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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.

Author: Jack Ciesielski Created: 10/13/2006 2:54 PM
The AAO Weblog is a weblog published by Jack Ciesielski , dealing with accounting issues and news topics related to investment and finance.

CFO.com's David Katz takes a moment to remind us: SarbOx turns four today!

As the article discusses, most executives have moved away from "shock and anger" towards an attitude more resembling acceptance and "moving on" - like the stages in the way people react to a death, according to John Hagerty of AMR Research, which the article cites as having done extensive number crunching on the costs of SarbOx compliance.

It doesn't hurt companies in the "acceptance phase" that costs have moderated lately, according to Hagerty. Joining the "acceptance" camp are the foreign issuers, who can learn from the experience of their US pioneers who complied first.

Just in: the Public Company Accounting Oversight Board just issued its first audit alert (ever) on none other than "Matters Related To Timing And Accounting For Option Grants."

Took a quick look: good reiteration of relevant accounting principles, good reminders of audit responsibilities. The significance, to me, is that auditors are now on notice (not that they weren't already) that they'd better be figuring on the effects of options-related matters on planned or ongoing audits. With that as part of their charge, we might get to the bottom of how widespread (or not) is the whole backdating mess when the next audit season really gets under way.

A few months ago, McAfee announced that it was investigating its option dating practices over a stretch beginning in the 1990's; it later received an SEC subpoena relating to the matter. Yesterday, they announced that the investigation was not completed, but complete enough to warn investors not to rely on its annual financial statements for the fiscal years 2003, 2004, 2005, and the quarterly statements contained in those years plus those issued for the first quarter of 2006.

From the 8-K: "McAfee believes that it is more likely than not that the amount of such additional adjustments relating to prior periods will be material and that McAfee will restate its financial statements in at least one, and potentially several, prior periods." No surprises in that statement; it pretty much fits the pattern of the disclosures about restatements seen so far. And no numbers yet, but there was one other interesting statement in the 8-K:

"... in the event that a restatement of these financial statements is required, it likely will affect financial statements for prior periods." Which is a bit of a warning, not a strong one, not to rely on the financials too far back in time. It also leads you to believe that they may be finding problems as far back as 2000, because of the May 30 8-K filed when their general counsel was dismissed. In that disclosure, they mentioned that the investigation had turned up one episode involving an improper grant and the general counsel.

So, we have to wait for a fuller story. In the meantime, the New York Times covers the IRS exam side, something that hasn't been discussed nearly as much as the SEC and Attorney General investigations. Link here.

At yesterday's Board meeting, the FASB reaffirmed its commitment to requiring firms to put the full amount of their net pension and other postemployment benefit plans on their balance sheets. For public companies, those changes will be effective for fiscal years ending after December 15, 2006. That means calendar year-end public companies will be the first to show the effects on their balance sheets.

It's something to keep in mind as companies prepare for the change. They might very well become extremely picky about what goes on the balance sheet as opposed to what they show in a footnote - especially if it's going to be unflattering. So we might be hearing about more changes to pension and OPEB plans in the last half of the year as companies try to minimize their obligations or fine-tune their pension/OPEB assumptions. Stay tuned.

Yes, the SEC did drop the "Katie Couric clause" from their new executive comp disclosures. That may not be the end of it: it might be re-proposed for only large accelerated filers to disclose about their three most highly compensated employees, whether they're executives or not, if their total pay exceeds any of the named executive officers. For a good read on what the Commission considered in their deliberations, check the opening remarks of Daniel Greenspan, Special Counsel of the Division of Corporation Finance. Here's a link to Chairman Cox's introductory comments (Notable: the Commission received 20,000 comments on the proposal!). Finally, a link to the SEC's press release summarizing the new disclosures - and if you'd like to simply see the shape of (some of the) disclosures to come, here's a link to a sample executive comp disclosure table.

An interesting joint effort on the part of odd bedfellows Business Roundtable and the CFA Institute: a document that urges companies to stop issuing earnings guidance.

It's a document entitled "Breaking the Short-Term Cycle" (catchy, yet accurate) and you can download it here.

I haven't read the entire document yet, but I can't help but agree with their basic principles: companies should stop spoon-feeding "guidance" to analysts and issue hard facts for them to work with - facts about strategies and plans for managing the assets owned by shareholders. Put it in the context of say, Microsoft. Are the interests of the firms' long-term shareholders better served by having their resources directed at a constant spewing of guidance about where this quarter's earnings are headed - or are the long-term investors better served by "guidance" about how the firm plans to meet the challenges of say, web-based software?

The groups' recommendations don't end with simply calling for the end of earnings guidance. They recommend an alignment of "executive compensation with long-term goals and strategies and with long term shareowner interests." (You know, what employee stock options were supposed to do. With the SEC 's new executive compensation disclosures, maybe some progress can be made towards that end. Jury's out for a while on that one.) You could say that that's the same old tired exhortation but they go one big step further: they make some pretty big demands on the institutional investor side to cure "short-termism." They recommend that asset manager compensation be aligned with long-term client interests and to improve disclosure of their incentives, fee structures and personal ownership of funds managed. Fair enough; people who live in glass houses shouldn't throw stones. And when we're talking about handling other people's money, whether it's corporate managers working for shareholders, or professional investors working for clients, glass houses are the only kind permitted by the construction code.

