Corporate America's toughest job?
Sarbanes-Oxley turns up the heat on chief financial officers

by Jack Milligan
for Virginia Business
July 2006

Until recently, chief financial officers toiled behind the scenes. They were the top penny pinchers, who made occasional appearances for Wall Street analysts.

Now their necks are on the public chopping block as scandals at Enron Corp. and WorldCom Inc. have transformed the CFO position into one of corporate America’s toughest jobs.

Not only did the scandals sully the profession (since both companies’ CFOs pleaded guilty to charges of defrauding investors), they also prompted a congressional crackdown in the form of the Sarbanes-Oxley Act of 2002.

“ SOX,” as the law is often called, made CFOs personally liable for any Enron-like dishonesty involving their companies’ audited financial statements. Chief executive officers and CFOs now must certify — with their signatures — that those statements are as truthful as an Eagle Scout’s oath. An intentional violation can land a CFO in a federal prison for up to 10 years.

With the guilty verdicts against former Enron Chairman Ken Lay and former CEO Jeffrey Skilling still fresh in everyone’s mind — both men could spend the rest of their lives in jail — people may be wondering why any CFO is willing to take the risk. “People look at you and say, ‘Gee, you’re taking on a lot of personal liability,” says Gary Perlin, the CFO at McLean-based Capital One Financial Corp. “I think that’s one of the challenges of the job now.”

In light of these growing challenges, Virginia Business began a program this year to recognize the state’s top chief financial officers. With the help of a business school dean and two CFOs, the magazine selected award winners representing small private companies, large private companies and public companies.

Proof that the job of CFO is getting harder can be found in higher turnover rates. A May survey by a New York-based executive recruiting firm, Russell Reynolds Associates, found that 19 percent of Fortune 500 companies changed their CFOs last year, compared with 16 percent in 2004 and 13 percent in 2003. Nearly a third of the turnover in each year resulted from resignations. Many other CFOs chose to retire. These numbers are above historical norms.

Lorraine Hack, a member of Russell Reynolds’ financial service practice, pins the higher turnover rate squarely on Sarbanes-Oxley. “I think it’s wearing on people,” she says. “The impact hasn’t subsided. And it’s on the CFO that most of the scrutiny has fallen.”

In fact, the survey indicates that the demands of SOX are forcing CFOs to focus more on the accounting and compliance aspects of their jobs, leaving less time to work with the CEO as a business strategist. The narrowed job focus may be making it more difficult for CFOs to eventually become CEOs — a career path that has traditionally been open to them, particularly when they could boast of playing an important strategic role in their companies.

Russell Reynolds reports that 2005 saw a 25 percent drop in CFO-to-CEO promotions. The most likely explanation: Many companies are reluctant to promote a CFO while SOX compliance is still a hot topic. “If you’ve got a good [CFO],” says Hack, “you really can’t afford to move them.” One saving grace: Salaries and bonuses for public CFOs are generally among a company’s highest.

The goal of Sarbanes-Oxley was to restore investor confidence in the stock market, which it attempted to do through a variety of means. Enron, WorldCom and other corporate scandals of the recent past were at their heart accounting scams. One important aspect of SOX gives the audit committee of the board of directors explicit authority for hiring and overseeing the external accounting firm that performs the company’s annual audit. This change prevents the CEO or CFO from exercising undue influence over the company’s independent auditor. Even auditors face more scrutiny since SOX established the Public Company Accounting Oversight Board to regulate auditing firms, which previously were self-regulated.

Section 404 of Sarbanes-Oxley requires public companies to maintain a comprehensive system of controls over their financial reporting process to ensure the integrity of public company financial statements. While laudable, its implementation has been costly and time consuming. A growing chorus of critics — including some CFOs at Virginia-based companies — believes that part of the law goes too far.

“ The government was trying to instill confidence in the integrity of the financial markets,” says Kenneth M. Eades, who teaches finance at the University of Virginia’s Darden School of Business. “It probably killed a fly with a sledge hammer. The pendulum probably needs to swing back some.” Hartwell H. Roper, vice president and CFO at Richmond-based Universal Corp., sums it up this way: “Sarbanes, for us, has been a royal pain.”

