Laundry Time

Plus, prosecutors pressure indicted CFOs to rat on their bosses; companies turn away small shareholders; pension plans still make unrealistic assumptions; and more.


Laundry Time

Last month former Enron CFO Andrew Fastow was formally charged for his alleged role in the scandal at the bankrupt energy giant. The criminal complaint includes charges of securities fraud, wire fraud, mail fraud, bank fraud, conspiracy, and money laundering.

Given the complexity of the alleged crime, the variations on the fraud theme come as no surprise. And conspiracy? Well, no man is an island, right? But the charge of money laundering is puzzling. Isn't it usually reserved for big-time drug dealers? It was, says attorney Scott Magargee of Philadelphia law firm Cozen O'Connor, but it is being applied more often to financial crimes, even in cases where the money laundering was incidental to the underlying crime.

In Fastow's case, the charge stems from his alleged use of ill-gotten gains to make legitimate purchases, including a $4.2 million house he was having built. "If you got $100 [illegally] and use that for your kids' education, some prosecutors say that is money laundering," says Magargee.

The charge carries with it a maximum sentence of 20 years, effectively doubling Fastow's potential sentence if he's found guilty. No house is worth that much. -- Joseph McCafferty

Executive Indictments

Who Will Take the Fall?

Call it a squeeze play. Prosecutors looking to pin corporate scandals on the top dog often press other executives for information that could prove a case against the CEO in exchange for leniency for the informers. And despite the intense camaraderie most CFOs claim to share with their CEOs, finance chiefs facing criminal sentencing have traditionally jumped at the offer.

So now that indictments have been brought against Scott Sullivan, former CFO of WorldCom, and Andrew Fastow, former CFO of Enron, you can bet that federal prosecutors are leaning on them to fess up about what part their bosses played in the alleged fraud. (At press time, the former CEOs of these companies, Bernard Ebbers and Kenneth Lay, respectively, had yet to be formally accused.) "In every case, the prosecutor is ultimately going after the CEO, and the CFO's testimony is usually a critical element in building that case," says former federal prosecutor John Falvey, now an attorney at Testa Hurwitz.

In the early 1990s, for example, former Phar-Mor CFO Patrick Finn was sentenced to less than 3 years in jail for accounting fraud after testifying against former boss Michael Monus, who received nearly 20 years.

In cases like Enron, WorldCom, and others, "the downside to fighting to the end and losing is enormous," notes Falvey. While plea-bargaining "doesn't necessarily mean a walk, it can reduce the years you spend in federal prison."

Already, prosecutors have recruited lower-level informants, like former WorldCom controller David Myers, to cooperate with the investigation as they move up the chain toward bigger fish. But how much leniency currently accused CFOs like Swartz or Sullivan stand to gain is open to question. "As CFOs continue to increase in prominence, they are becoming targets themselves," says Martin Weinstein, an attorney with Foley & Lardner and a former prosecutor for the Department of Justice. "I'm not sure that prosecutors will be so ready to make deals with CFOs." With CEOs at many of the companies in question sticking to their stories that they didn't know about the sophisticated financial frauds like that at Enron, some CFOs may find themselves taking the fall. --Alix Nyberg

Witch Ones?

According to a survey by Teradata, 54% of executives at Fortune 1,000 companies say the focus on corporate wrongdoing could turn into a witch-hunt.

M&A activity declined 10% during the third quarter compared with the second in terms of deal volume, according to Mergerstat.

Shareholder Management

Too Small to Keep

In this market you wouldn't expect companies to turn investors away, but that's exactly what some are doing. Why? To save money, of course, says Scott T. Gallagher, senior vice president at Georgeson Shareholder, a New York shareholder-communications firm. "Public companies are looking under every rock to eliminate hidden costs."

Odd-lot shareholder programs--in which companies offer shareholders with fewer than 100 shares a chance to either sell them at discounted fees or buy enough to hit 100--are making a comeback. Georgeson has conducted more than 700 of them.

Companies might be surprised by just how many shareholders fit the bill. On average, 55 percent of a company's investors hold fewer than 100 shares, but they represent less than 1 percent of shares voted, says Gallagher. It costs a public corporation more than $19 annually in servicing costs for every shareholder, regardless of how many shares he or she holds, according to a recent study by PricewaterhouseCoopers.

John Hancock Financial Services Inc. recently launched a voluntary odd-lot program. So far, the insurer says, it's "hitting its target" for eliminating odd-lot shareholders, but the company recently extended the deadline to participate by a month.

The average redemption rate is 30 percent to 40 percent, according to Gallagher, but investors don't always jump at the offer. International Absorbents Inc., a small-cap pet-care products company in Bellingham, Wash., recently launched an odd-lot program involving a share buyback. The company identified 90,000 shares held by odd-lotters, but at the deadline, only 3,198 shares had been redeemed. "Compared to what they bought the stock for, it wasn't worth it for a lot of them to do a trade," says Charles Tait, director of corporate communications. The odd-lot offer was $2.35 per share.

