Reform Effort Rebuked

A report on capital-markets regulation stirs criticism; coping with rising sick days; replacing an unpopular auditing standard; ''obvious'' patents are challenged in the Supreme Court; poor reviews for performance reviews; and more.


To anyone who has ever grumbled about shareholder lawsuits or Sarbanes-Oxley, last fall's debut of the Committee on Capital Markets Regulation should have been welcome. Comprising 22 members from the worlds of business, law, and academia, the CCMR announced that it would examine the effects of regulations on the competitiveness of U.S. capital markets. But both the committee and its first report, released in November, have come in for criticism.

For one, the committee has been accused of being sympathetic to the Bush Administration, despite professions of independence. Critics note that Treasury secretary Henry Paulson publicly praised the committee's efforts, and that one of its co-chairs, John L. Thornton, was a top executive at Goldman Sachs during Paulson's tenure there. Meanwhile, the other co-chair, Columbia Business School dean R. Glenn Hubbard, was formerly chairman of President Bush's Council of Economic Advisers.

Hal S. Scott, a Harvard Law School professor who assembled the committee, responds to charges of bias by noting that he asked Thornton to help lead the CCMR in the summer of 2005, nearly a year before Paulson was nominated to the Treasury.

Others assert that the CCMR's objectivity has been compromised by financial support it has received, including $500,000 from a charity tied to former AIG chairman Maurice Greenberg (currently the target of a civil lawsuit filed by the state of New York) and donations from two prominent investors on the committee.

As for the committee's report, it sets out 32 recommendations in four areas: Sarbox, shareholder rights, regulation, and enforcement. The report's repeated, albeit vague, emphasis on the need for greater shareholder rights would seem to mollify corporate-governance activists. But they read it instead as a cover for the report's stronger recommendations that regulators lighten up on Sarbox Section 404, and that shareholders refrain from filing class-action lawsuits.

"It is disingenuous of [the committee] to ignore the fact that Sarbanes-Oxley has played a crucial role in restoring confidence to the capital markets," says Nell Minow, editor of The Corporate Library, a corporate-governance research firm. As far as litigation is concerned, she adds, "courts, the [Securities and Exchange Commission], and the [Public Company Accounting Oversight Board] are able to handle any abuses to the system." But Office Depot CEO Steve Odland, a coauthor of the shareholder-rights section, says the authors' intention "was not to weigh in on shareholder rights, but rather to look at empirical evidence on the competitiveness of U.S. capital markets."

Critics say the report won't inspire notable changes. The SEC has already proposed some adjustments to Section 404, and while the report does advocate majority-voting policies for directors and shareholder approval of poison pills, Pat McGurn, executive vice president of Institutional Shareholder Services, says that "the CCMR jumped on the crest of the wave that was already crashing onto the beachhead."

Noticeably absent from the report are controversial issues such as the disclosure of performance thresholds for executive compensation and shareholder access to proxies, a subject now under debate at the SEC. — Alix Stuart

Who's Who on the CCMR

Accounting: PricewaterhouseCoopers Global CEO Samuel DiPiazza, Deloitte CEO William Parrett

Wall Street: The Financial Services Forum CEO Donald L. Evans, Former chairman and CEO of the NASD Robert Glauber, NYSE president and co-COO Cathy Kinney, Lehman Brothers chief legal officer Thomas A. Russo, Brookings Institution chairman (and former Goldman Sachs president) John L. Thornton

Corporate America: Office Depot CEO Steve Odland, CIT Group CEO (and a former Merrill Lynch EVP) Jeffrey M. Peek, Venture capitalist Arthur Rock, WellPoint Health Network founding chairman Leonard Schaeffer

Political/Academic: Dean of Columbia Business School and chairman of the Council of Economic Advisers (2001–2003) R. Glenn Hubbard, Harvard Law School professor Hal S. Scott, Harvard Business School professor Peter Tufano, University of Chicago Graduate School of Business professor Luigi Zingales

Investors and Governance Activists: CEO of Governance for Owners USA (and former chief counsel at TIAA-CREF Investments) Peter C. Clapman, TIAA-CREF EVP of Asset Mgmnt. Scott C. Evans, Citadel Investment Group CEO Kenneth Griffin, Weil, Gotshal & Manges partner Ira M. Millstein, MFS Investment Mgmnt. chairman Robert Pozen, WL Ross CEO Wilbur L. Ross Jr., Capital Research and Mgmnt. chairman James Rothenberg

Curing Spring Fever

As flu season approaches its peak, employers beware: sick days may affect the bottom line more than usual. A survey by CCH found that in 2006 unscheduled absenteeism among employees reached its highest rate since 1999. Large companies are paying up to $850,000 a year in payroll for sick time, not to mention the cost of temporary replacements and lost productivity. That's doubly painful when you consider that only about one out of three of those "sick" days are for actual illness, while 65 percent are the result of family issues, personal needs, stress, and the so-called mental-health day, according to Pamela Wolf, a workplace analyst at CCH.

But companies that crack down by enforcing stringent sick-time policies (or offer none at all) risk "presenteeism": sick employees show up but do little work and infect their co-workers.

