable income.

The new filing will make it easier for IRS agents to spot inconsistencies that could reveal aggressive tax treatments or even fraudulent accounting. Treasury assistant secretary for tax policy Pam Olson says the rule will cut down on unnecessary audits and allow agents to focus on aggressive positions more quickly. "The increased transparency will have a deterrent effect," she says.

The move is part of a general crackdown on aggressive tax treatments by the IRS. "The increased attention to tax-avoidance activities by firms is clearly part of the motivation for the IRS's wanting to get additional information," notes George Plesko, an assistant professor of management at MIT's Sloan School. And it shouldn't present companies with too much additional work, he argues. "It generates additional for the IRS while imposing relatively little additional burden on firms," says Plesko.

But Fred Murray, director of tax affairs at the Tax Executives Institute, says the form is somewhat redundant. "A lot of this information is already provided elsewhere," he says. And while TEI welcomes a move toward faster audits, Murray worries that the new rule will create a lot more work. "There is some angst that the new form will lead to new burdens on tax departments," he says. —J.McC.

Hold the Recommendation

Some equity research houses are ditching the standard buy, hold, and sell recommendations for stocks in favor of more-nuanced assessments.

On March 1, SG Cowen Securities Corp. announced that it will no longer issue ratings for stocks. "Investment conclusions have been 'dumbed-down' by the attempt to categorize each opinion into one of a small handful of buckets," wrote Barry Tarasoff, director of research at SG Cowen, in a letter to clients. He says the firm will issue investment opinions that use "the full richness of the English language."

So far, companies are applauding the decision. "I give them credit. It's a bold move," says Mark Aaron, director of investor relations at Tiffany & Co., which counts SG Cowen among its analysts. "If it shifts investors from a narrow focus on ratings to discussion of more-thought-provoking research, we are all better off."

The move comes just days after HSBC, the world's second-largest bank, announced that it would forgo recommendations in its equity research. So did America's Growth Capital, a small investment bank when it launched in Boston just eight months ago. Maria Lewis Kussmaul, director of investment research, says the problem with ratings is that one size doesn't fit all. "What might be a 'sell' for a short-term investor could be a 'buy' for an investor with a longer time horizon," she says. And institutional investors don't use ratings anyway, she adds. "They're beyond useless."

Marv Burkett, CFO of Nvidia Corp., a Santa Clara, Calif.-based graphics chipmaker, expects other sell-side analysts to follow suit. He says that the trend could shift the focus to the longer term. "Doing away with ratings and price targets could help move people from a trader mentality to more of an investor mentality. That's a good thing," he says.

Of course, another good thing is that by forgoing ratings, research firms can avoid the sticky problem of issuing—or failing to issue—sell recommendations on their investment-banking clients. "It will alleviate pressure on analysts to avoid angering clients," says Jeffrey Haas, professor of securities law at New York Law School. —J.McC.

Hearing Voices at Proxy Time

The Walt Disney Co.'s annual shareholder meeting this past March made headlines for the unprecedented rebellion of large investors that led Michael Eisner to step down as chairman. But smaller investors had already been debating this topic for weeks, thanks to a new Website for shareholder activists., which launched in January, features multiple message boards, organized by company, where shareholders and other interested parties can express their opinions for or against director candidates or other proxy initiatives. Brian Heil, the site's founder, says many individual investors don't vote their proxies—38 percent of those who remember ever receiving ballots fail to cast them, according to a Harris Interactive poll—in part because the fine-print documents are too dense and difficult to read. He thinks the structured forum will give investors more involved.

It will also offer large shareholders a way to reach smaller investors, as people who post messages can pay to have them displayed more prominently. Heil hopes that by giving top placement to paid messages, the site will enable investors to find valuable information quickly without having to weed through the kind of less-useful rants that can dominate other sites. (The pay-per-post model is also his attempt to create a sustainable business.)

Heil expects that individuals or organizations with strong opinions on certain issues will pay to get their messages heard. Paid messages have no set price but appear in order by the amount paid' posters can spend as little as a penny per day. Free messages are also accepted, and are placed below paid messages.

