Making the List

The SEC tries to tease apart the tangled connections between pension-investment consultants and money managers. Also: IRS aims to soup up audits; companies collecting antidumping tariffs; hotel fees irk business travelers; and more.


Embarrassed by N.Y. Attorney General Eliot Spitzer's aggressive muckraking, a newly assertive Securities and Exchange Commission is now scouring neglected corners of the investment business for wrongdoing. In its latest foray, the Commission is trying to tease apart the tangled connections between pension-investment consultants and money managers. Critics have long alleged that investment consultants—a category that includes such firms as Watson Wyatt Worldwide, Mercer Investment Consulting, and Frank Russell—put products on their recommended list in exchange for payments or for agreements to buy the consultants' products.

Competition for a spot on these lists is fierce. "Investment managers want to be on the recommended list, because the consultants are gatekeepers for a huge amount of assets," says Michael Caccese, a partner with Kirkpatrick & Lockhart LLP in Boston.

"Pay-to-play" schemes aren't necessarily illegal, assuming that any conflicts of interest are fully disclosed and informed consent (that is, written acknowledgement of the conflict) is received from the fund's trustees, says Steven Felsenstein of law firm Greenberg, Traurig LLP in Philadelphia. If the consultants are registered investment advisers, trustees probably wouldn't be liable for bad investment decisions stemming from their advice.

It's not clear yet whether the SEC will take formal action, and the big players have roundly proclaimed their innocence. But if pension funds and 401(k) plans have included underperforming funds because of collusion between investment advisers and investment managers, the consequences could be serious. Compounded over many years, those less-then-optimal returns add up.

The investigation may at least shed some light on the mystery of why investors continue to put money into funds that are consistent losers. "How can [the underperforming funds] stay in business?" asks George J. Benston, a finance professor at Emory University's Goizueta Business School, in Atlanta. He adds that although he lacks evidence to prove it, the logical answer is that they're recommended by investment advisers who get paid to recommend them.

Wall Street professionals have long known to take the recommendations of sell-side analysts with a grain of salt. Perhaps it's time for retirement-plan trustees to grab a fistful for themselves. —Don Durfee

Hard Time

Andrew Fastow isn't getting much sympathy from his peers these days. A recent CFO magazine survey suggests that many CFOs think Enron's former finance chief got off easy with a 10-year sentence for securities fraud.

Only 5 percent thought the sentence was too long, while 50 percent said it was just about right. Almost as many—45 percent—think he should be doing more time. "I certainly don't think the punishment was too harsh," says James Judge, CFO of NStar, a Boston-based energy company. "Fastow's manipulation of the financial statements for personal gain devastated Enron investors, cost thousands of decent and hard-working Enron employees their jobs, and shook investor confidence globally."

Robert Leahy, vice president of finance at Brooktrout Technology Inc., a Needham, Mass.-based telecom-equipment provider, agrees. "The sentence should reflect what it cost shareholders," he says. He wonders, half-jokingly, if corporate criminals should get a day in prison for every dollar they cost stakeholders. By that assessment, the fraud at Enron, which is estimated to have cost $89 billion in lost market capital, would put Fastow in prison for 240 million years. —Joseph McCafferty

IRS Aims to Soup Up Audits

The Internal Revenue Service is expediting its process for auditing corporate taxpayers, cutting the three-year examination time to 18 months by promoting electronic filing, narrowing the scope of its checkups, and encouraging its agents to initiate prefiling discussions about touchy issues. "Taxpayers told us they wanted more certainty and timeliness about whether we'll challenge them," says Deborah M. Nolan, commissioner of the Large and Mid-Size Business Division.

Does that mean more audits? Yes, but that's not all, according to Larry R. Langdon, a tax partner at Mayer, Brown, Rowe & Maw LLP in Palo Alto, Calif. Langdon worries that some IRS agents, under pressure to resolve cases quickly, might give up too easily on a sticky audit, funneling it to tax court rather than working a few more months to reach a settlement. If that happens, he notes, any reduction in audit cycles will be offset by subsequent legal-system delays.

The IRS's new approach emphasizes open lines of communication between taxpayers and auditors. Both the boiled-down "LIFE" (Limited Issue Focus Examination) audit and any so-called prefiling agreements require companies to admit, and sign off on, their potential areas of infraction. CFOs, says Langdon, should seize the chance to display their integrity. "Coming clean on a few warts will make most IRS officials act more reasonably with you," he says.

