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Financial execs who do the right thing.

Would you sign a company financial statement, knowing it could be inaccurate? It is the stuff of every finance executive's nightmares--situations where they come upon fraud or are asked to report more favorable numbers. Integrity runs smack up against job preservation--and they have to choose. If they stand up to superiors, could they be fired? Or, if they grudgingly go along, do they put their reputation (or worse) at risk?

There's the instance of the CFO who found that the CEO and a sales executive had cooked up phony sales to boost quarterly numbers; the case where a general auditor found that divisional management was systematically underpaying hourly workers to pare losses; the time when a treasurer raised questions about an overly rosy forecast for an IPO and found himself ostracized and eventually forced to leave.

Virtually any financial executive with long years of experience has tales to tell; the more companies he or she has worked for, the greater the odds that there has been an uncomfortable or job-threatening situation. In many instances, they face a culture of entrenched practices and are asked to quietly "go along."

Clearly, telling tales out of school can be a difficult thing for a financial executive, schooled in probity, confidentiality and the perceived virtue of silence to the outside world about corporate practices. Yet many are clearly aggrieved by situations they've encountered, which in some instances even resulted in them resigning or being fired.

An Atlanta executive says he was involved in uncovering unethical practices at two different companies. "In most cases, I was supported," he says. "In one case, I was supported publicly, but given my walking papers privately." He also remembers vividly walking into a meeting on business ethics, only to find "that one of the guys I fired was one of the speakers."

In a lengthy letter to Financial Executive earlier in the year, Joseph W. Harwell, CFO of Manchester Tank & Equipment Co. in Brentwood, Tenn., said: "At the end of the day, there's probably not a CFO out there who has not been pressured at some point in his or her career. How we respond to the pressure is what defines our character, our integrity and our ethics."

Echoes Mark Zorko, CFO Partner at Tatum Partners, a former CFO and past president of FEI's Chicago Chapter: "When a CFO is confronted with fraud, it's a moment of truth The onus is on the CFO to do the right thing. If the CFO is asked to play along or look the other way, he or she should be mentally prepared to leave the company, and then get on with convincing the management team to fix the business instead of fixing the books." He adds: "You can always get another job, but you can't get another reputation."

The stories that follow, most drawn from FEI members, are true, and not all are U.S. companies, a reminder that fraud or potential fraud knows no borders. In a few cases, the executives were willing to share the details but not the specifics of their name or the name of the offending company Understandably, most mentioned fears of lawsuits, retribution or blacklisting for future jobs.

Following the massive corporate scandals of recent years, ethics and integrity have become touchstones of today's corporate management. The shape of the tales these executives have told is very instructive about how principled most financial managers are when they feel pressured to dissemble, deceive or simply look the other way.

Ethical Conduct Lacking

The tone at the top was questioned by the CFO, who says the board of directors was the CEO's "yes men." In this executive's own words:

i found myself working with a small, ($40-million) public company in the education industry run by a very autocratic CEO who had surrounded himself with a board of directors composed of mostly insiders. His top management team evolved into a group ok "yes men" who rarely challenged his direction. Decisions were not made based on their financial merits, but rattler on what the CEO thought--and he would present a one-sided view. After going along with many of these decisions, my predecessor had supposedly resigned over ethics issues.

Knowing there was nO One else who was as familiar with the company's issues, I took the CFO job as a promotion from Director of Finance and felt I could hold firm where necessary. Consequently, after seeing the detrimental effect to the company of this management style, when several decisions were being evaluated that I believed not in the best interest of the company, I felt it was important that the board hear both sides of the story. While I don't remember the exact moment, or having what might be viewed as an epiphany, there was a time I just knew I had to take the lead to bring the situation to the attention of those who were in a position to right the wrongs.

I tried to discreetly communicate the other side to one of the board: members (using both telephone and email), but underestimated the "old boy" network, and information got back to the CEO that I had challenged his opinion. I was, from then on, kept out of the information loop, even though I was expected to sign the 10-Qs.

I held my ground on being informed of a material transaction involving the transfer of restricted government funds to a "legal war chest" for fighting an investor takeover. After that, in July 2000, we "parted company," as my ethics kept getting in the way of their plans. After that, they managed to hold things together for a few months, but eventually filed for bankruptcy. The company was sold off piece by piece, with creditors getting very little and investors getting nothing.

