THE NEW BALANCING ACT

John Karolefski

It was a little more than a year ago -- July 30, 2002, to be exact -- when President Bush signed the Sarbanes-Oxley Act into law, thereby throwing a new onus of regulation into corporate boardrooms and IT shops throughout the land.

With its stringent reporting requirements and stiff penalties for failure to comply, SOA was designed to protect investors shaken by a wave of corporate scandals (see box, Page 46). "Officers who don't comply with these rules run the risk of huge fines, or going to jail," noted Paula Rosenblum, research director, AMR Research, Boston.

In the past year, the food industry hasn't helped matters as several high-profile companies -- including Ahold, Fleming, Kmart and Nash Finch -- have become embroiled in accounting scandals over vendor promotional allowances.

"Several characteristics of retailing -- lots of cash, distributed operations, manual processes, trade allowances, and settlements involving holdbacks and deductions -- expose the industry to too many risks without any thought of foul play," noted Greg Girard, vice president, retail application strategies, AMR Research, in an AMR Alert on Retail report published in June.

"We've honed in on a lightning rod in the retail industry for both grocers and other retailers," said Scott Chamberlain, chief financial officer, Fuego, Plano, Texas, a business process management vendor. "There's been over half a dozen informal SEC inquiries in the last two months." Ron Lunde, an industry consultant based in Ponte Vedra, Fla., confirmed that many major food retailers have received requests for information from the SEC concerning promotion and trade marketing practices.

While SOA officially covers only public companies, those in the private sector are aware of the issues and are reacting. For example, SOA has prompted Giant Eagle to review its accounting procedures and standards with the goal of upgrading them.

"We're very familiar with Sarbanes-Oxley," said David Shapira, chairman and chief executive officer of the regional grocery chain based in Pittsburgh. "Although we are private, we like to have the same corporate governance procedures that public companies have. So, we're already in the process of trying to adhere to the law."

Fallout on IT

The fallout of Sarbanes-Oxley is being felt in the IT departments of companies, which are expected to come up with new ways to create audit trails and document the effectiveness of internal controls.

Because much of the attention in the food industry is on promotional funds, food distributors are beginning to turn to AMP (advertising, marketing and promotion) systems, which help to efficiently plan, execute and track promotional campaigns. AMP systems can often provide an audit trail of promotional activities that could make them useful as proof that funds were utilized as intended. (See SN, April 21, 2003, Page 75.)

Yet many other applications are being called upon to help with the new world of accounting compliance, including financial and accounting systems, sign-off and tracking systems, and other retail operations and enterprise tools. Technology and business consultants are finding considerable opportunity in this environment.

According to a survey on SOA compliance by AMR Research, 85% of companies are planning for changes to their information technology systems to support compliance efforts. The report said that companies must evaluate technology solutions for SOA compliance, and there is no one-size-fits-all solution.

"Anecdotally, companies are mounting an aggressive response to SOA compliance," according to James Hagerty, an analyst with AMR Research. "No one wants to be the company [or individual] that becomes the test case for SEC enforcement." Yet many retailers are in the early stages of trying to come to grips with the regulations, said executives familiar with the law.

One vendor positioning itself as a supplier of technology solutions that address SOA is Lawson Software, St. Paul, Minn., which hosted a Web seminar on the subject with consulting firm Deloitte & Touche, New York, last month, available at www.lawson.com/retail.

"It's the beginning of a brave new world for these guys," said Carol McKenzie, retail vertical market director at Lawson. "It's broader than accounting per se as a business process because it touches everything internally in the organization. There certainly is an awareness building in the retail community."

McKenzie said companies need to put a "controlled environment" in place in their organizations. "Assuming that they already have the CEO and the CFO signing off on the documents, which is needed now, how do they put this compliance control environment in place and where are the biggest pieces of their exposure?" queried McKenzie.

The problems may be monitoring functions, internal audit, or documentation of all policies and procedures, she noted. "They've got to prioritize where the gaps are internally. It may require some business process reengineering. None of these will be alike so it is not vanilla out of the box." As a first step, McKenzie recommended starting with documented controls for financial applications and human resources applications.