It's hard to see how the issuance of earnings guidance doesn't create a climate of "real men make their earnings forecasts - by any means possible" - including the stretching of judgment to ridiculous lengths in preparing accounting estimates. I think the Business Roundtable and the CFA Institute are on to something here.

Today, the SEC commissioners (and staff) will meet and decide whether to adopt the much-discussed new executive compensation disclosures.

It will be interesting to see how different the final regulations will be from the proposed regulations. It seems like a foregone conclusion that the non-executive disclosures will be abandoned, and that there will be some required disclosures of option backdating transactions. The robustness of those backdating disclosure requirements - and where they might lead investors (and investigators) once they're effective - are of the highest interest to investors.

The driver of the convergence bus decided to put it into neutral for a while.

The International Accounting Standards Board released a bombshell yesterday that's gone pretty much unnoticed in the US press. (Though the Financial Times picked it up.) The IASB is declaring a moratorium on the effective date of any new International Financial Reporting Standards (IFRS) or major modifications of existing standards until after January 1, 2009.

The only other mention I could find in the world press was this from the Irish Examiner, who said the "Institute of Chartered Accountants in Ireland (ICAI) has welcomed the announcement by the International Accounting Standards Board (IASB) that it will suspend the introduction of new accounting standards until 2009." That's not what the IASB said: they said there'd be no new standards effective until 2009. They didn't say they wouldn't issue new standards until 2009. Keep your hopes in check, guys.

The idea behind the moratorium: give folks in the European Unionsome time to catch their breath. The transition to IFRS has been difficult in many countries, and this will give them a chance to evaluate their situations in less of a panic mode. Furthermore, the IASB will slow down some of its work with the FASB on a joint conceptual framework project.

And some of the comments of Sir David Tweedie in the Financial Times article, indicate the delay might also calm down some constituents "inflamed" by a February announcement of the IASB and the FASB to speed up "writing joint standards in 11 areas by 2008 and to examine existing standards in 10 other areas."

It's not a bad idea, and in fact it synchronizes well with the SEC's own convergence plans. (Recall that there's currently a requirement for a foreign company to reconcile the accounting used in its financial statements to US GAAP-based accounting. By 2009, the SEC wants to eliminate that requirement if IASB standards are used by a foreign company - provided the Commission is satisfied with the IASB standards in place by that time.)

The danger is that, rather than use the time to get on board with the IASB standards, companies will use the time to try and exploit politics to further avoid the standards or roll them back. And delays might become a serial habit, with or without political interference. Keep tuned. (For the next few years.)

On Friday, the Wall Street Journal reported that SEC Chairman Christopher Cox is expected to name Conrad Hewitt as the new chief accountant.

According to the article, he's a a CPA who served as commissioner of California's department of financial institutions and superintendent of banking for the state - after a 33-year career with Ernst & Young. Currently, he serves as a director (and chairman of the audit committee) for both North Bay Bancorp and Varian, Inc.

An interesting choice on the part of Chairman Cox: Mr. Hewitt has been retired since 1995, so he certainly isn't taking the job as a resume-builder. And it's an interesting choice on the part of Mr. Hewitt, too: if you've been retired for 11 years, you'd have to be pretty bored to take on a job where one of the first things you'll have to take on is the bucking bronco called "options backdating."

* * * * * * * * * * *

On Monday, Hewitt's appointment was announced by the SEC. Press release here. Let's wish him well.

No need to wonder any longer. And no need to mix up "Brocade" with "Broadcom." Get it straight: Brocade Communications is the first company to face civil and criminal charges. The former CEO/president/chairman, Gregory Reyes, the former VP-Human Resources, Stephanie Jensen and former CFO, have all been named in separate suits brought by the US Attorney's office and the SEC.

Being the first case brought regarding backdating, you'd expect it to be the strongest case that could be presented out of the passel of companies under investigation - and it probably is. "Probably" because we don't know what's been uncovered in the other investigations - but from the looks of the SEC's complaint, this one has all the ingredients of a good hand for the prosecution. CEO Reyes acted as a one-man compensation committee; he enlisted Jensen's help in backdating option documents (and she understood the implications); Reyes benefitted personally from the options backdating scheme.

The firm issued misleading financial statements that investors relied upon. When the firm made a restatement of results in January 2005, the 2004 results showed an increase in net loss from $2 million to $32 million. The 2003 net loss increased from $136 million to $147 million, but the 2002 net income increased by $60 million to $126 million. For the period between 1999 to 2001, cumulative income declined by a total of $304 million. During the period, CEO Reyes and CFO Canova knew the statements were misleading, yet represented to the auditors that they'd provided them with factually correct, non-fraudulent information for the audits and also signed off on the certifications of the 2002 and 2003 10-K annual reports.

There doesn't seem to be a lot of gray area here, though I'm sure the defendants' counsel will devise some. You've got a case involving long-established accounting principles and blatant document-doctoring to make the transactions support the accounting result that was desired. There was personal gain, and there were outright lies to investors through the financial statements. The only question is: what about the activity like this that may have been occurring in companies that haven't been investigated?