Debra T. Johnson subsequently launched her own company; she is President of Emissions Products International LLC.

Lesson: Don't ever let the job override your ethics. Stick to your guns, even if it means losing your job. I did both--stuck to my guns and lost my job--but I have never regretted it for a moment. Personally, I am very happy with my decision to take the high road, though it cost me a large severance package.

Questioning Payroll Discrepancies

Faced with systematic evidence of payroll fraud, a General Auditor took the issue to legal counsel and his corporate parent's board.

back in the mid-1980s, the General Auditor (GA) of a $1 billion-a-year division of a $5-10 billion multinational services company in the hospitality industry, found out that field management had developed a scheme to systematically underpay lower-level workers--about 20 percent of the divisional workforce, numbering about 40000--by some 20 percent each month. In fact, due to healthcare costs, many pay-checks held negative balances, and employees actually wrote checks to the company to cover their health insurance. By the time the ploy was uncovered, it had been in place for a couple of years.

No one's pockets were being lined--the scheme was intended to pare losses and dress up the bottom line. The workers weren't complaining; as waitresses or bartenders, they were making hefty tips and didn't really worry about why their small payroll checks had been shrinking. They also may not have noticed that senior and line management compensation was tied to profitability and revenue levels.

But the GA and the audit team noticed, and did field reviews to confirm the problem. When the issue was brought to the divisional management, they kept assuring the GA that it was only an isolated instance. When evidence persisted, the GA talked more with management, which raised the issue of mitigating circumstances, such as workers clocking out early--a notion that didn't pan out.

In fact, there were two payroll systems in force. The field employees focused on the time card records, but paychecks were being generated under a separate system that local management had the opportunity to retroactively adjust.

The GA says "there was denial at the CEO level, the CFO level, and the divisional president and my management levels," adding that superiors "questioned our sanity. They questioned our allegiance." The GA reported to the CFO, and believed that as a result of raising the issue, his job was in jeopardy.

But the GA persevered, realizing that the issue had huge implications, among them that it could become a "RICO" case potentially involving triple damages in a guilty verdict, perhaps costing more than $100 million. The GA took the findings first to the local general counsel and then. after a month of little progress, to outside legal counsel. The matter then went up to the parent company, where the GA says he "built relationships with senior management at the corporate level." The GA met with the parenT CFO, general counsel and, ultimately, the board--saying, "quite frankly, we got the attention of the management and the divisional office to make changes."

The GA personally worked with federal authorities to establish a field-control process to ensure implementation of remedial controls, so that if employees had a retroactive change to their salaries, they were aware of it and could approve it. Moreover, the punch-card machines were taken off the walls, and a single payroll system was installed.

The GA says he benefited from having made allies in the parent company management, including people reporting to the corporate controller mad the CFO. The end result was a happy one. "Professionally, my career blossomed. My income doubled in probably five years. They relocated myself and my family three times in 39 months." And he continued in a series of promotions that eventually took him to a General Auditor slot one floor below the corporate chairman's office.

--O. Donald Billing Jr. is now the owner of his own financial consulting firm

Lesson: Support from staff and a good relationship with corporate officers can be critical in overcoming entrenched resistance from immediate superiors.

A Rosier IPO Road Show

The Treasurer's input to investor communications lot a road show presentation was largely ignored, and a rosier picture was painted to potential investors. In this executive's own words:

in the late 1990s, I joined a publicly traded manufacturing company as Treasurer, reporting to the CFO. A few months later, the company made a sizable acquisition of another manufacturing company in the same industry. The initial financing of the acquisition was accomplished by increasing short-term debt, which was later to be refinanced by issuing common stuck through a public offering.

The company originally went public decades ago and, with no further public offerings since then, time offering of new stock justified a road show, much like an initial public offering (IPO). As Treasurer, I had the responsibility, along with the investment bankers and lawyers, for coordinating this road show.

Prior to the acquisition, extensive financial modeling was done, principally by the Controller's group, to demonstrate that the acquisition would be accretive, or would increase earnings per share, both before and after time common stock offering. Understandably, the financial modeling was based on assumptions and estimates about time performance of both companies and the future economic environment. A key element of the financial model was time synergies time companies would realize by merging. At that time, time company's CEO and CFO were each a few years from retirement, and wanted to grow the company to leave their mark and to increase the value of the stock.

