Trials Show Job Requirement No. 1 For CFOs Is Courage

n federal courtrooms about 1,000 miles away from each other, two high-profile criminal trials of corporate CEOs are proceeding with so many similarities that it sometimes can be hard to keep them straight. In New York, a jury will likely reach a verdict this week on whether former WorldCom CEO Bernie Ebbers will go to prison in connection with the massive accounting fraud that occurred at that company. In Alabama, the trial of former HealthSouth CEO Richard Scrushy for his alleged role in that company’s accounting fraud is ongoing.

ABOUT THE AUTHOR

Bruce Carton is the vice president of ISS' Securities Class Action Services (SCAS), a provider of outsourced claims filing solutions for institutional investors. Prior to joining ISS, Carton was a partner with the law firm Piper Rudnick, where his practice focused on securities class action litigation, SEC enforcement matters, and corporate governance issues and disputes. From 1995 to 1997, Carton served as Senior Counsel in the U.S. Securities and Exchange Commission's Division of Enforcement. Carton speaks regularly at institutional investor conferences and writes a monthly column in ISS’ SCAS Alert. In addition, Carton is the creator and writer of Securities Litigation Watch, a popular web log devoted to securities litigation and enforcement issues. Carton has been quoted in major financial publications such as the Wall Street Journal, The New York Times, Bloomberg, Financial Times, Institutional Investor magazine, and numerous other publications on securities-related topics. He can be reached via email.

In their defense, Ebbers and Scrushy have testified or otherwise publicly stated that they had no idea that any accounting fraud had occurred, and that responsibility for the fraud lies with the person who controlled the company’s books—the chief financial officer. Indeed, the star prosecution witnesses in both trials are former CFOs of the companies involved. These men have pleaded guilty to participating in the frauds, but have testified that they did so at the direction of intimidating and unrelenting CEOs.

The WorldCom and HealthSouth CFOs’ testimony about the origins of the accounting fraud at their companies is strikingly similar: HealthSouth’s first CFO, Aaron Beam, testified that he advised Scrushy in August 1996 that although he had pushed HealthSouth’s accounting to the legal limits, the company’s financial results would not meet analyst expectations for the quarter. According to Beam, Scrushy simply responded, “it is not an option to miss your numbers. Fix the numbers.”

In the Ebbers trial, former WorldCom CFO Scott Sullivan testified that he told Ebbers that WorldCom could only meet Wall Street estimates for the third quarter of 2000 by booking improper accounting entries. Sullivan testified that Ebbers “looked at the information, and he didn't say a lot. He looked up and said, ‘We have to hit our numbers.’”

The CFOs claim that following these discussions, they began to “fix” and “hit” the numbers as ordered.

The cases against Ebbers and Scrushy raise an interesting question: why and how do CFOs often come to be the point-person for accounting fraud in public companies? WorldCom and HealthSouth are the most recent examples, but the past few years have brought so many criminal or civil charges of securities fraud against CFOs that they fail to really even surprise us anymore: Enron, Gemstar-TV Guide, Network Associates, Rite Aid, Computer Associates, McKesson HBOC, Gateway, Symbol Technologies, Xerox, and dozens of other companies of which you may have never even heard. Perhaps HealthSouth is unique only in that it has now had five former CFOs plead guilty to securities fraud.

Why is this? Is there some disproportionate lack of integrity among people who fill the CFO position? Are they simply prone to breaking rules? Logic and experience would dictate to the contrary. If anything, CFOs—typically risk-averse accountants and CPAs who have risen to the very top of their profession—would presumably gravitate to accounting careers due to a respect for rules and order.

Or is it as the CFOs in the WorldCom and HealthSouth cases have testified—that the intimidating, volatile people who were their bosses made it crystal clear through their words and conduct that the only financial report they would accept from these CFOs was one that “hit the numbers,” despite having already been told that such numbers could not be met legitimately? Placed between such a rock and a hard place, CFOs have in the past had a handful of unappealing options falling in the narrow range between possible career suicide and financial fraud:

• Report the CEO to the company’s board. This option historically was made even less appealing by the fact that in many cases, the board was beholden to and functioned as a rubber-stamp for the CEO;

• Report the CEO to federal authorities;

• Quit;

• Refuse to comply with the CEO’s demand and presumably be fired; or

• Take the path of least resistance … capitulate and prepare financial statements that did not comply with GAAP, with the hope that discrepancies could be made up in later, more successful quarters.

Many CFOs have chosen poorly. It undoubtedly takes rare courage for a CFO to stand up to an insistent CEO’s demands. Even Scott Sullivan, who was already a multimillionaire, a member of the WorldCom Board, and CFO Magazine’s 1998 CFO of the Year when he was allegedly ordered to “hit the numbers,” was unable or unwilling to do so. “I knew it was wrong,” he testified, “but I thought we were going to get through it in a short period of time.”

It is part of the CEO’s job to zealously drive his or her company to meet short-term financial targets. There have always been CEOs, however, whose ambition to meet such goals is not bounded by GAAP. Maybe the high-profile prosecutions of CEOs and CFOs in recent years and the prospect of significant prison time for falsely certified financial statements under Section 906 of Sarbanes-Oxley will embolden CFOs to take a stand when CEOs demand that they hit numbers that cannot be hit using legitimate accounting. Maybe some of the other provisions of Sarbanes-Oxley such as Section 301’s requirements of an independent audit committee to receive and review complaints about accounting matters will provide a viable alternative for CFOs in such situations. But until CEOs no longer push CFOs to do what cannot legally be done, the courage to do what is right under even the most trying of circumstances will continue to be job requirement number one for CFOs.

This column solely reflects the views of its authors, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.

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