CEOs sign; investors still wonder

By the end of Wednesday, most Fortune 500 chief executives will have sworn before a notary public that their reported results accurately represent their company finances.

This new requirement – mandated by Congress and the Securities and Exchange Commission – means that corporate honchos will now have to take personal responsibility for any fudging or misstatements on the balance sheet. And the penalty for signing off on a fraud has been stiffened – with the possibility of 20 years behind bars and the stigma of a perjury conviction.

"Nothing focuses the attention like the prospect of a personal prosecution," says Jeffrey Stone, head of the white-collar criminal defense division at McDermott, Will & Emery, a Chicago law firm.

But investors believe the change, affecting 745 companies as of Wednesday, is an important first step in rebuilding investors' confidence in the markets. They hope it will result in a higher standard of reporting, with firms striving for clarity and consistency.

"It's a step toward getting gem-quality earnings," says Duncan Richardson, chief equity investment officer at Boston-based Eaton Vance, which manages $50 billion in investments.

Market analysts expect the vast majority of companies will have no trouble certifying their earnings. A few, including General Electric, even filed certification letters early as an indication of their own confidence. But, says former SEC trial lawyer Christian Bartholomew in Miami, "There are a fair number of cases where people are having serious anxiety whether they can sign a statement."

The stock market has already begun to anticipate that some chief executive officers may have trouble signing off on earnings. "The more complex a company, the more these issues come up," says Lynn Yturri, an equity fund manager at One Group. "We're quicker on the trigger if we suspect some issues."

For example, Mr. Yturri says he recently sold shares in DuPont because of his concern over possible charges to earnings. "It's better to shy away than be shot in the foot," he says. (On Aug. 9, DuPont's CEO and CFO both filed certification letters with the SEC.)

Just the hint that there may be a problem now causes investors to flee from a company. For example, last week Interpublic Group, the giant marketing and advertising company, delayed its earnings release to give its audit committee more time to review its accounts. The stock lost 30 percent of its value in two days. "Over the near term, there is very little trust," Mr. Richardson says.

In fact, there is some evidence that investors are going to vote with their feet even more often. On Monday, finance leaders from 14 states and a few cities met in New York to discuss ways to use their $1 trillion in assets to improve corporate accountability.

"We just can't be passive investors, we can't be docile," says Philip Angelides, California's Treasurer. "We will use the power of the purse and hopefully use it judiciously."

One reason for the lack of trust is big stock-market losses. Mr. Angelides says the two largest California pension funds lost $850 million on WorldCom alone. Tom Gallagher, Florida's Treasurer, says his pension funds lost $330 million on Enron.

Lawyers who advise companies say there is no doubt that CEOs and chief financial officers are sweating over the new requirements, particularly those in the Sarbanes-Oxley Act.

"The new law requires that the CEO and CFO be responsible for internal controls, including some steps to measure their effectiveness," says Mr. Stone. "We're advising clients to be much more assertive and proactive."

As a result, some top executives are requiring subordinates to swear that the information they are providing is accurate. They reason that the longer the paper trail, the better off they are. "There is all kinds of auditing and monitoring going on to make sure the CEO does not get in trouble," says Gregory Wallance, a former assistant US Attorney in New York, now a partner at Kaye Scholer LLP in Washington.

One of the uncertainties is that the SEC has yet to say how it will implement some of the new requirements. By the end of the month, the agency expects to issue new guidelines. "It's not clear yet where the bar is going to be set," says Stone, a former assistant US Attorney in Chicago.

The new law also does not allow much wiggle room. For example, corporations used to qualify their earnings statements by saying they were accurate using Generally Accepted Accounting Principles (GAAP). Instead, under the new law, CEOs must swear that their reports fairly present the companies' business. "There are no qualifiers," says Mr. Bartholomew, a partner in the law firm Morgan Lewis in Miami. "There is a lot of room for anxiety."

And, according to Bartholomew, companies should be worried. He says the Department of Justice is under a lot of pressure to mount trials. Prosecutors are now looking anew at cases they had passed on earlier. "A lot of cases not in the WorldCom league are being looked at," he says. "The bar has been lowered as far as what prosecutors are looking at, and we are counseling people to be very careful."