During the development of time financial model, I participated in the review with others in management, frequently questioning some of the assumptions. But, as the new person on the team--who came from a smaller company and was not experienced with public markets--my views were not strongly considered. In addition, one of the key drivers for time acquisition was the CEO, a well-respected veteran of almost 40 years in the industry, who actively managed time process with the board of directors and the management team. While significant to the company, time cost of time acquisition was not large enough to require shareholder approval.

In my view, the CEO's desire to make the acquisition, and the CFO's and Controller's desire to please the CEO, fed on each other. The "too-optimistic" financial model fed the CEO, and the CEO's enthusiasm drove a more optimistic financial model.

The completed financial model projected a range of additional earnings per share of approximately $.30 to $1.00 over three years. At the time, time additional $1.00 per share would have increased earnings per share (EPS) by about 40 percent. In addition, the acquisition resulted in a considerable amount of goodwill.

After the acquisition and initial financing, the next step was the public offering. This involved preparing a prospectus and a read show presentation, including all the traditional disclosures on risks and other matters. The road show presentation was to be given by the CEO, with backup by the CFO; I participated in the process since I had been heavily involved in its drafting.

We conducted several practice sessions for this presentation with company management and the investment bankers, with each session resulting in changes to the "canned" presentation. The investment bankers thought it critical to include the merger's impact on future EPS, since it was so significant; this was initially done by including the estimated range of the impact, along with several key assumptions.

However, in one of the final run-throughs of the draft presentation, a key analyst commented that the range of the EPS impact was too broad and would not provide sufficient guidance to prospective investors. So, the CEO and the CFO decided that rather than use a range, they would disclose and comment on the number at the high end of the range during the road show.

I expressed my concern that, although this number was supported by a financial model and its underlying assumptions, it was a very optimistic projection, and a change in the economic environment or in the ability to realize the projected synergies would significantly impact the financial benefits of the acquisition. Again, my concerns were not strongly considered, and we moved forward.

Because I was not comfortable and because I was heavily involved in the road show; discussions with analysts and review of draft documents, I took the position that the wording of any comment regarding the estimated earnings per share would read: "up to $1.00 per share, assuming all the assumptions proved to be correct." However, the CEO and CFO were clearly painting a more optimistic position, to the point that I would clarify their comments, in a professional manner, by talking about the assumptions and the risk that they might not materialize. Analyst reports that followed the public offering generally adopted my wording. The public offering was considered very successful, increasing the price per share of common stock about 50 percent.

This situation and similar incidents resulted in my being viewed as "not a team player." My frustrations and alienation from others in the management team grew, and I found my career at a dead end. Several months later, I resigned from the company.

The economy subsequently turned down, with imports adversely affecting the manufacturing industry, so several years later, the company has not realized the benefits of the acquisition--even at the low end of the estimated EPS range. The common stock price declined considerably, and the goodwill was subsequently written off. The CEO, the CFO and the Controller all retired.


Lesson: Once you start down the road of challenging your superiors, you may well be truly on your own and have to be willing to follow through--no matter what the outcome.

Blowing the Whistle on Securities Violations

A director tells of press release misrepresentation, CEO stock manipulation and illegal-issuer bids in this case, which was widely covered by the Canadian press. In this executive's own words:

between Dec. 12, 2000 and Dec. 15, 2001, I was an independent director of Technovision Systems Inc., a TSX Venture Exchange public company in the Internet-services business. The company--currently Canada's 17th largest technology service provider--has been renamed Uniserve Communications Corp. I became a director after a company called Inc. was acquired in a share exchange offer. I was the venture-capital financier of iTCANADA.

As background, our deal involved the consolidation of up to 28 Internet Service Providers (ISPs) into a large national company, with revenues of $40 million (Canadian) and positive cash flow of $6 million. In our search for project financing, the Canadian banks said we needed to select an operating public company to serve as a base company for financing. Royal Bank of Canada supplied a $10 million acquisition financing line to Technovision, and the iTCANADA business plan was supported by a $60 million, five-year Internet access-networking contract from Telus Corp. The iTCANADA vendors and ISP owners thought that our collective vision would move forward quickly.

The iTCANADA vendors accepted a best-efforts approach with a share cancellation schedule based on number of subscribers bought. We were not concerned about Technovision failing to execute the deal, since Technovision had already produced eight press releases indicating that it had purchased 19 of the iTCANADA ISPs, representing over 87,000 subscribers.

