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Leland Smith, general counsel of Equity Marketing Inc., usually has trouble getting everyone’s attention when he’s preparing financial statements for his company, which helps other companies with marketing promotions. First he has to slow down the executives long enough to gather the numbers. Then he has to chase down board members for comments on the 10-K filing. “Usually, generically speaking, you have a couple of people on the board that are very involved and you’re chasing after the others,” he says. Not this year. In the wake of Enron and the many other companies that have been questioned about their accounting practices, no one is too busy or too bored to pay attention. In this respect, in-house counsel and lawyers who specialize in corporate governance agree, Enron’s implosion has had a salutary effect. It has focused the business world, including the lawyers, as few events have. While corporate anxiety has rippled through in-house legal departments, Enron’s full impact won’t be clear until reactions in Washington, D.C., play out. Since December, when Enron filed for bankruptcy, the Securities and Exchange Commission (SEC) has issued a series of statements advising public companies to expand and simplify their financial disclosures. More than 30 bills have emerged from congressional committees investigating Enron’s demise, and this month, President Bush offered his own plan to protect investors. THE ‘FOCAL POINT’ How are general counsel responding? It varies from industry to industry and company to company. But one subject that seems to be on many companies’ agendas is the audit committee. Smith says it is “the focal point.” Stanley Keller, who chairs the American Bar Association’s federal regulation of securities committee, calls it “the first line of defense for the board of directors in dealing with accounting issues.” A partner at Boston’s Palmer & Dodge, Keller urges his clients’ audit committees to “ask the hard questions” and to “think about the business justifications and not just the accounting needs.” Intel Corp. is one company taking a fresh look at the process, according to Cary Klafter, the senior counsel who directs the chip maker’s corporate affairs group. In addition to reviewing SEC rules and advisories with audit committee members, Intel lawyers also gave members the transcripts of congressional testimony by the chairman of Enron’s audit committee. Evaluating Enron’s structure, “you look to see whether there seemed to be obvious problems,” Klafter says, adding: “You have to translate it into the context of your own operations. The goal isn’t to solve Enron’s problems. The goal is to make your own process better.” As part of this process, Klafter says, Intel is closely following the new SEC directive on “critical accounting policies” — defined as those most important in portraying a company’s health and most difficult to nail down. He says Intel’s annual statement will spell out more about the company’s valuation of inventory, merger-and-acquisition goodwill and equity securities. Another change, he adds, is that Intel’s recently released 10-K expands last year’s footnote explaining nonaudit fees Intel paid its auditor, Ernst & Young. Though it’s “not something you would typically have a statement about,” he says, it seems like a good idea “in this climate.” Federal-Mogul Corp., a Fortune500 auto parts supplier, is also taking a close look at this issue, says deputy general counsel David Sherbin. “Since Enron,” he says, “I’ve seen the audit committee ask about the range of services our outside auditor provides and the appropriateness of those services.” They are paying particular attention to “tax-related services” — examining what other companies are doing and evaluating whether such services are likely to influence the audit, Sherbin explains. Pfizer Inc.’s audit committee is also poring over the Enron case, says Margaret Foran, an attorney and the drug company’s vice president for corporate governance. Foran and her colleagues have distributed advice from a variety of sources to their audit committee. One popular document available on the American Corporate Counsel Association’s Web site, www.acca.com/legres/enron/ liptonmemo.html, features questions and answers for company directors, especially those on audit committees, by Martin Lipton, co-founder of New York’s Wachtell, Lipton, Rosen & Katz. “Can we continue to use off-balance sheet financing?” reads one. “Should we rotate accountants on a five-year basis?” asks another. (Answers: yes; and not necessarily, but worth discussing.) Even before Enron, Pfizer devoted considerable resources to audit committee training, Foran says. She was part of a team last spring that gave about 25 hours of orientation to the new chairman of Pfizer’s audit committee. This included a briefing on SEC filings and best practices in the field, Foran says. In the wake of Enron, she suggests other companies may follow suit. Another issue on some agendas is pension plans. After so many Enron employees