Barry Blass, CFO of Hachenberger Management, a holding company that owns and manages more than 40 businesses ranging from realty to horticulture, recommends a middle ground: his company instituted a paid-time-off bank five years ago that gives employees at least 10 days a year for illness or personal needs. He says the policy did not cause absenteeism to increase. "Our workers understand that if they abuse the system, they'll pay out of pocket for each day they take over the limit," he says.

Increasingly, businesses appear to see the wisdom in more-flexible approaches to time off. The average number of work-life programs a company offers, such as leave for school functions and telecommuting, has increased from 9 to 11, and more companies are providing elder and on-site child-care services. It's not all a matter of accommodation, however: the survey also found that an overwhelming 97 percent of companies use disciplinary action to enforce time-off policies and rank such action as the most frequently used means of preventing abuse. — Laura DeMars

Adieu to AS2?

After two years of complaining about Accounting Standard No. 2, finance executives may finally get some relief. Last December, the Public Company Accounting Oversight Board (PCAOB) proposed repealing the much-maligned rules for auditors conducting internal-control audits. The board also voted unanimously to announce a new standard, AS5, which is open to public comment until February 26.

Critics maintained that AS2 drove auditors to go overboard (and thus ring up enormous fees) in their testing and examination of controls. The new standard aims for a more risk-based audit, in part in an effort to match the audit's scope to a given company's scale. The PCAOB now proposes that auditors be allowed to rely on previous years' audits as well as on the work of others, such as internal auditors. In addition, auditors would no longer have to sign off on management's assessment of internal controls.

"I believe the proposals we're considering today will help bring about a better alignment between the costs and benefits of the internal-control audit," said PCAOB chairman Mark Olson upon announcement of the proposed changes.

Finance executives are optimistic that the pending modification will answer a number of complaints. "I'm really encouraged," says Sharon Tetlow, CFO at Cell Genesys, a biotech firm. "I think most CFOs understand the importance of regulatory oversight, but I don't think AS2 was successful in providing that." Tetlow says the ability to use prior years' work should help reduce audit bills. She also hopes to see clearer definitions of materiality incorporated into the new standard.

"I think we all welcome some reform," says Kathy Schrock, the national Sarbanes-Oxley practice leader at executive services firm Tatum LLC. "But what will determine the effectiveness of the reform is the timeliness of the guidance." Schrock says many Tatum clients are already working on Sarbox requirements for 2007, so guidance issued prior to the end of the first quarter would give filers time to adjust accordingly.

The new standard will ultimately need approval from the Securities and Exchange Commission and may not be finalized until late this year. — Kate O'Sullivan

Not Invented Here

A seemingly mundane dispute over gas-pedal design may result in a Supreme Court decision that would invalidate patents deemed too "obvious." And that may be bad news for, among others, companies that rushed to patent E-commerce business processes such as one-click transactions.

The case, involving Canadian company KSR International and Pennsylvania-based Teleflex, hinges on whether the existing patent standard — that a design would not have been obvious to someone with ordinary skill in the art at the time of the invention — is too vague to be of value.

According to Chief Justice John Roberts, the existing federal test for obviousness is "worse than meaningless." Critics say the unclear definition leads to the granting of marginal patents for things that are not entirely original or that incorporate elements of devices or services that already exist. Such patents stifle innovation, they argue, and also make it possible for companies to game the system by acquiring intellectual-property rights to which they are not entitled.

"The purpose of the patent system is not to serve patent holders but to serve the public interest, help the economy, and provide the public with access to knowledge," says Jason Schultz, a staff attorney with the Washington, D.C.-based Electronic Frontier Foundation, which supports reworking the current standard. "The only companies that should be concerned about this potential ruling are those that have weak and suspect patents."

No one is offering a guess as to how many patents might be affected. The ruling could invalidate patents already granted, but only if a party pursues a legal challenge to a specific patent.

The Court is expected to decide the case sometime between March and July. If the judges simply throw out the existing test instead of providing new guidance, the decision may come soon. — John McPartlin

Phoning It In

What's the best way for an employee to blow the whistle on fraud or related infractions? The most popular way seems to be via hotlines or similar reporting tools. According to a joint report from the CSO Executive Council, an organization of corporate and government security executives, and The Network (a hotline provider), almost two-thirds of the nearly 200,000 reports it studied were made via hotlines without first alerting anyone in management.

Few of those alerts prove to be false alarms. The study, which tracked incidents at 500 organizations over the past four years, found that 65 percent of the reports were serious enough to warrant investigation, while 46 percent led to some type of action being taken. Corruption and fraud accounted for 10 percent of the incidents, well behind personnel-management situations (51 percent). Company and professional-code violations accounted for 16 percent and employment-law violations 11 percent.

Tony Malone, CEO of The Network, maintains that internal audits are not as effective as anonymous tips in shedding light on serious problems. "Whether it's sexual harassment, racial discrimination, corruption, or fraud, companies need to give employees an easy way to speak up about what is going on," he says. About 54 percent of the 200,000 incidents tracked in the report were made anonymously.

