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Tougher oversight reining in cheaters

A troubled corporation desperately looking to hire a new accountant, so the story goes, asked three candidates for the sum of adding two plus two.

The first answered, "four," the second, "three."

The third candidate won the job with this response: "What number were you looking for?"

Despite tougher rules enacted over the past year to rein in the financial practices of both companies and mutual funds, it is impossible to completely eliminate those willing to do whatever it takes to supply numbers that are desirable to their companies and analysts.

In addition, enough flexibility still exists within generally accepted accounting principles to be able to polish financial results.

But cheaters now operate in a different climate than even a short while ago. Financial America, forced by regulators to look in the mirror, didn't like what it saw. With less winking at impropriety and hush-hush transactions, average investors should stand a better chance.

"Compared to a year ago, it's like two different worlds," said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware in Newark, Del. "While changes in the listing standards for companies on the New York Stock Exchange now call for independent directors, it's even more important that there's a common acceptance that this will actually help investors."

The crackdowns continue.

An investigation into possible accounting fraud to meet earnings goals by mortgage giant Fannie Mae was recently opened by the U.S. Justice Department. Executive compensation, still corporate governance's "hot button," is also being studied. The probe follows an agreement between Fannie Mae and the Office of Federal Housing Enterprise Oversight that reduced its growth rate and required that it increase capital reserves.

The Sarbanes-Oxley Act raised the bar for all public companies by requiring, among other things, detailed account analysis and strict internal controls. A code of ethics and potential criminal penalties for a firm's signing officers were also instituted. Compliance requires some work.

"A handful of companies have either decided to become private companies or not go public because of the new requirements," observed Pat McGurn, senior vice president with the Institutional Shareholder Services Inc. (www.issproxy.com), or ISS, a provider of proxy and governance services in Rockville, Md. "Despite some real pain and expense for firms, most investors believe it was money well spent."

In rating corporate policies, McGurn recommends that investors scrutinize executive and board compensation, board structure and composition, audit issues, charter and bylaw provisions, laws of the state of incorporation and director education.

While many companies initially contended the corporate governance push was out of control, a Hill & Knowlton survey recently found that only 8 percent of senior executives surveyed now consider new disclosure governance requirements a significant challenge to running a competitive business.

Familiar names are falling in line.

Walt Disney Co., frequently criticized over the years for lax corporate governance, is expected to name a new independent director by the end of the year. Its announcement that Michael Eisner will retire in September 2005 and that it will employ an independent search firm to identify his successor by next June were prompted by governance criticism and accompanying lawsuits.

In mutual funds, the Securities and Exchange Commission adopted regulations to prevent trading abuses by requiring that a chief compliance officer be named. Three-quarters of a fund's directors and its chairman must be independent, and much greater disclosure is required. Fund firms have already agreed to pay about $2.6 billion in fines, restitution and fee reductions on charges of trading irregularities.

There are indications that after the election the SEC will take action on hedge funds, which currently have few rules for their operation.

"With the mutual fund chief compliance officer reporting to both management and the board, that might seem like having two masters, so we'll have to see how it works," said Hoffer Kaback, president of Gloucester Capital Corp. in New York City, a corporate governance expert who has served on three public company boards. "Another intense issue in mutual funds is the requirement for an independent chairman of the board that should be coming in early 2005."

What ultimately produces good corporate governance is a combination of character and ability on the part of a board's members, Kaback said. Enron's audit committee had very impressive qualifications, but that didn't mean anything in practice.

No company can elude the corporate governance spotlight in 2004. ISS ranked the newly public Google Inc. lower on corporate governance than any company in the Standard & Poor's 500 Index.

Google has a dual-class capital structure, with the shares held by its founders, directors and employees representing 83 percent of voting power. Only three outside directors are not linked to the company. It also allows repricing of its stock options so they're protected if the Google stock price goes down, even though common shareholders won't be.

Prior to Coca-Cola Co.'s board meeting last spring, ISS even recommended that Coke investors withhold support from its most famous director, Warren Buffett.

ISS contended that Buffett's business ties to the company disqualified him from serving on the company's audit committee because only independent directors should be on key panels. However, the beloved Buffett, the company's largest shareholder, was approved by the shareholders.


Andrew Leckey answers questions only through the column. Address questions to Andrew Leckey, "Successful Investing," P.M.B. 184, 369-B Third St., San Rafael, Calif. 94901-3581, or by e-mail at andrewinv@aol.com.