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Tech learns lessons of accounting woes

Corporate governance has become a hot topic, with tech executives struggling to make sense of President Bush's new law and the changes it could require.

Dawn Kawamoto Former Staff writer, CNET News
Dawn Kawamoto covered enterprise security and financial news relating to technology for CNET News.
Dawn Kawamoto
6 min read
PALO ALTO, Calif.--When attorney Gordon Davidson recently met with executives from a large technology company, they spent half of a four-hour meeting peppering him with questions about corporate governance.

A year ago, Davidson said, most executives would have spent about 15 minutes talking about the seemingly mundane issue, which covers topics such as how a board of directors oversees executives' performance, compensation, business strategy and corporate accounting.

"Interest in corporate governance education is very high," said Davidson, an attorney with Palo Alto-based law firm Fenwick & West, which has seen a tenfold increase in requests for educational programs by its clients. "It used to be on specific topics, but now it's on general governance information and getting an update on the pending reforms."

Davidson expects interest to remain high in the wake of scandals over accounting practices at Enron, Arthur Andersen, WorldCom and Qwest. Fueling interest in the subject, President Bush on Tuesday signed the Accounting Industry Reform Act, which provides for tougher regulations for corporate wrongdoers and boosts board members' responsibility for the financial condition of publicly traded companies.

The reforms will require major policy and strategy shifts for companies throughout Corporate America, but technology companies could face the most formidable changes, corporate governance experts say. Because of that, the tech sector is mobilizing its directors and executives, who are often more focused on products and technology than on board structure and oversight, to seek out more education on corporate oversight.

In a packed room Monday at the Crowne Plaza Cabana here, an array of corporate directors, company attorneys and chief financial officers (CFOs) listened attentively to the Fenwick & West seminar, titled "Crisis in Corporate Governance & Accounting: Steps You Should Take Now to Reduce Your Exposure."

Sitting at long tables draped with white linen tablecloths and toting two-inch thick binders filled with aspects of the new law signed Tuesday, participants jotted notes about cautionary steps to take in the changing environment. Much of the seminar focused on the difference between a board's current liabilities vs. liabilities under the new laws. Fenwick's panel of attorneys also offered tips on managing internal investigations when misconduct is suspected.

The quest for knowledge was evident: Participants grilled the panel with questions ranging in topic from changes in liability insurance for directors to the timing of the new law's rollout. Davidson noted that while the law becomes immediately enacted upon Bush's signature, it will take about nine months before most of it goes into effect.

Crisis in corporate governance
According to the newest survey by WhisperNumber.com, investors ranked Berkshire Hathaway CEO Warren Buffett as the most trustworthy executive in Corporate America. The online survey of 680 people found that AOL Time Warner Chairman Steve Case was the least trustworthy, followed by others in technology and financial services.

Executives who can be trusted most:
1. Warren Buffett, CEO, Berkshire Hathaway
2. Jeffrey Immelt, CEO, General Electric
3. Bill Gates, chairman, Microsoft
4. Michael Dell, CEO, Dell Computer
5.* Meg Whitman, CEO, eBay
5.* Alan Lafley, CEO, Procter & Gamble
*Tied for fifth place.

Executives who can be trusted least (excluding those from WorldCom and Enron):
1. Steve Case, chairman, AOL Time Warner
2. Larry Ellison, CEO, Oracle
3. Sanford Weill, CEO, Citigroup
4. John Chambers, CEO, Cisco Systems
5. David Komansky, CEO, Merrill Lynch

Source: WhisperNumber.com, an independent research firm owned and operated by Sentiment, Expectations, and Earnings.

There's also increased interest in Stanford University's corporate oversight programs.

Joseph Grundfest, a professor of law and business at Stanford University and a former Securities and Exchange Commission official, said a two-day program in June at Stanford Law School's Directors College sold out in record time--faster than any other time in the event's eight-year history.

"Every director and executive knows they will be under more scrutiny now than in the past, and they are interested in acquiring additional expertise," Grundfest said.

New rules tighten scrutiny
Under the new law, a board's audit committee should have at least one "financial expert" on the team. That stipulation could cause a commotion in the tech industry, where executives have long prided themselves on picking directors based on their entrepreneurial background, deep technical experience and connections. Accountants and auditors still grumble that they suffer under "bean counter" stereotypes in the Silicon Valley, where relatively few chief executives and chairmen rise up from their companies' accounting department.

"Many of these companies were trying to collect high-impact people for their technical knowledge, and not so much for their audit committee knowledge," said Joan Susie, publisher of Corporate Board Member magazine. "Now they're having to bring these kind of people in."

The law also requires every director on the audit committee to be independent--someone who does not work for the company, does not accept consulting fees from the company and is not an "affiliate" or in any other way associated with the company.

But for board members hired as consultants, that rule could change the value that tech companies place on industry experience and connections. Although it happens less now, the idea of using board members to help a company push products or make connections was common in the late 1990s Internet boom, especially in tightly knit tech communities such as the San Francisco Bay Area, Boston and Seattle.

The law could also make it harder to find appropriate board members for audit committees, because directors may be more interested in scaling back the number of companies they sit on as they become increasingly on the hook for a company's actions.

"It'll be hard to find a CEO who wants to take on a new board seat. You're asking them to take on a huge amount of work, a huge amount of liability, and you can no longer compensate them in any large fashion," Susie said.

Goodbye, relocation loans
The new law also bans companies from issuing loans to their senior executives and directors. Existing loans may be maintained, but even they can't be extended, renewed or materially modified.

This provision was aimed at ending the practice of doling out generous, low-interest loans to company executives, such as the controversial $15 million in loans E*Trade's board forgave to its CEO Christos Cotsakos.

But the stipulation could create particular problems for companies seeking to relocate executives to Silicon Valley, where home prices rank among the most expensive in the nation. Loans are a common way to cover an executive's relocation fees and the extra cost of buying a house. They may also be more acceptable to investors than offering a cash bonus.

"The issue of relocation loans was not addressed in this act, and that's a problem," Davidson said. "If a high-tech company wants to relocate a CEO from the East Coast, they'll probably have to provide a cash signing bonus"--a prospect that few cash-strapped companies can afford.

Tech companies, which are fond of providing stock options as a large portion of an executive's compensation package, may also be surprised to discover that their corporate officers and directors now have to report trades more quickly.

Under the new provision, directors and executives must report trades within two business days, as opposed to the previous time allowance of 10 days after the end of month in which the trade took place. This is designed to give investors a quicker look into insider sales and serve as just another tool to evaluate their investment in the company.

Also as part of the new law, CEOs and CFOs will have to forfeit any bonus or profits from stock sales in the 12 months following the release of some quarterly financials. They must only forfeit if the restatement is due to "material noncompliance of the issuer as a result of misconduct."

Criminal penalties for misconduct will be steep. Any CEO or CFO who signs off on financial reports that are false could receive a 20-year prison sentence and a fine of up to $5 million.