Investment Consult

February 18, 2005

Tactics for surviving business scandals

Congress and regulatory authorities such as the SEC and NASD have looked at these problems and acted on them. One major accounting firm, Arthur Andersen, has gone out of business, and other companies have been hit with significant fines. Corporate executives have been indicted, and some may be exchanging their pinstriped suits for suits with wider stripes.

Mutual fund companies, too, have faced increased scrutiny, from the SEC and from their own boards of directors. Beginning this year, some will pay considerable monies to compensate shareholders. To placate clients, some firms-including a few that haven't been accused of wrongdoing-have lowered their ongoing management fees and may drop them further.

Given all of these scandals, you may wonder whether it's any safer these days to trust financial institutions with your money. I believe it is. Research analysts can no longer be supervised or controlled by a firm's investment-banking department. Brokers, in turn, are now required to provide clients with independent research. They also must disclose any conflicts of interest in making recommendations-for example, when the company they're touting is a source of investment-banking money for their firm.

Another good result of the scandals is that companies' accounting practices are more conservative today. CEOs now must attest to the accuracy of their financial statements each year. Moreover, the independent Financial Accounting Standards Board is expected to pass changes to curtail attempts by the companies' in-house accountants to fudge the numbers.

For one thing, the FASB would require companies to list stock options as an expense, something that should have been mandatory long ago. (Stock options give executives and certain key employees the right to purchase the company's shares at a specified price within a stated period. The company can effectively forfeit big bucks if the option price is much lower than the stock's price on the open market when the options are executed.) Such a policy may have helped to limit the number of technology companies whose stock prices soared into the stratosphere in the late 1990s, then fell back to earth again.

Despite these reforms, however, accounting "artistry" is unlikely to be eliminated entirely. Some companies will continue to act like a motorist who speeds up when the cops are safely out of range: They'll adopt their old behavior once the spotlight of scrutiny fades. So as an investor, you'd do well to protect yourself and not rely on the regulators to keep your money safe. Here's what you can do:

The author, a fee-only financial planner, is president of L.J. Altfest & Co. ( http://www.altfest.com), a financial and investment advisory firm in New York City, and an associate professor of finance at Pace University. The ideas expressed in this column are his alone, and do not represent the views of Medical Economics. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics, 5 Paragon Drive, Montvale, NJ 07645-1742. You may also fax to 973-847-5390 or e-mail to meinvestment@advanstar.com
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