The Foes of Enforcement

State vs. federal regulators; mutual-fund CFOs are clean, so far; Sarbox Section 404; executive compensation and the IRS; and more.


When CFO sat down with New York Attorney General Eliot Spitzer this past fall, he claimed that all was well between state and federal regulators as they worked to pursue securities fraud without stepping on each other's toes (see "Wall St. Warrior," November 2003). In fact, the two sides had just announced the establishment of a joint task force to explore ways to work together.

But the former partners in crime-fighting are now fighting each other. Tension over the best way to handle the mutual-fund scandal set off a war of words between Securities and Exchange Commission chairman William Donaldson and Spitzer, who publicly scolded the SEC after it an-nounced a settlement with Putnam Investments (which has been accused of allowing market timing in its mutual funds). "To Chairman Donaldson I would say, obviously we're on the same team, but don't cut deals behind my back in the middle of the night and call me the next morning and not expect to get criticized," fumed Spitzer in late November at a Practising Law Institute forum on hedge-fund regulation. In an op-ed piece in the New York Times, he wrote that any resolution with his office would "go far beyond what the [SEC] has obtained from Putnam."

Donaldson defended the SEC, telling the Senate Banking, Housing, and Urban Affairs Committee that criticism of the settlement was "misguided and misinformed." And in his own Wall Street Journal op-ed piece, Donaldson countered that "many state agencies (including that of the New York attorney general) willingly and regularly forgo blanket achieve meaningful and timely resolutions of civil proceedings."

But that hasn't put an end to the criticism. "The states don't think the SEC has done all it can to protect investors," says Ralph Lambiase, president of the North American Securities Administrators Association. "The public doesn't care whose role it is."

Others claim the criticism is unwarranted. "As soon as the SEC became aware of the market-timing issue, it papered the Street with subpoenas," says Ron Geffner, a former SEC enforcement at-torney now with Sadis & Goldberg LLC, in New York. Richard Phillips, a former SEC official and a senior partner in the San Francisco office of Kirkpatrick & Lockhart LLP, agrees. "There was nothing wrong with what the SEC did when it made a partial settlement with Putnam," he says. "Spitzer is upset because the SEC got in ahead of him." He adds that the likely result of all the bickering is that the SEC and state regulators will go after cases more aggressively. —Joseph McCafferty


Unlike the recent accounting scandals, which brought the world images of CFOs being led away in handcuffs, finance chiefs have not played a role in the mutual-fund scandals. So far, no CFOs have been fired or forced to resign from mutual-fund companies that have been accused of market timing or after-hours trading.

For example, while former Putnam Investments CEO Lawrence Lasser was forced to resign in November—a few days after Putnam was accused of securities fraud—CFO Irene Esteves remains in her position. CFOs at Strong Financial Corp. and Invesco Funds Group have also remained while their companies have come under fire.

The reason, say mutual-fund industry experts, is that CFOs are not usually responsible for compliance. "It is not typically the responsibility of the CFO to manage the regulatory-compliance function at mutual-fund companies, as it might be at a manufacturer," says Douglas Zingale of law firm Greenberg Traurig LLP. "These firms have separate compliance departments, and those folks have a lot to answer for right now," he adds.

However, says Zingale, the CFOs are in a good position to get involved in the damage-control effort: "It's likely that they are being sought out as a trusted adviser." —J. McC.

Courting Disaster

By many accounts, merger-and-acquisition activity is poised to roar back in 2004. But just as companies are considering new deals, along comes another potential roadblock: Section 404 of the Sarbanes-Oxley Act of 2002.

At this point, the Securities and Exchange Commission has not issued guidance on how to interpret Section 404—which calls on companies to certify that they have auditable internal controls—in relation to mergers and acquisitions. But since any com-pany that consolidates another is then responsible for the target's internal controls, finance executives are understandably concerned that Section 404 may chill certain deals.

"Any acquisition we do next year has to be 404-ready," says Steve Paladino, CFO of Henry Schein Inc., who adds that such verification could prove to be a problem if the target is a private firm. Moreover, he says, the Melville, N.Y.-based health-care supplies company may postpone acquisitions if there's any question a deal might impede its ability to certify financial statements or meet the deadline for Section 404 compliance.

Paladino's sentiment is understandable, says James E. Hoffman, managing director at Robert Baird & Co. "Buyers want to make certain that a particular deal is not going to jeopardize their ability to certify their own financials and internal controls." So while Section 404 may not "hurt M&A volume over the longer term," he says, "it will change the nature of due diligence and the timing of deals."