I soon discovered, however, that the iTCANADA business plan was at the core of a Technovision stock promotion; yet Technovision insiders did not appear concerned about the prospects of being caught violating securities laws. Issuer bids were made to my former partners that did not comply with Ontario securities law, since identical offers were not made to all shareowners, accompanied by an information circular.

Most people in the situation I faced would walk away; I felt that I had no choice but to confront it. I had invested $1.2 million cash in the Ontario company that was sold to Technovision in the share exchange offer. Furthermore, I was a director, aware of continuous disclosure misrepresentation, stock-trading manipulation and other securities problems at the company.

A director in a public company must, by exchange policies and securities law, Supervise the management, ensure that a company operates lawfully and report non-compliance with securities laws to the relevant exchange and provincial securities Commissions. More importantly, S. 122 (3) of the Ontario Securities Act and S, 155 (4) of British Colombia Securities Act state that "a director who authorizes, permits or acquiesces in the commission of an offence by the company or person, whether or not a charge has been laid or a finding of guilt has been made against the company or person in respect of the offence, is guilty of an offence and is liable on conviction to a fine of not more that $1 million or to imprisonment for a term of not more than two years, or both."

I also confronted the securities problems at Techovision for ethical reasons. I had made a critical, decision to join Technovision on behalf of the 28 ISP owners, and I had an ethical responsibility to those owners who had pledged their companies to the iTCANADA business plan for over a year. Technovision had announced publicly by name that it had bought 19 of the 28 iTCANADA ISPs; only one small ISP from this announced group was [actually] bought.

On Oct. 22, 2002, the CEO, Gordon Tremain, admitted in a Settlement Agreement with the British Colombia Securities Commission that he was responsible for misrepresentation in 10 press releases and omission of material information pertaining to company acquisitions and Royal Bank funding. He also admitted that he ought to have known that his personal trading created the appearance of a higher volume of trading and an artificial price.

He accepted a three-year ban from being a director or officer of a public company, a three-year restriction on personal trading and a $30,000 fine. The unlawful issuer bids to insiders, who had the benefit of insider information, are the subject of a pending Ontario Securities Commission hearing.

Being a whistleblowing director has been costly for me. I have been unsuccessful in civil litigation for restitution of my investment losses. I turned down a $500,000 unlawful issuer bid made tome just after I began communicating my concerns about continuous disclosure misrepresentation and Stock trading manipulation to the board of directors. I have been struck with a Strategic Lawsuit Against Public Participation (know as SLAPP) lawsuit, alleging unfounded and damaging complaints to the securities regulators, the Royal Canadian Mounted Police (RCMP), the auditor and Royal Bank

All of my complaints have been corroborated by the TSX Venture Exchange, the British Columbia Securities Commission and the Ontario Securities Commission investigator. The SLAPP lawsuit has not been abandoned.

The Enron and other U.S. corporate fiascos rocked investor confidence and brought the U.S. significant reforms. My story illustrates that the Canadian system of gatekeeping was as culpable as the U.S. system. Independent directors cannot perform effective corporate governance unless securities regulators have the will and resources to quickly enforce securities violations brought to their attention by independent directors. Independent directors should not be expected to protect public investors unless there is whistleblowing legislation to protect their own tenure and personal liability.

--Diane A. Urquhart currently is a full-time private investor. The company discussed here Still exists; she is no longer associated with it.

Lesson: Good corporate governance is not possible in public companies when management does not want it and other directors, insiders, auditors and the regulators are willfully blind and unwilling to intervene. The whistle-blowing director cannot protect shareowner interests on his [or her] own, and may be served as I was.

Challenging Suspicious Sales

A CFO discovered apparent collusion aimed at boosting quarter-end results.

the CFO of a Massachusetts-based technology firm talks about a situation at a previous company. In this executive's own words:

As a public company CFO, I was accustomed to a fair amount of quarter-end battle with my CEO regarding reserves and revenue numbers. He needed to hit his revenue number, but I needed it to be accurate. In general, I had an excellent relationship with my CEO, and these skirmishes were simply part of our working relationship.