But critics say even the best hotline system won't work if a company's culture doesn't support ethical behavior. David Gebler, president of consulting firm Working Values Ltd., says companies should train midlevel managers to be better listeners and train high-level executives to lead by example. "If your CEO says, 'We're going to walk away from any opportunities that might compromise our ideals,'" says Gebler, "that's much more effective than just publicizing a hotline number and mandating that everyone take a Web-based compliance module." — J.McP.

"How'm I Doing?"

What you think about performance reviews may depend on which side of the desk you sit. When surveyed 2,000 employees and 330 human-resources professionals, it found that while two-thirds of companies believe their performance reviews are effective, only 39 percent of employees agree.

One reason for the disconnect, says Jeff Summer, a global leader of talent management at Deloitte, is widely divergent expectations. "Employees actually want to have a meaningful conversation about their performance and career development, but employers are often simply complying with performance-review policies."

As further evidence of a disconnect, the survey also found that 82 percent of employers believe they provided clear goals to their employees before conducting formal reviews, but only 46 percent of workers said they fully understood their goals. Mark Albrecht, vice president of talent-management solutions for, says that managers often try to communicate such matters via informal conversations, but employees don't realize the import of such talks. An employee may not realize his or her performance is at issue, Albrecht says, "unless the manager comes right out and says it."

Companies have plenty of motivation to improve their performance evaluations. "There aren't enough knowledge workers now, and it's going to worsen over the next 10 years," Summer says. Younger employees have also come to expect more career guidance and a clearer picture of their paths to the top, he adds.

Summer says companies should train managers on effective communication and emphasize coaching and career development. Albrecht recommends that managers discuss performance with their employees at least quarterly. — L.D.

Ignorance Is a Defense

Directors around the country sighed with relief late last year when the Delaware Supreme Court ruled for the defense in Stone v. Ritter, a lawsuit involving director liability at AmSouth Bancorporation. The court clarified its views on director liability, reaffirming the landmark 1996 Caremark decision that requires a very high standard of proof. Complainants, in short, must show that directors "knew that they were not discharging their fiduciary obligations," says the court.

Shareholders filed the suit against AmSouth in 2004, after the bank paid $50 million in fines and civil penalties to resolve investigations into its failure to disclose the activities of bank customers who were engaged in a Ponzi scheme. (AmSouth has since merged with Regions Financial Corp.) Plaintiffs argued that AmSouth's 15 directors had breached their fiduciary duty by failing to detect the scheme. But the court ruled that the directors could be held liable only if they had completely failed to implement any reporting or control structure, or if they had consciously failed to monitor such a system. AmSouth did have control systems in place, and the court found the directors not personally liable.

To win cases against directors going forward, plaintiffs will need to show that directors willfully did something wrong. "Proving simple negligence is not going to be enough," says William Schuman, a partner at McDermott Will & Emery in Chicago. "What [the Delaware court] is looking for is something very close to intent. It's a really tough standard to meet."

The Stone decision may play an important role in what seems likely to be an onslaught of upcoming cases involving stock-option backdating. Rather than suing directors on the simple basis that they allowed backdating to occur, plaintiffs will have to allege that the directors backdated options on purpose. Of course, if a director himself benefited from board-approved backdated options, such an allegation could be easier to prove. — K.O'S.

Fear of FIN 48

In January, the Financial Accounting Standards Board surprised businesses by refusing to delay issuance of FIN 48, an attempt to clarify how companies account for uncertain tax positions on their financial statements. The guidelines, effective for fiscal years starting after December 15, 2006, have generated a good deal of confusion and uncertainty.

"The new guidelines are meant to create consistency, but they're not clear," says Marian Rosenberg, a tax analyst for Thomson Tax & Accounting. Under FIN 48, "managers have to make a lot of subjective decisions."

Chief among FIN 48's new requirements is that companies should assume the IRS will examine their uncertain tax positions, leaving it up to them to determine whether those positions will pass muster. And if the company takes a tax position that may be subject to a legal claim, the guidelines require the company to figure out what the resolution will be before reporting the position on its financials. Says Rosenberg: "It's difficult to determine what the outcome of a dispute will be when the issue hasn't even been disputed yet."

Aside from causing tax analysts and CFOs to assume the worst, the guidelines will create "a tremendous amount of extra work" for finance and tax departments, says Bob Willens, a tax analyst at Lehman Brothers.

There is also concern about another form of pain: a recent survey by the Corporate Executive Board found that 68 percent of corporate controllers and heads of taxation expect that audits and requests for supporting documentation will increase as a result of FIN 48.

FIN 48 adds other complications as well. A particularly painful example is the R&D tax credit, recently revived by Congress. Although welcomed by business, squaring the new, complex tax-credit calculations with FIN 48 will send many companies scrambling. — L.D.

All Clear Now?

Under FIN 48, companies are required to disclose information on uncertain tax positions when it is "reasonably possible" that the amount of unrecognized tax benefits will change significantly within one year. But controllers and tax professionals disagreed on the definition of "reasonably possible."

70% said it meant there was a 20% probability

22% said it meant a probability over 30%

8% said more than a 10% probability

Source: Corporate Executive Board


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