Traditionally the job of CFO has been divided into four more-or-less equal parts. One is basic controllership, where the CFO is ultimately responsible for the accuracy of financial information, including reports public companies file with the Securities and Exchange Commission. Another responsibility is managing the company’s finances by raising capital and investing its excess cash. Many CFOs also participate regularly in strategic deliberations with the company’s CEO and top business line managers, bringing a sharp pencil and calculator to planning sessions. Lastly, the CFO is often the company’s ambassador to Wall Street and maintains a close relationship with the large institutional investors that buy its stock.

Sarbanes-Oxley added a fifth dimension to the job of a public company CFO — compliance. Virtually all companies have a system of policies and procedures, usually referred to as “financial controls,” designed to protect against fraud. Section 404 requires the CEO and CFO to assess the effectiveness of these controls every year and report their findings in the company’s annual report. This requirement has been difficult for two reasons. First, each control must be tested by a member of the internal auditing department or an outside consultant to make sure it works, and the entire process must be documented — which has turned out to be a bureaucratic nightmare.

Secondly, the company’s annual assessment must be reviewed and attested to annually by the company’s independent auditor, which has sent audit costs through the roof. Financial Executives International, a professional association based in Florham Park, N.J., estimated in March 2005 that implementing Section 404 in year one cost big companies an average of $4.6 million. While FEI President Colleen Cunningham says the association supports the spirit of Sarbanes-Oxley, “The implementation is where we went wrong.”

Such sentiments draw no argument from Roper at Universal. The company’s principal activities are in tobacco, agri-products and lumber and building products. Since it does business globally including operations in Africa and South America, Universal operates in a highly decentralized environment. “Getting timely and accurate accounting information that I can report to my constituencies is a big challenge,” says Roper. Implementing Section 404 required Universal to strengthen its control structure throughout its far-flung operation, which turned out to be an expensive and time consuming undertaking. And Universal’s independent auditor had to review that same global control structure. “Our basic audit fees doubled,” says Roper.

At LandAmerica Corp. — a Richmond-based company that provides title insurance and a variety of real estate-related services — CFO G. William Evans says the 404 assessment process went more smoothly in 2005 when the company went through it for a second time. “That’s not to say it was easy the second year, but it was easier,” Evans says. “I think there certainly has been some benefit from Sarbanes-Oxley, but I think it’s difficult to quantify. The benefit is more like a one-time lift, while the cost is ongoing.” Evans estimates that SOX compliance cost LandAmerica about $2.2 million after-tax in 2005. With the company’s stock trading about 10 times its annual earnings, that $2.2 million cost has an “economic value” to the company of approximately $22 million. “And I can tell you that I didn’t get $22 million in value,” Evans says.

It’s not that Sarbanes-Oxley wasn’t needed or doesn’t provide investors with greater confidence. But many CFOs question whether the benefits of Section 404 equal the costs. “I’ve never heard an investor say they would actually pay a premium for a company with strong financial controls,” says Perlin at Capital One.

Instead, 404 compliance costs have now become “table stakes.” In other words, the professionals who manage zillions of dollars for big pension and mutual funds won’t pay up to buy the stocks of companies that have strong financial reporting controls — but they’ll avoid the ones that don’t.

“You can quantify the cost [of compliance], but you’ll never be able to quantify the benefit,” says Perlin. “That’s up to each CFO to do.”
While Sarbanes-Oxley threatens to overrun their job, it’s not the only worry for public-company CFOs. Perlin says the biggest part of his job is to help guide Capital One toward the future. “I spend most of my time engaged with our CEO and other executives in advancing our strategic goals for the company.”

The CFO remains a company’s chief penny-pincher — a role Kurt Harrington has assumed at Friedman Billings Ramsey Group, an Arlington-based investment banking firm. “We try to maintain low fixed costs because we’re in a volatile industry,” Harrington says. And at LandAmerica, Evans worries that accounting standards — which dictate how companies value financial assets such as mortgage loans — have become so strict that their application ends up creating unnecessary volatility in corporate earnings. “Generally I think accounting standards are becoming increasingly complex and losing their logic,” he says.

While it may sound like the CFO’s job has become something of a career dead end, Harrington remains optimistic. Sure, he shares the same frustrations about Sarbanes-Oxley voiced by his colleagues, but Harrington figures his job is still pretty good training for handling pressure because of SOX. “The CEO and CFO are on the firing line a lot,” he says. Besides, Harrington still likes what he does for a living. “I love working at this company,” he says. “It’s an exciting place. There’s a lot going on.”