Towards the end of one particularly slow quarter, the CEO became closely involved in working the deals, getting on the road with one of the sales VPs. This was not that unusual, but when three sizable orders unexpectedly crossed my desk at quarter-end none of which I had signed off on, I questioned why they had gone out of process. The orders themselves appeared relatively standard, except for their high total dollar value. But the fact that each order had been secured without CFO or Controller sign-off (we had strict policy on this), coupled with a soft quarter, was sufficient reason to explore their origins

My CEO was vague about the details, but asserted that each order was valid and should be recognized in the quarter. I did some further exploration, and found each order rife with problems: there were veiled contingency and barter arrangements on two of them, and the third was unfunded. None appeared to represent a real business transaction.

I promptly informed the CEO that none of the orders could be taken to revenue that quarter, and it was doubtful they could ever be recognized. He fiercely defended the validity of each transaction, and countered each of my arguments; the sales VP had similar responses. I found myself in the extremely uncomfortable position of not believing either of them.

I was mid-audit at this point, coming up on the quarter-end analyst call, and had withheld all three orders from our preliminary numbers, I explained to my audit partner that I was in a sensitive predicament with some questionable deals that the CEO had transacted. We surmised that matters would shake out if we sent A/R confirmations for each order. Based on emails and conversations with employees, none of the customers intended to issue cash as part of the transactions. Not only did the orders not constitute valid revenue, they were not real orders.

But, surprisingly, every confirmation returned signed, attesting to the anticipated payment on each respective order. The customers had already spoken with the CEO or sales VP and agreed to sign them. The signatories at the respective companies were long-time acquaintances of the CEO and VP, and two of them had reciprocating orders that they would be taking to revenue on their books in the same quarter. So, despite mounting concern, I still had very little hard evidence of wrongdoing.

In the interim, a large delivery appeared on our loading dock from one of the customers in question. The product had not been ordered, it was not product we had any use for, and there was no accompanying paperwork. I instructed Shipping to turn it away. The reciprocating orders purchases on behalf of my company had not gone through our purchase requisition process. Another customer in question spontaneously issued a replacement purchase order for a completely different product mix than their original order. The only identical item was the total price.

I repeatedly presented the new data to my CEO, explaining why they could not be taken to revenue, while diplomatically stating my concerns that they were not legitimate orders. I fully expected him to gracefully relent, but he continued to defend the deals vehemently, and his explanations grew more and more obtuse. I had hoped that the CEO's steadfastness was simply a matter of ignorance, but now I understood that he had manipulated the orders for the sole purpose of hitting his revenue number.

My audit partner and I discussed the matter a number of times, and he had surprisingly little advice; It was clear to him there was a problem at the highest level, but the was reluctant to get involved, He advised me to Consult with my board.

Instead, I called corporate counsel and relayed the sequence of events. He became immediately concerned and also advised me to call the board. This was difficult, as all of the directors but one were hand-chosen by the CEO and were his friends. I called the one truly independent director, who was angry and demanded action, and together we consulted with counsel. Counsel then set up interviews with all of the key players (the CEO, VP Sales, CFO and Controller) to explore the sequence of events and determine if there had been fraudulent activity, then report to the board.

I was told at the outset of the interrogations that the CEO and VP of sales had corroborating accounts that did not support my allegations. I anticipated this. and presented a thick file of purchase orders, A/R confirms, email trails, minutes of senior staff meetings in which the transactions were heatedly discussed, and hard copies of the corporate revenue recognition policy, delegation of authority and all relevant policies and procedures. The Controller's level of detail and sequencing of events paralleled mine, and he voiced to me his concern that I would be fired for elevating the issue.

When counsel shared its findings with the board, it concluded that fraudulent activity occurred between the CEO and the sales VP. The independent director demanded the CEO's termination. but did not receive it. The CEO was verbally admonished, and while the sales VP was subsequently released, the incident was not cited as grounds for his termination.

I had no desire to continue working under these circumstances but remained in my role until I found another suitable opportunity some months later. What was shocking to me, in retrospect, was that neither the CEO nor the board seemed to comprehend that I had protected the company and the shareholders from a potentially devastating and very public SEC investigation--in their eyes. I had betrayed my CEO. My only real ally in this mess was legal counsel, and I was unable to move forward until I involved them.


Lesson: Careful stockpiling of documents and records of suspect activity helps immensely in any investigation and can counteract verbal denials from those who may be perpetrating fraud.
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Author:Heffes, Ellen M.
Publication:Financial Executive
Article Type:Cover Story
Date:Nov 1, 2003
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