But the program, which ended on September 9, had a positive, if unexpected, outcome. "A lot of people decided to hold on to their shares," says Tait. "And some even bought more after I spoke with them." --Kris Frieswick

With a Doubt

A Web poll by Hyperion revealed that 19% of financial managers say they lack confidence in the integrity of their own financial reports.

Pension Plans

The Party's Over; Why Plan Like It's 1999?

Pension plan sponsors are living in the past. Some critics say that many companies have not updated their investment-return and interest-rate assumptions to reflect the current conditions of low interest rates and dismal stock-market performance. And while plenty of plans are now underfunded, the true picture could show underfundings at crisis levels.

"Plan sponsors have become increasingly aggressive. They're pushing the envelope on this stuff," says Stephen Church, president of Piscataqua Research Inc., a Portsmouth, N.H., consultancy. "Interest-rate assumptions are too high, as are investment-return assumptions."

Church says that plan sponsors are overstating interest rates--used to calculate a discounted present value of future liabilities--anywhere from 1 to 2 percent. The miscalculation has the effect of drastically underestimating what companies will owe future retirees in benefits.

Jeffrey Speicher, a spokesperson for Pension Benefit Guaranty Corp., which insures pension plans, says that pension assets have deteriorated. "Conditions are certainly very drastic right now," he says.

Indeed they are. A recent survey by benefits consultant Watson Wyatt Worldwide found that of 500 pension plans studied, the percent with enough assets to cover total pension liabilities had dropped from 83 percent in 2000 to about 33 percent this year.

That means that companies are on the hook to make up the difference. Even though General Motors, for example, announced this summer that it contributed $2.2 billion to its pension fund, the plan is still underfunded by $20 billion, according to an estimate by UBS Warburg. Church, however, says that using more-conservative assumptions, the actual amount could be even higher.

GM's plan assumes that investments will return roughly 10 percent annually. In 2001, however, the return on plan assets was a loss of more than 5.6 percent, and losses are expected to be higher this year. "Bad information leads to bad decisions," says Church. "Companies need to do more to make sure things are presented in fair fashion." -- J.McC.

The Big Three's Big Ifs

Automakers' 2001 pension assumptions could hide shortfalls.

CompanyInterest rate

Expected return


Source: Futuremetrics Inc.

Learning to fly straight: 80% of executives surveyed by Teradata say they have learned from the recent accounting scandals.

Cost Cutting

Printing with Less Red Ink
Despite the promise of a paperless society, companies are spending more on printed materials than ever before--up to 3 percent of revenues at most large companies. And while many companies don't realize how much they spend on printing, those that do can find it difficult to trim.

"Print is overlooked, because it is not a core product and it is fragmented throughout the organization," says Ron Seavey, managing partner of The Open Approach Consulting Group. High shipping and distribution costs, fluctuating paper prices, rapidly changing orders, and the short shelf life of printed materials add to the difficulty of cutting costs.

While centralizing the print function might not make sense, since each department has different needs, Seavey maintains that sharing information about print spending across the corporation does. Aggregating ordering and price information can eliminate 20 to 40 percent of the red ink, particularly now that online procurement tools are readily available.

In the past year, for example, Concord Communications Inc. saved nearly 20 percent of its print spend, mainly by setting up an intranet that lets global sales reps order brochures and data sheets as needed. Previously, reps ordered from a central printer in advance, only to find that the materials quickly became outdated. "The level of waste was tremendous," says CFO Melissa Cruz.

Many national print vendors have begun to offer their larger customers similar online ordering tools. Consolidated Graphics Inc., for example, says some 200 of its customers are now using its online ordering system and reporting capabilities. And at least one company, Cirqit Inc., has begun selling software independently that helps companies maintain relationships with multiple vendors. The tools, which cost from $150,000 to $500,000 annually, bid out a project automatically. "Buyers are able to see in real time, across all of their printers, which can produce the project the cheapest," says Cirqit CEO Mark Hausser.

With spending data in hand, companies have more leverage to negotiate with vendors. Even so, Seavey urges companies signing long-term contracts to make sure suppliers keep up with fluctuating variables, like paper prices. "The products and quantities of orders change so much, it's easy to miss it when prices are out of line." --A.N.

Leveraged Buyouts

Where Are All the Raiders?
According to Weiss Ratings, 75% of brokerages kept buy or hold ratings on firms that were "in distress" and later filed for bankruptcy.

With share prices at stomach-wrenching lows and a reasonably healthy high-yield climate, market watchers are anxiously waiting to declare a return to the era of the corporate raider. But instead, leveraged-buyout players have been strangely slow on the draw, while their cash has been piling up, uninvested.

