The world according to GAAP
How Interpublic’s reckless global expansion led to legal issues and accounting chaos
In The Wizard of Oz, a young American named Dorothy embarks on a long, strange trip though a perplexing parallel universe, only to find out along the way that there is no place like home. Michael Roth knows the feeling.
Mr. Roth heads Interpublic of the United States, the world’s third-biggest marketing services group and a case study in the perils of reckless global expansion. During a buying spree that petered out with the advertising recession at the start of this decade, Interpublic made more than 400 acquisitions and then failed to integrate its far-flung operations, leading to accounting chaos.
The Securities and Exchange Commission began an official investigation of the company’s accounting in 2003, and Mr. Roth has been installed more recently to help resolve the mess. An accountant and a former chief executive of MONY, the insurer, Mr. Roth became CEO of Interpublic in January after assuming the chairman’s mantle the previous July.
His focus has been financial. Last month, Interpublic, which owns such global advertising agencies as McCann-Erickson Worldwide, Foote Cone Belding Worldwide and Lowe Worldwide, restated results dating back more than a decade, shaving US$ 514- million from reported earnings.
It was a Herculean effort involving thousands of accountants and it is not over yet. Mr. Roth has asked his investors to wait until early next year for a strategic plan and it could take longer to install new computer software needed to give managers a clear view of day- to- day finances.
Interpublic’s accounting problems involve both domestic and international operations. It said, for example, that between 1996 and 2002 “ it was not uncommon” for it to book revenues and expenses of acquired companies “from a point in time that was earlier” than the closing date.
But in an interview in New York, Mr. Roth struck a decidedly Dorothy-esque tone in his emphasis on his overseas problems. As Interpublic followed its multi-national clients around the world, it acquired too many assets in too many places that were too different from the United States to stand up to the American generally accepted accounting principles, or GAAP, he says.
As part of its restatement, Interpublic executives said they had sold, or were in the process of selling, some of their offices in Spain and Greece. They were also pulling out of Azerbaijan, Ukraine, Uzbekistan, Bulgaria and Kazakhstan.
“I never heard of these countries until I found out that I had problems in them,” Mr. Roth jokes. “So now we don’t have them any more — or we won’t.”
Interpublic’s international issues fall into two broad categories. On one hand, its lack of accounting and control systems seems to have resulted in a company that was ill- equipped to prevent inappropriate or potentially unlawful behaviour by its employees.
The company discovered “instances of deliberate falsification of accounting records, evasion of taxes in jurisdictions outside the United States, inappropriate charges to clients, diversion of corporate assets, non-compliance with local laws and regulations, and other improprieties.” In terms of their impact on Interpublic’s restatement, the biggest problems were in Turkey, where the company has said it might fire senior local managers at its McCann and FCB agencies.
A more subtle issue facing Interpublic involved legal local business practices. One such question turned on vendor discounts or credits — cash that agencies receive in return for buying large blocks of advertising time or space on behalf of clients. In Latin America, the Mediterranean and other regions, agencies often keep this money.
Interpublic’s problem was that this practice was difficult to reconcile with some of its global contracts with clients and with its obligations under U.S. GAAP. It is clearly trying to make amends. Paying back this money accounts for most of the US$250-million that Interpublic has set aside to compensate hundreds of counterparties under the restatement.
“ Those business practices are, in certain circumstances, inconsistent with GAAP and the business practices in the U.S.,” Mr. Roth says. “ Rather than fight it, we just said, you know what, if they can’t be consistent with our GAAP and business practices then we shouldn’t be doing it.”
In some countries, Interpublic will sell operations but retain a presence through softer arrangements. In Spain and Ukraine, it said it intends to sign affiliation agreements with the managements of the operations it is selling. It is using a similar affiliation structure in Russia.
The idea behind these schemes is that Interpublic will be able to have its cake and avoid indigestion, too. It could turn to the affiliate for help — earning fees or royalties as a result — but avoid combining accounts. Such arrangements are also used by some of its competitors.
“If you don’t have ownership and you don’t control it, the issue of GAAP accounting is not the same,” says Mr. Roth. “When you have an interest in something from a financial point of view, in terms of ownership, there are certain GAAP accounting rules that will have to apply.”
Mr. Roth says the pressure on U. S. companies to keep some distance from their harder-to-manage foreign operations is growing because of the passage of the SarbanesOxley act in 2002, which requires chief executives to certify their results.
“You don’t need Sarbanes-Oxley to say that if someone is doing something wrong in a foreign country, you get rid of them,” he says. “ The form of geographic expansion may be different as a result of Sarbanes- Oxley. Because, again, ownership is a different requirement from affiliation. I think you will see affiliation arrangements become more prevalent in those type of countries.”
Advertising agencies face the risk that their more distant outposts will not produce enough revenue to justify the cost of compliance with Sarbanes-Oxley. This is a big issue for Interpublic. While discussing the earnings restatement, Interpublic executives said overall professional fees — mostly for compliance with Sarbanes- Oxley — represented 4.7% of the company’s US$2.9-billion in firsthalf revenues. If that trend continues, and the company suggests it will, Interpublic could end up spending an astonishing US$300-million this year on accountants, lawyers and other professional service providers. That compares with professional fees of US$28.5-million as recently as 2002.
In smaller overseas markets, Mr. Roth says, “ you have to convert all these books and records into GAAP accounting. That costs money and it costs people who are able to do it ... So what you have to do as a business person is see how you can service your clients in that location on a more efficient basis.”
The requirements of advertisers’ big clients are also changing, in a way that gives Mr. Roth more flexibility in staffing his international advertising networks. Even in the best of times, advertising agencies are often reluctant internationalists. They follow their multinational clients wherever they go and set up smaller offices as loss leaders to maintain these relationships.
Now, many bigger clients seem content to hire advertising agencies — such as Bartle Bogle Hegarty — that use smaller networks to service global accounts. Mr. Roth’s plans for his beleaguered Lowe agency reflect the growing popularity of these arrangements. Lowe has set up 12 “lighthouse” offices and Mr. Roth wants to base its operations on that backbone.
Interpublic, in other words, is not the only multinational considering whether it needs to be in as many places around the world. Its lesson is that U. S. managers can get nervous when they discover they are not in Kansas any more.