Langdon's mix of faith and skepticism is echoed by Tax Executives Institute Inc. "Everyone supports the concept of a faster process and better communication," says Timothy McCormally, TEI's executive director. "The question is, will it work, and what are the unintended consequences?"

One consequence might be that IRS audits become less thorough and more error prone. Nolan downplays that possibility, stressing that the agency can make process improvements without sacrificing accuracy if it does a good enough job in preaching a kind of preventive medicine: getting corporations to admit and address their problems before they reach an auditable level of severity.

Richard Kadet, a consulting CFO with The Brenner Group consultancy, in Cupertino, Calif., was pleased to learn about the changes. "The longer an audit takes, the more key people leave the company or forget things. It becomes harder to get at the truth of what happened," he says. "Anything the IRS does to speed up audits is a good thing." —Ilan Mochari

A Few Good Lawyers

The Securities and Exchange Commission received $30 million less than it requested from Congress this year, putting its new budget of $811.5 million roughly 15 percent above last year's. Is Congress starving the securities watchdog? Not quite. The real problem is that the agency can't spend money fast enough.

Most of last year's funding increase was dedicated to adding 842 new positions, which would have boosted the SEC's total staff by nearly 30 percent. But the agency could not hire quickly enough to exhaust the funds before its fiscal year ended in October.

The agency will not need the $30 million that was cut, says SEC spokesman John Nester, since it was designated for salaries of people not yet hired.

Others say the agency could easily have used the money for other purposes, like upgrading its IT systems. "These guys could spend $100 million on technology without batting an eye," says Lynn Turner, a former SEC chief accountant.

Hiring at the SEC continues, Nester says, with only about 25 percent of the 842 new posts still unfilled at press time. The Division of Corporation Finance should add 40 percent more employees compared with 2002, while the Chief Accountant's Office should grow by about 50 percent and the Division of Enforcement by 16 percent.

More spending on enforcement will likely mean more cases, says Gregory Bruch, a former SEC enforcement official and now co-chair of law firm Foley & Lardner's Securities Litigation, Enforcement, & Regulation Practice Group. "If they have 20 percent more staff, they'll bring 20 percent more cases," he says.

"Adding people will lead to more [frequent] review of periodic filings," says David Cifrino, a partner in McDermott, Will & Emery's Boston office, "but whether it increases the quality and value of the reviews remains to be seen." —Alix Nyberg

You're Hired
According to the SEC, the FY'05 budget includes $18.7 million for 106 new staff in:
Investment management regulation44
Prevention and suppression of fraud30
Regulation and securities markets30
Office of the Inspector General2
Source: Securities and Exchange Commission

Food Fight

If only that mad cow in Washington State were the worst beef facing U.S. trade representatives. Sure, it's payback time for the countries whose meat was once banned here. But the United States has far more countries frothing at the mouth over the Continued Dumping and Subsidy Offset Act (CDSOA), also known as the Byrd Amendment.

The CDSOA requires that the proceeds of antidumping tariffs, which traditionally went into the U.S. Treasury, be given instead to the companies that filed the original dumping complaint. (Dumping is generally defined as the export of a product at a lower price than the company charges in its home market.)

Passed in October 2000, the CDSOA sparked complaints from an unprecedented 25 countries. The World Trade Organization declared it illegal in January 2003. "This measure clearly flies in the face of the letter and the spirit of WTO law," EU trade commissioner Pascal Lamy said at the time.

Congress, however, has refused to repeal the Byrd Amendment, and as CFO went to press, a WTO arbitrator was in the midst of deciding how much the complaining countries could charge in retaliatory tariffs.

Domestic critics of the Byrd Amendment argue that it encourages companies to file trade complaints. "It is a subsidy to companies that claim they were victims of dumping," declares Laura Baughman, an economist for the Consuming Industries Trade Action Coalition and a registered lobbyist. "It is a perfect example of corporate welfare."

Gregg Warren, spokesman for Weirton Steel Corp., which received an $885,000 CDSOA payment in January, begs to differ. "Does anybody think $800,000 even comes close to covering the cost of fighting these illegal imports? That's crap," he argues. "These tariffs are being collected, period. It is none of the WTO's business whether they go into the U.S. Treasury or back to the companies that filed these cases."