In the Web seminar, Rob Wilson, retail product marketing manager, Lawson, pointed out some of the Lawson systems designed to help with SOA. These include a smart notification system, an event- or time-driven system for alerting decision makers via e-mail or PDA; a knowledge management system that can search for pricing and promotion management documentation; a process flow tool that provides an audit trail of approvals; a portfolio management application that handles risk management and assessment for projects; a merchandising suite that tracks allowances, issues alerts and maximizes discounts; and a comp-store reporting system.

Doug Neve, an audit partner at Deloitte & Touche, noted in the Web seminar that retailers can use modest tools like Microsoft Excel and Access to manage sign-off and tracking before going to more sophisticated Web-based systems.

Lawson systems have "improved our business processes and tightened internal controls, shortening the turnaround time on our financial reporting," said Dennis Hernreich, CFO, Casual Male Retail Group, Canton, Mass., in a prepared statement. "Since audit fees are expected to increase sharply, good systems and controls are the best way to manage costs while complying with [SOA] requirements."

Food retailers, of course, need to be particularly vigilant about trade allowances. Fuego has met with about 18 retailers over the last four months, and all said they needed to change the way they manage, automate and control vendor allowances, said Fuego's Chamberlain.

Typically, said AMR's Rosenblum, trade funds are "in some pile on a buyer's desk." At better companies, she noted, a conversation takes place with the CFO or controller about what the allowance is going to be, where it should go, and how it should work. But even then, "it's booked at a topline level," she said. "What has to be done now is it should be booked at minimum at a category level and ideally by SKU."

Manufacturer Worries

In addition to SOA, manufacturers also need to worry about new rules that affect how they report trade promotion dollars. Much of the funds manufacturers spend on trade promotions, as well as on consumer promotions, can no longer be classified as cost of goods sold or a marketing expense; they are now considered a reduction in revenue. These rules were developed by the Emerging Issues Task Force, which operates under the auspices of the Financial Accounting Standards Board, the recognized standards-setting authority for U.S. accounting.

"CPG manufacturers and its executives will be under tremendous pressure and face significant consequences if both their information systems and financial statements do not comply with the new stringent requirements imposed as mandatory by U.S. government agencies," said Lunde. "Information systems that are able to predict the impact of a promotion on revenue, maintain up-to-the-minute data, [and] analyze and accurately report results are now an absolute necessity to avoid both civil and/or criminal penalties."

Considering the new accounting regulations, a logical question emerges: Will retailers be getting less trade dollar support from manufacturers?

"Retailers may not be able to look forward to continuing historic levels of CPG marketing funds support," said Lunde. "The EITF accounting issues affect both retailers and manufacturers. While they generally do not prohibit the expenditure of marketing funds, they do make the expenditure far more transparent to management, analysts, stockholders and regulators. Therefore, expenditures will undoubtedly receive close scrutiny for both efficiency and effectiveness."

Rosenblum of AMR Research doesn't agree. "At the end of the day, retailers have the most power. Maybe manufacturers will get creative and find another way to give retailers money," she said.

Sarbanes-Oxley, in a Nutshell

Here are the three major provisions of the Sarbanes-Oxley Act of 2002 that apply to retailers:

Section 302: The chief executive officer and chief financial officer must personally attest to a company's financial results. This regulation is already in effect.

Section 404: Companies must establish and auditors must certify that internal controls and processes are in place. The deadline for compliance has been extended to June 15, 2004.

"This requires retailers to take a look at everything that's going on in their organizations, and this is the one that is causing the most consternation," said Carol McKenzie, retail vertical market director at Lawson Software, St. Paul, Minn. "From a retailer point of view, they've never been charged with such a huge endeavor like this before. So it's a bit daunting right now."

"Most grocery retailers have embarked on 404 compliance," said Scott Chamberlain, chief financial officer of Fuego, Plano, Texas, a business process management vendor.

Section 409: Companies will in the future have to provide real-time disclosure of material events that may affect performance -- for example, if the CEO suddenly departs or there is a major infrastructure collapse. An implementation deadline for this provision has not been set yet.