In response, says Robert L. Filek, partner in transaction services with PricewaterhouseCoopers, "expect the scope of the due-diligence procedures to be much more robust." Hoffman, for example, expects that acquirers will drill down deeper and "interview everyone from the controller to the audit partner to the IT person to make sure there are no glitches." Such increased due diligence, coupled with tougher scrutiny from boards, means it will take even longer to complete a deal. —Lori Calabro

Turning the Legal Tide

After years of watching punitive-damange awards and class-action settlements careen out of control. CFOs may start breathing a little easier. Tort reform—which had stalled in the fall—has made surprising progress.

In November, key Senate Democrats reached a compromise with Senate Republicans over the language of the Class Action Fairness Act. The original legislation, which sought to move big class-action cases from state courts to federal courts—which are generally considered to be more predictable—was blocked by a Democratic filibuster in October. But it was revived by the compromise, which is expected to come before the full Senate next spring. The legislation seeks to limit forum shopping, in which plaintiffs' attorneys file class actions in small state courts with a history of plaintiff-friendly decisions.

"The legislation deals with the abuse of [plantiffs' attorneys] picking judges who are incapable of dealing with national issues," says Michael Pope, a partner at McDermott, Will & Emery in Chicago.

Meanwhile, an April ruling by the U.S. Supreme Court has led to a dramatic reduction in some of the largest punitive-damage awards ever made. The Court ruled that punitive-damage awards of more than nine times the compensatory damages might represent a violation of due-process rights. Since that ruling, lower courts have slashed punitive damages in a number of high-profile cases.

"Things had gotten completely out of whack", says Jeffrey E. Curtiss, CFO of Service Corp. International, a funderal-service firm in the process of settling a $100 million class-action case. "One company in our industry was brought to its knees by a huge jury verdict. —Kris Frieswick

IRS Takes a Closer Look at Pay

Executive-compensation packages are getting a lot of attention these days, and now the Internal Revenue Service is taking a harder look. In November, the IRS quietly announced an audit initiative focusing on executive compensation. The campaign—an effort of its Large and Mid-Size Business Division—will dig deeper into complex pay arrangements.

Among the areas under scrutiny: deferred compensation, stock-based pay, family limited partnerships, and fringe benefits such as corporate-jet use. The IRS will also examine golden parachutes, split-dollar life insurance, and the $1 million cap on compensation deductions. "Maybe this extra light will help people to take a closer look at their plans," says Keith M. Jones, director of field specialists for the IRS division.

IRS representatives say the service is not making any new rules at this point, but is simply turning a spotlight on executive-compensation packages, which have grown more complicated in recent years. "They've decided they need to go after this in a more coordinated way," says Andrew Liazos, a partner at McDermott, Will & Emery's Boston office and chair of the firm's executive-compensation practice. "This is the time to inventory exactly what you have and identify what your exposure is," he adds.

The IRS says its audits will involve an evaluation of whether corporate tax deductions are consistent with income reported by the executive. The service will also investigate whether companies and their executives have accounted for such taxable perks as company-car use and relocation benefits, and whether they've valued the benefits appropriately. To prepare for such scrutiny, says Liazos, a company's finance, human-resources, and tax groups all need to work together to review compensation practices and make sure each department knows where unusual arrangements, if any, have been made.

Will companies simply try to stay one step ahead of regulation, devising new ways to lessen the tax impact of compensation? "It's certainly possible that some companies will seek other ways to get around the new scrutiny," says John Challenger, CEO of Chicago-based outplacement firm Challenger, Gray & Christmas Inc. "But I think we're in an environment where companies are going to be careful to comply." —Kate O'Sullivan

Age-old Arguments

The U.S. Supreme Court is considering a case that could make it more difficult for companies to provide perks to workers based on age. Unless the high court overturns a ruling by a lower appeals court, it will be considered discriminatory to use age to determine eligibility for such workplace benefits as early-retirement packages and health care.

The case of General Dynamics Land Systems Inc. v. Dennis Cline et al. involves a renegotiated labor contract with full health-care benefits available only to retirees with 30 years' seniority and who are at least 50. Younger workers at the company argued that the package discriminates against them, and a U.S. Court of Appeals for the Sixth Circuit agreed. If the decision stands, it would be a blow to companies' efforts to provide favorable benefits to older workers, and could open the door to a multitude of reverse age-discrimination cases.

"If the Supreme Court affirms the case, it will be cataclysmic for benefits of retirees," says Judith Mazo, director of research for The Segal Co. She adds that retiree health plans could either be diluted or scrapped to avoid discrimination lawsuits, since many of them have age qualifications.