Preliminary data suggests U.S. Customs plans to disburse at least $240 million in tariffs collected in 2003. In 2002, U.S. companies received $330 million, but claimed dumping damages totaling more than $1.4 trillion.

Although steel and metal manufacturers account for the greatest number of claims, companies filed claims for dumping of everything from flowers to crawfish-tail meat. The top 20 recipients of payouts in 2002 also included six candle makers and two pasta companies.

William Reinsch, president of the National Foreign Trade Council, opposes the Byrd Amendment, but adds, "What worries me is that [these disputes] create pressure on the WTO as an institution, and growing numbers in Congress are skeptical about its ability to deal with its responsibilities." —Tim Reason

Paid for Trade
Largest CDSOA payouts for 2002 (in $thousands)
Micron Technology14,413
Home Fragrance Holdings11,970
Zenith Electronics9,016
* The Timken Co. acquired Torrington in 2/03
Sources: U.S. Customs Bureau; CITAC

Twice as Nice?

In January, six Big Board companies announced that they would also list on Nasdaq, as part of the competing exchange's "dual-listing initiative." The six—Hewlett-Packard, Charles Schwab, Countrywide Financial, Cadence Design Systems, Apache, and Walgreen—cite a desire for competitive markets and the best price for shareholders as the drivers of the move.

Matthew Spiegel, finance professor at Yale School of Management, likens the practice to real estate's Multiple Listing Service, in which realtors from competing agencies post their property listings in a common database for all to see. The opportunity to test Nasdaq's all-electronic trading model, in which multiple anonymous market-makers determine security prices, is another draw, says Ray Bingham, CEO and former CFO at San Jose, Calif.-based Cadence.

Bingham had noticed that around 30 percent of the company's trading volume had moved away from the New York Stock Exchange to electronic exchanges. "Clearly, investors find value in using different exchanges," he says, adding that he hopes the dual listings will be a "catalyst for change" at the NYSE by demonstrating the appeal of electronic trading and listed firms' willingness to investigate other markets. (The NYSE announced in February that it would expand automatic trading, in response to customer requests.) Spiegel says the scandals may have opened the door for dual listings, as regulatory pressure on the NYSE may have forced it to allow the moves.

The dual-listed companies say they are testing the waters at Nasdaq, a worthwhile experiment in part because the exchange waived the $60,000 listing fee for the first year. "It was a no-cost way to look at something that will increase competition among the markets," says Walgreen spokesperson Michael Polzin. —Kate O'Sullivan

Alien Nation

With an estimated 8 million to 10 million undocumented workers in the United States, many businesses are hailing President Bush's recently proposed "temporary-worker program" as a much-needed step in the right direction. The measure would grant temproary legal status for illegal immigrants already working in the United States, which could be renewed in three-year increments. It also outlines a new mechanism for importing workers from abroad "when no Americans can be found to fill the jobs."

Opinion is mixed about the impact of the proposal on employer costs. For those that employ undocumented workers at below-minimum wages, payroll costs will probably climb. "I would think companies would at least have to offer prevailing wages," says David A. Martin, professor of international law at the University of Virginia. Laura Foote Reiff, a partner with Greenberg, Traurig LLP, says that most already follow the legal requirement to pay minium wage, However, Eliseo Medina of the Service Employees International Union says the proposal creates a precarious situation for participating workers looking for a raise, because they run the risk of losing employer sponsorship if they ask for higher wages.

Despite the potential threat of increased payroll costs, Reiff calls the plan "terrific for business," as it offers a legal solution for companies that find themselves in the difficult position of needing to fill low-wage jobs but worrying about documentation. "Right now you can be fined for hiring workers who are undocumented, or prosecuted for asking for too much documentation," she says.

The proposal has many critics, including Professor Martin, who says it leaves out important details, including wage and benefit guidelines. Jeff Goldman, chairman of the immigration practice at Boston-based law firm Testa, Hurwitz, & Thibeault LLP, believes the proposal will never become law in its current form, in part because it fails to offer a path to permanent residence.

