As evidenced by the recent stock option and travel expense reporting scandals that rocked some large public companies, SOX 404 and its sister reporting requirements are bringing lots of skeletons out of the closet. Do you know which, if any, of your executives that your financial reports might incriminate?

by Jay Whitehead

George Perlegos, recently fired CEO of Atmel, now knows about the power of newfangled financial reporting. He got whacked recently for pocketing money earned by alleged fraudulent booking of airline tickets to the company account. And even though he was a co-founder of the $1.7 billion, 8,000-employee chip company, his board showed no mercy.

Oh sure, the company is in the middle of a takeover battle with outside investors. That adds a bit of intrigue to the story. Regardless, Atmel’s board had to send the signal that rules are rules. Transparency cuts all ways. Chalk one more up for the power of the new financial reporting requirements, without which the alleged airfare-manipulation scheme would not have been revealed.

Gregory Reyes and Stephanie Jensen, the former CEO and VP of HR at Brocade Communications, are both now under indictment for falsifying documents to back-date stock options. New reporting picked up the alleged fraud because some of the options were supposedly granted by the company’s board on dates when there were no board meetings. Oops. The VP of HR’s counsel, John Keker, defended his client, saying “she knows nothing from nothing about the accounting function.” If Jensen is anything like most HR VPs I know, Keker is telling the God’s honest truth about that. The fact remains that someone will be held accountable for the Brocade option fraud, and the whole mess would never have been revealed without new financial reporting requirements.

And then there is the former CEO and a co-founder of Comverse Technology, Inc., Kobi Alexander. He and his finance chief David Kreinberg and former general counsel William Sorin all have been hauled before magistrates on charges that they back-dated stock options improperly. In Comverse’s case, the U.S. Justice Department and the SEC say Alexander and Kreinberg used false names to “generate hundreds of thousands of backdated options, which they then parked in a secret slush fund designed to evade the requirements of Comverse’s stock option plans.” Investigators have snatched more than $45 million in investment accounts from Alexander.

In all three cases, and more than 80 others now reportedly under investigation, the violations occurred because detailed reporting showed that the executives crossed the line when they tried to keep their actions secret. When Atmel’s income statement failed to account for the travel expenses, they were red-flagged. And when Brocade’s and Comverse’s balance sheets and income statements accounting for options liabilities did not jive with the number of options outstanding, alarm bells went off.

BACK-DATING, SPRING-LOADING, AND BULLET-DODGING
In the case of Brocade, the SEC is looking at a pure-play back-dating scenario. The company’s CEO and VP of HR faced a problem. The stock option price that they could legally offer at the time was “under water,” or higher than the prevailing price of the stock. And they were unable to pay more in salary. So how could they recruit key technology employees without an in-the-money stock? Simple answer: back-date the options to a time when the shares were in-the-money. That locked in an immediate profit for the recruits and sealed the deal for them to join Brocade.

In the case of Comverse, other tactics are also under scrutiny. One is known as spring-loading, and it works like this: Say you are expecting a positive financial announcement in the near future. To “spring-load” a bunch of options to be granted upon that announcement, the CEO would simply reserve the pile of option certificates that show a date in the past when the company’s stock was suitably depressed. Then wait for the announcement. When the announcement comes, voila´, like magic, the options appear, and somebody gets rich.

The other technique is known as bullet-dodging. This works when the company is expecting a negative announcement. As soon as the lousy news comes out and the stock price takes a tumble, the CEO issues a chunk of options dated as of the day of the lowest price ebb. They are then either issued immediately to someone, or held onto for a more opportune moment.

All three techniques—back-dating, spring-loading, and bullet-dodging—are technically legal if they are allowed under the company’s stock option plan and properly disclosed, taxed, and accounted for. But in both the Brocade and Comverse cases and 80 others under investigation at press time, the company’s reports either did not disclose, properly account for, or allow for taxes on the option grants.

In many of these financial scandals, several of my colleagues in the media have argued that stock-option cheating is a “victimless crime” that should not occupy so much of the legal system’s time and resources. But FAO Today disagrees. Existing shareholders are penalized when wrongly-dated option-holders get a free ride without having taken the same risks. This is especially true when companies buy back stock, as happens often these days. The buy-backs are paying option-holders a risk premium for their shares, while the wrongly-dated option-holders took no risk.

HERE'S ANOTHER FLA (FOUR-LETTER ACRONYM) FOR YOU: XBRL
To bring financial reporting into our increasingly bar-coded, RSS-obsessed, email-dominated world of instant communications, Christopher Cox, the Securities and Exchange Commission’s chairman, has been championing a technology known as Extensible Business Reporting Language (XBRL) since 2005. Cox’s goal is to make the numbers in company financial reports “jump off the page … be instantly searchable and retrievable.” In the cases of Atmel, Brocade, and Comverse, XBRL allowed investigators to nearly instantly detect discrepancies in disclosed data. Like bloodhounds locked onto a certain scent, XBRL allows analysts to target specific data relationships that indicate a host of irregularities—insider trading, options misdating, expense disclosures, self-dealing among commonly-owned entities, conflicts of interest, and inadequate tax payments, among others.

Today, there are a few thousand tags that have been created that cover virtually every type of financial data that you would want to map. Microsoft, Oracle, and SAP products all have the tags built in. To date, the companies report that only 10 to 15 percent of their clients are actually using the tags. Sure, the SEC tells public companies that their reports will get reviewed faster with the tags, and the IRS says it makes reviews and audits go faster and with less pain. But analysts and financial leaders contacted by FAO Today say the real cattle prod to increased XBRL usage is going to be outsourcers offering XBRL as a bundled part of their services.

FAO Today’s Roseland, NJ neighbor, payroll outsourcing leader ADP is already championing the effort by submitting its recent 8-K filing using the protocol. But that effort is simply a first step in getting comfortable with the new common language. The real boom will come when FAO providers realize the extraordinary implementation-lubrication qualities of XBRL and XML.

ENTER THE CRO
On August 9, MSNBC.com picked up my piece from our sister magazine HRO Today. Reporter Selena Maranjian writes: “There’s a new bigwig on the block—meet the CRO, the corporate responsibility officer. According to a recent HRO Today article, the CRO position addresses an existing market reality:

“Stakeholders want accountability. By stakeholders, we mean customers, employees, vendors, creditors, stockholders, government and the media. And for large companies, there has to be one throat to choke. That’s why Sarbanes-Oxley requires CFOs and CEOs of public companies actually sign off on their periodic financial statements. The signatures are the equivalent of a personal guarantee, just like when you borrow money at the bank.

“Securities and Exchange Commissioner Cynthia Glassman has explained that to do right by Sarbanes-Oxley, companies should have corporate responsibility officers overseeing corporate compliance and ethics issues ... CRO responsibilities are often a part of another job, so expect some CROs to do double or triple duty on the executive roster.

“The advent of the CRO should be at least a partially good thing for investors. It will cost firms to maintain the post, but if the CRO can find and stop bad behavior, it could prevent future losses.”

MSNBC points out that several companies are creating a CRO post, including Chiquita Brands, IBM, Avon Products, Wal-Mart, Chevron, and Schwab.

FAO Today readers got this career news first. Today ushers in the era of the financial reporting trifecta: new reporting requirements plus XBRL plus the newest corporate leadership role, the corporate responsibility officer or CRO. Together, the trio forms a potent web for enforcing stakeholder accountability. And it’s a three-part career bet you need to make.