Instead, companies would be forced to explore alternatives such as an employee's length of service and salary-grade systems. But these "age-neutral" practices come with risks. Ultimately, such programs could have a disparate impact on older workers, says Condon McGlothlen, a partner in the Chicago office of law firm Seyfarth Shaw LLP. "Age-based programs are far better for employers, who can then exit employees with severance benefits. It's a better and kinder way of downsizing," he says.

Early indications are that the Supreme Court is inclined to reverse the decision. After arguments were heard on November 12, Justice Sandra Day O'Connor expressed her concern for older employees suffering employee-benefits setbacks if they are not protected more favorably under the Age Discrimination in Employment Act of 1967. McGlothlen thinks the decision should be reversed. "I'd be surprised if the Sixth Circuit's decision is affirmed," he says. The final Supreme Court ruling is not due until June. —Caitlin Austin

Force-feeding the PAC

A Bank of America executive recently claimed that the bank forced him to make political and charitable contributions against his will. Duncan Goldie-Morrison, a former executive in BofA's corporate- and investment-banking division, says that he was "ordered" to make "donations to specific political campaigns dictated by Bank of America." He lost his job in a reorganization in 2003, and has since filed a whistle-blower suit.

While coercing employees to make political contributions is illegal, experts say many workers are pressured to give to their companies' political-action committee (PAC) or directly to candidates.

"There is a fairly common practice of implied coercion [to make political contributions]," says Paul Sanford, general counsel at the Center for Responsive Politics. "It's an unwritten rule that if you want to climb the ladder at a company, you don't want to be missing from the list of givers."

However, he says, it is a challenge to prove that executives are forced to give. Fred Murray, general counsel at the Tax Executives Institute, admits that there is a certain amount of peer pressure—which varies from company to company—for executives to give to their companies' political causes. Yet he says he is not aware of any that have been coerced to give. "Most executives value these programs on their merits," he says.

"It's complicated to apply an economic concept to these structures," explains FASB chairman Robert Herz, "but we had to do it because trillions of dollars were being hidden off the books." Asked if recent restructuring by banks to keep VIEs off their books was in keeping with the underlying principle of Fin 46, Herz noted that banks "took further steps to deconsolidate the risk, so at least directionally, they went in the right direction."

"Individual givers are motivated by the companies' interests as much as their own," says Sanford. Executives are able to give a total of $5,000 a year to each company or industry PAC, and $2,000 to an individual federal campaign per election.

While financial executives may continue to be pressured to make hard-money donations to political concerns, the McCain-Feingold Campaign Finance Reform Act, passed in 2002, protects executives from being hit up for large donations by making it unlawful to solicit "soft money" for federal campaigns. Before the act was passed, "many executives felt that it was a legal shakedown—that unless you give, you won't have access to get your issues heard," says Michael Petro, director of business and government policy at the Committee for Economic Development. However, he says that candidates will look for loopholes in the legislation: "There are already people who are looking for ways to circumvent the law." —J.McC.

Online Travel Sites Go Business Class

Web travel agencies are targeting business travelers and their cost-conscious managers, launching sites that pose yet another real threat to traditional travel agencies. Road warriors have been digging up alternative fares on their own for a few years, and such sites as Expedia, Orbitz, and Travelocity are responding with services tailored to their demands, complete with features to help finance executives track spending down to the last jet-setting salesperson.

Expedia Corporate Travel, Orbitz for Business, and Travelocity Business all promise to help companies save money by using the Internet. With booking fees as low as $5, the Web sites are significantly cheaper than bricks-and-mortar agencies, which charge anywhere from $25 to $60 for a telephone reservation. Each site also promises live customer service when a traveler needs it. A travel manager can customize his or her chosen site to highlight preferred airlines or hotels with which the company has negotiated discounted rates, but the sites also provide access to last-minute Web fares. In addition, trips that might be disallowed because they involve an inconvenient airport can be flagged. When a traveler chooses a so-called out-of-policy flight, he or she can be prompted for a reason code, such as "traveling with a client."

Terry Sullo, travel manager at Akamai Technologies Inc., in Cambridge, Mass., says the company switched to Expedia Corporate Travel from an offline agency in August to help control costs. Sullo cites the real-time reporting feature as a key advantage to the online service. "I'm able to determine travel-policy compliance before the trip is taken," she says. "After the trip, it's too late." She also receives reports that help her track how often travelers fly on a certain airline or stay in a particular hotel. Bob Cobuzzi, Akamai's CFO, adds that employees can easily book their own travel on the site, saving administrative time. -K.O'S.


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