"This proposal says, 'Come on down, sign up, tell us your name and address, and agree to be deported three years from today.' I don't understand who woulddo that," he says. —Kate O'Sullivan

States with the highest number of illegal immigrants in 2000 (the latest available figures)
California2.2 Million
Texas1.0 Million
New York0.5 Million
Illinois0.4 Million
Florida0.3 Million
Source: U.S. Immigration and Naturalization Service

The Mint Is Extra

Business travel may be picking up, but some hotels still boost revenues by tacking unexpected and sometimes ludicrous charges onto bills, according to ongoing research by PricewaterhouseCoopers LLP.

Among the charges likely to make travelers flip out at checkout are resort fees ($15-$20), fax charges ($1-$5 per page), automatic gratuities for bellhops and housekeepers, handling charges for packages, room-service delivery fees ($2.50, in addition to an automatic gratuity), and minibar-restocking charges (up to $2.50 of the item price). The Sheraton chain even adds an automatic charge for charitable contributions.

The worst offenders fall into the two most expensive categories of hotel, says Bjorn Hanson, head of the hospitality and leisure practice at PricewaterhouseCoopers.

"The velocity with which surcharges arrive and disappear has increased," adds Hanson, making it difficult for experts to track just how much the practice costs companies.

"There is no one place on the [hotel's] financial statement where those surcharges are captured discretely," says Robert Mandelbaum of PKF Consulting in Atlanta, which benchmarks hotel financial performance. "When you add them all up, I'm sure they are less than 2 percent of a hotel's typical revenue." Nonetheless, the last few years put a pinch on revenues, he says, "so hotel managers have focused on those minor sources of income."

Mandelbaum says the first half of last year showed phone calls—another long-loathed hotel charge—declining to 1.6 percent of hotel revenues from 1.9 percent for the same period in 2002, as travelers increasingly relied on mobile phones. And more consumer rebellions are likely, says Lalia Rach, dean of the Tisch Center for Hospitality and Tourism at New York University. Indeed, a judge is now reviewing a proposed class-action settlement with Starwood Hotels & Resorts, which allegedly misrepresented a resort fee as a tax, says plaintiff's attorney Peter Morgenstern of Bragar Wexler Eagel & Morgenstern LLP.

"It's almost a slap in the face of the customer to think we're too unaware to notice" the fees, says Rach. She still remembers being dumbfounded when a checkout clerk told her a few years ago that an energy surcharge of almost $10 on her bill was "to combat the cost of the California energy crisis."

"Do you know that we're in Chicago?" she asked. —Tim Reason

Benchmarking Anxiety

As politicians debate, companies wait anxiously for word on the new benchmark for measuring pension obligations.

In late January, the Senate passed the Pension Stability Act, which will replace the current discount rate with one based on an index of investment grade corporate bonds. The U.S. pension Benefit Guaranty Corp. estimates that the new rate could save $80 biliion over the next two years.

But as CFO went to press, Congress still hadn't begun reconciling the House and Senate versions of the bill, and President Bush was threatening to veto it if it gives a break to companies with severely underfunded plans.

The poltical wrangling leaves companies stranded. If the legislation isn't passed before April 15, says Jack A. Abraham, a principal with PrciewaterhouseCoopers HR Services, companies will have to recalculate their 2003 contributions—using a rate of 105 percent of the 4-year weighted average of the 30-year Treasury bond rate instead of the stopgap measure of 120 percent—in order to figure out 2004 payments.

Not only will they incur administrative and consulting fees to redo the numbers, he says, some will also end up "experiencing increases that more than double their minimum contributions."

"The line in the sand is April 15," agrees Mike Johnston, leader of Hewitt Associates's North American retirement and financial management practice. "If we don't have [a new benchmark] by then, a lot of CEOs and CFOs will be calling their congressmen." There are huge implications for corporate cash flows, he says, and for compliance with FAS 132, which requires new disclosure for pension contributions.

"The market," says Howard Silverblatt, an analyst at Standard & Poor's, "can be the bigger monkey wrench [in pnesion accounting]." Last summer, for example, General Mills disclosed that its pension plans were underfunded by $224 million, after being $571 million overfunded the year before. The culprit was the firm's May fiscal year-end, which didn't allow it to take the market gains most calendar year-end firms enjoyed in '03. "They got killed," he says, "and it had nothing to do with what Congress did or will do." —Lori Calabro


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