To be sure, some vulturelike investors have saddled up. At press time, The Carlyle Group and Welsh, Carson, Anderson & Stowe were arranging as much as $1 billion in high-yield financing to fund their $7+ billion purchase of Qwest's directory unit. Following a number of similar deals this fall, it's no surprise that some observers were predicting a stampede of buyouts.

But experts say a return to a buying frenzy like that of the late-1980s is unlikely. For one thing, the current limited buying may be due more to pressure from fund investors to spend than to good opportunities. Uninvested LBO capital crept up to $123 billion in 2001, according to research firm Venture Economics. "It's tough to justify the amount of money they've raised if they're not investing it," says Robert Dunn, associate editor at Private Equity Analyst newsletter.

Leveraged buyers are also facing less-favorable terms. LBO firms parted with equity worth an average 41 percent of the deal price in the third quarter, according to Standard & Poor's Portfolio Management Data. "It's the highest in recent memory," says PMD's Marc Auerbach. In the late 1980s, the average fell to 10 percent.

Patient investors say that it's a seller's market. "I am seeing very few bargains--quite the opposite," says Frederick Iseman, chairman of $2 billion fund Caxton-Iseman Capital Inc. -- A.N.

Medical plans with co-pays for doctor visits of $15 or more rose to 47% in 2002, according to the Hay Benefits Report.


Another Nick in the Wall
Wall Street just can't seem to get out of its own way these days. Even as the scandal over the breakdown of the wall between research and investment banking continues to cast a dark cloud over large banks, another gathering storm threatens to further weaken their credibility.

This time it's the commercial lenders that stand accused. Regulators are looking into allegations that banks are making loans contingent upon the corporate borrower's ability to provide other fee-based business, such as cash-management services or investment banking. The illegal practice, known as "tying" or "pay to play," is said to be widespread among commercial banks.

The National Association of Securities Dealers launched an investigation into tying after it received complaints from corporate borrowers. Although NASD won't comment on the investigation, it did issue a notice warning member banks that tying arrangements are against the law. "NASD is concerned that the practice of tying commercial credit to investment banking is becoming increasingly widespread," it said.

According to the Association for Financial Professionals, tying is endemic. It surveyed 3,500 financial officers and found that 48 percent believed that "if they didn't award other business to short-term lenders, the amount of short-term credit would be reduced." And 39 percent said they didn't expect to get loans at all if they didn't award other business to lenders. "It's very much a real issue," says James Haddad, a member of the AFP's board of directors and vice president of finance at Cadence Design Systems Inc., a San Jose, Calif., software firm. "I've seen it throughout my career [in finance]. Every company sees it. Banks aren't bashful about letting you know they expect loans to bring in other business."

The treasurer of a Fortune 500 company who asked to remain anonymous agrees that tying has created headaches for corporate borrowers. (Most finance executives won't talk about the problem openly, for fear of damaging their banking relationships.) "It's nothing official--they don't ask you to sign anything," says the treasurer. "But it's understood that creditors are trusted to get their share of other banking business. That's just the way it is." The treasurer was forced to move the company's lock-box business to a new bank after the company secured a new line of credit with that bank, even though the finance executive preferred the existing one. The treasurer blames the practice on the low-interest- rate environment, explaining, "Banks don't want to lend money anymore."

The practice of tying could have grave consequences for the economic system, says Haddad. He says that plenty of large banks made big loans to companies based more on what fee-based business the loan could generate than on the creditworthiness of the borrower. That practice has already contributed to large losses in loans made to technology and telecom firms--losses that could affect the rates and terms of credit for companies at large. "Effectively, banks look at lending as a loss leader," says Haddad. But when they make bad loans to a company like WorldCom based on how much other business they can get, the backlash has an impact on all companies. "Everyone ends up paying higher fees and rates," he adds.

Rep. John Dingell (D­ Mich.) is urging the Federal Reserve to crack down on tying. In a letter to Alan Greenspan, Dingell said he was "concerned about the implication of these practices on the health of the financial markets and on the availability of credit to U.S. corporations."

The prevalence of tying is largely a product of the consolidation of banks in the late 1990s, and of the repeal of the Glass-Steagall Act in 1999, which kept commercial banks out of the investment-banking business, says Dimitri Papadimitrious, president of the Levy Economics Institute at Bard College in New York. He doesn't think Glass-Steagall should be reinstated, but he does think regulators need to enforce existing laws, including those that prohibit tying. Says Papadimitrious: "I'm not so sanguine that regulators will do the due diligence on lenders until it reaches a crisis; then it's already too late." -- J.McC.

Salary freezes in 2002 were reported by 10% of companies surveyed by Hewitt, but only 1% expect freezes in 2003.


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