The site does have its detractors. Prof. Charles Elson, a governance expert at the University of Delaware, fears that posters' lack of accountability could lead to abuse. "How do you know that the people participating are not just short sellers trying to affect the price of the stock?" he asks. Elson also warns that shareholders can run afoul of Securities and Exchange Commission regulations that require investors acting together to identify themselves to the agency.

ProxyMatters likely won't be able to eliminate all junk postings, but Heil says it will help facilitate serious discussion. "This isn't foolproof," he says, "but it's a giant improvement." —Kate O'Sullivan

Go Ahead, Delist Me!

Usually, getting delisted from a stock exchange is the kiss of death for a company, but these days a few are actually asking to be kicked off. That's because some companies can't afford to abide by the heap of costly new regulations from the exchanges and the Sarbanes-Oxley Act.

The Ohio Art Co., maker of the Etch-a-Sketch drawing toy, announced that it was voluntarily delisting from the American Stock Exchange and deregistering with the Securities and Exchange Commission in February. CFO Jerry Kneipp says the costs of complying with Sarbox outweigh the benefits of remaining public. "It would cost at least $100,000 just to set up the initial controls," he estimates. Going private wasn't an option for Ohio Art. "That would entail buying back the stock, which we're not in a position to do," says Kneipp.

The process of delisting and deregistering is generally free and fast, and does not require shareholder approval. To delist from Nasdaq, for example, a business need only write a letter to the exchange. To deregister, the last formality is filing Form 15, a one-page document, with the SEC. "It's relatively easy to complete," says attorney Marci J. Frankenthaler of Graubard Miller in New York. Once delisted and deregistered, a company is free from the SEC's mandates—even though its shares are still eligible for over-the-counter trade on the so-called Pink Sheets.

There's plenty of controversy over the ease of delisting and deregistering. "Too many small-cap stocks are clearly exploiting a loophole," says Stephen J. Nelson, an attorney who has petitioned the SEC on its deregistration policy. He says companies can blindside investors by vanishing from exchanges without warning. That's because federal law states that any company with fewer than 300 record-holders can deregister by filing Form 15. Back in 1964, when the current law was enacted, investors tended to buy stock in their own names. Today, with brokerages (Schwab, Fidelity, and so on) doing most of the buying, only they are listed as record holders—even if thousands of individuals hold stock through them.

That's not to say that delisting can't be used successfully. Addison, Ala.-based Southern Energy Homes Inc. delisted in January, and CFO James Stariha says there has been no backlash from investors. In fact, the move has brought good fortune: as of March, the stock was at a three-year high of $3.15. —Ilan Mochari

Slipping Through the 'Net

Despite the millions of dollars companies have poured into online investment tools, a new study by consulting firm Greenwich Associates reveals that only 35 percent of employees are using them to manage their 401(k) plans.

Many employees shun online resources in large part because retirement planning is just not something they think about regularly, says Stephen Utkus, a principal at Vanguard's Center for Retirement Research. In fact, a study by American Express Financial Advisors (AEFA) finds that many people spend just three hours or less working with their 401(k) plans each year. Some employees are insecure about investing, and prefer in-person advice to going it alone online. "There's so much information to wade through, it's hard to do on your own," says AEFA's Craig Brimhall.

But that hasn't stopped companies from moving account management onto the Internet and away from costly paper-based processes. "There's a corporate mandate to move employees online, and that's not going away," says Jeff Maggioncalda, CEO of Financial Engines, a provider of 401(k) management tools and services based in Palo Alto, Calif.

Plan sponsors might be discouraged from further investment in online tools by such low utilization numbers. But 401(k) experts caution that the best approach for reaching employees with retirement information is to combine a variety of methods for different types of investors. For example, technology giant Motorola Inc. offers workshops throughout the year for those who prefer face-to-face education, says Randy Boldt, director of employee rewards. The company also provides online advice through Financial Engines.

"There are very different needs within each company's retirement plan," says Vanguard's Utkus. "You have to offer basic program as well as sophisticated tools." He adds that companies can also increase the use of online tools by sending personalized E-mails to direct people to the site, and by reminding them of the importance of saving for retirement. —K.O'S.

Helpful Hints
How companies provide 401(k) advice services*:
Over the Internet43%
In person19%
Do not offer advice, only education14%
Over the telephone12%
* 2003, U.S. Corporate Funds ($25 Million-$250 Million)
Source: Greenwich Associates

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