lost everything, Equity Marketing’s audit committee decided to look into its 401(K), which is partially funded with company stock, says GC Smith. Asked to research “what our options are,” Smith says he will hire outside counsel because it’s beyond his expertise and that of his other in-house lawyer. Companies in the energy sector grapple with the additional burden of guilt by association. To distinguish itself from the taint of Enron, Dynegy Inc., the company Enron tried to merge with in a last-ditch effort to avert bankruptcy, has gone so far as to explain mark-to-market and other accounting issues in a high-profile advertising campaign. General counsel Kenneth Randolph also points to the company’s 10-K, which features lengthy explanations of long-term and short-term contracts and potential “trigger events” in which the company’s credit rating could affect debt payments — as it did, with disastrous results, in Enron’s case. SOME COMPANIES UNAFFECTED Of course, not all companies are touched by the shadow of Enron. The general counsel of a public company in the furniture industry says that banks often try to entice his company’s financial officers into complex deals, but they never bite. “We’re too conservative to get involved in off-balance sheet stuff,” he says. The only effect Enron has had on his department is that “it makes you more aware” and vigilant, he says. Michael Roster, general counsel of Golden West Financial Corp., a savings and loan holding company based in Oakland, Calif., says recent events remind him of the S&L disaster of the 1980s. Though his company was not affected then (or now), he says, the scandal caused the government to pass stricter laws and tighten regulations. As a result, boards of directors at his company and other financial institutions are now required to scrutinize off-balance sheet transactions and banks’ hedging activities. There also are strict limitations on partnerships. And if these new rules don’t command sufficient attention, the host of lawsuits that target accountants and lawyers certainly do. In light of Enron, “these warnings aren’t limited to banking,” he says. The focus of outside counsel who specialize in this area is to help companies avoid such problems. And one good place to start, according to Linda Griggs, a partner in the Washington, D.C., office of Morgan, Lewis & Bockius, and formerly chief counsel for the SEC’s chief accountant, is for companies to be sure their board members are independent. To help companies do so, in February Griggs developed a 29-page directors’ and officers’ questionnaire that asks not only about their backgrounds but whether they consider themselves financially literate, and why. But some lawyers believe that, in the current frenzied climate, companies are missing the point. An East Coast health care company had no accounting problems but worried that the board lacked accounting experience. They called Bruce Toth, a partner at Chicago’s Winston & Strawn, and asked if he could recommend a chief financial officer they could recruit as a board and audit committee member. You don’t need a CFO, said Toth, co-author of a recent BNA publication on boards of directors. Most would be too busy and would not necessarily be knowledgeable about the company’s industry. Moreover, the audit committee doesn’t have to possess all the answers, he told them. But they should have access to professionals they can consult. And rather than rely on the in-house lawyers and outside auditors the company generally uses, which could compromise the audit committee’s independence, he recommends they hire their own outside counsel and accountants when they need help with complex issues. (Other lawyers counter that, unless an investigation is required, there’s nothing wrong with using the people the company usually does.) The bottom line, for virtually every lawyer interviewed, is that to ensure that audit committees and outside auditors are truly independent and not unduly influenced by management, they should meet with each other regularly without management present. John Olson, a partner in the Washington, D.C., office of Los Angeles’ Gibson, Dunn & Crutcher, who also chairs the ABA’s corporate governance committee, recommends that audit committees ask auditors: � Is management pushing the envelope in its application of accounting principles? � How does our accounting differ from that of our competitors? � Is management forthcoming, and does it respond quickly? � What is your assessment of its ability and integrity? The role of lawyers in this arena, Olson says, is to “help the board and committees implement processes that will help them arrive at sound decisions.” They have a special role in judging whether financial disclosures “are a fair and accurate portrayal of what’s going on.” Liability isn’t the issue. There’s more at stake than lawsuits and damages. “Once a corporation’s reputation for reliability is damaged,” he says, “the dollars and cents repercussions of that can be devastating.”

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