Over 30 years of reporting on Congress, federal agencies and the White House for corporate America as well as national trade and professional associations.

streetwise

From September 2006 Strategic Finance

S T E P H E N B A R L A S , E D I T O R

Section 404 Saga Continues

The Securities & Exchange Commission will issue guidance for corporate
management on how to comply with the provisions of Section 404 of the
Sarbanes-Oxley Act, which requires companies to explain their internal controls
and test them. The SEC issued a “Concept Release” in mid-July that outlined
some of the areas it may address when the guidance is published. No
date for publication was mentioned. Large companies, of course, have had to
comply with 404 for two years. Smaller companies received an initial reprieve,
but, with first-time compliance looming, they are pushing the SEC hard to
make some changes in required compliance. The SEC Advisory Committee on
Smaller Public Companies raised a number of concerns in an April report on
the ability of smaller companies to comply with 404 in a cost-effective manner. That was followed days later by a U.S. Government Accountability Office report that said much the same thing. Of course, larger companies and the U.S. Chamber of Commerce have been arguing for
the past year that Section 404 is too costly. The SEC took a first crack at quieting that murmuring when it issued limited guidance in April 2005 relating to the exercise of professional judgment, the concept of reasonable assurance, and the permitted communications between management and auditors. But this next round of guidance will go further. For example, the 2005 guidance stated that management needs to use “reasoned judgment” in identifying internal controls. But few understood what that meant. The July 2006 Concept Release maintains that “many companies did not efficiently and effectively identify risks to reliable financial reporting and relevant internal control functions, ultimately leading to the identification, documentation, and testing of an excessive number of controls.We are also
skeptical of the large number of internal controls that some companies have
identified, documented, and tested.” Part of the reason for that problem is that corporate management, in implementing Section 404, may have leaned too heavily on the Public Company
Accounting Oversight Board (PCAOB) Auditing Standard No. 2 (AS2), An Audit of Internal Control over Financial Reporting Performed in Conjunction with an Audit of the Financial Statements. Published in June 2004, this was meant for outside auditors, not management. But many corporate financial and accounting departments interpreted AS2 very conservatively, increasing costs far beyond what was necessary. This is

c o n t i nue d o n p a ge 2 4

the problem that the SEC hopes to resolve with its new guidance, which the agency emphasized will be “scalable.” That apparently means the guidance won’t be written only with
small companies in mind but also will take the concerns of Fortune 500 companies into account.

New Chief Accountant

With more expansive 404 guidance now in the SEC pipeline, Conrad Hewitt, the SEC’s new chief accountant, joins the Commission at a critical time. The post was vacant since
Donald Nicolaisen departed last fall. Hewitt, who had been serving on three corporate board audit committees, had otherwise been retired from a full-time job since 1998,
when he was a California state banking official. From 1972 to 1995, Hewitt was the managing partner of Ernst & Young and its predecessor firm, Ernst & Ernst, in the firm’s
Northern California (1986-1995), Seattle (1979-1986), and Honolulu (1972-1979) regions. In his statement upon joining the SEC, Hewitt noted that he has worked with many of the big accounting firms to implement Sarbanes-Oxley and looks forward to working with the PCAOB
“to maximize the protection of shareholders while eliminating excessive costs and burdens both
here and abroad.”

Bill Would Eliminate Some State Taxation of Corporations

Protests from states and local governments forced House Republican leaders to postpone a floor vote on a bill limiting state taxation of corporations. A spokesman for Rep. John Boehner (R.-Ill.), the House Majority Leader, said, “Some misperceptions about [the bill’s] effect on
states” resulted in the vote being delayed, probably until after the August recess. The bill (H.R. 1956) would establish a national standard for when states can collect business activity taxes from multistate companies whose principal locations are outside the state but who have many
customers within the state. The bill has been strongly supported by companies in the retail, financial, and medical industries. The bill would require companies to have a physical presence in a state for at least 21 days before they could be taxed. But there would be some exceptions. The National Governors Association spooked both Republicans and Democrats in the days prior to the scheduled House floor vote by publicizing a study that projected revenue losses to the states would be nearly double the annual losses of $3 billion by 2011 that the Congressional
Budget Office projected. Besides business activity taxes, states couldn’t levy gross receipts, license, or franchise taxes.

Stricter U.S. Gas Standards Stalled


IEEE Spectrum from September 2006

By Stephen Barlas
Bipartisan opposition defeats bipartisan efforts to strengthen CAFE regulations

Gasoline may be more expensive than ever in the United States, but talk is still cheap on Capitol Hill. Flocks of bills promoting automobile fuel efficiency and alternative fuels, which took flight on soaring rhetoric last spring, have dropped to the ground like so many downed birds. Nearby, the special interests stand with shotguns still smoking.

Congress had tried in previous sessions to increase Corporate Average Fuel Economy (CAFE) standards for passenger automobiles from a fleetwide average of 27.5 miles per gallon (8.55 liters per 100 kilometers), where they have been stuck since 1985. With gas prices at more than US $3 per gallon [see photo, “High Prices, Big Cars”], Representatives Sherwood Boehlert (R‑N.Y.) and Edward Markey (D-Mass.) thought that they had the political impetus they needed to pass a bill that would increase CAFE standards for both cars and light trucks—light trucks have had a separate standard—to 33 mpg (7.13 L/100 km).

Boehlert, who will retire this year as chairman of the House Science Committee, has been tirelessly pounding home the main message of the influential 2002 report issued by the National Research Council, Effectiveness and Impact of Corporate Average Fuel Econ­omy Standards. “The technologies needed to meet the standards our bill sets already exist,” Boehlert says. “Indeed, some of them have already been surpassed since the report was issued in 2002.”

Rather than boost CAFE standards as such, the Bush administration has preferred to give the National Highway Traffic Safety Administration the authority to change the way the standards are figured for passenger cars to achieve some of the same effect. It has moved to a method that focuses on footprint, a measure of a car’s wheelbase, and away from automobile weight and fleet averages [see box, “Calculating CAFE”].

Last March the highway safety administration, which already had the authority to use the footprint method to determine CAFE standards for the light truck category, adopted that method for cars as well. The result is that average miles per gallon for sport utility vehicles (SUVs), small trucks, and minivans will increase from 21.6 mpg on 2006 models to 24 mpg for 2011 models on an industrywide scale. The increase is better than it looks, because huge vehicles like Hummers were included in that group for the first time.

But when a footprint bill came be­fore the House Energy and Commerce Com­mittee in May and passed, Markey tried to attach an amendment with his preferred fuel mileage boost to 33 mpg. He lost by a vote of 36–17. Michigan Representative John Dingell, the committee’s senior Democrat and a close ally of the automobile industry, led a number of other Democrats in opposition to the Markey amendment, which was also opposed by some Republicans.

In the estimation of Eli Hopson, the Washington representative of the Union of Concerned Scientists, not even the underlying footprint bill, which made it through the committee, will pass the full House. That view is seconded by Joe Pouliot, Boehlert’s spokesman, who says there are three separate camps of House members with three mutually exclusive approaches to higher fuel efficiency, none of which commands a House majority: (1) no CAFE changes, no way; (2) CAFE light, that is to say, the footprint approach; and (3) CAFE heavy, the Boehlert-Markey alternative.

Inaction suits the auto companies just fine, and this goes as well for the main union representing their employees, the United Auto Workers. Alan Reuther, the legislative director of the UAW, told members of the House committee that imposition of a higher miles-per-gallon requirement “would severely discriminate against full line [auto] producers whose product mixes contain greater percentages of larger cars and light trucks.” The UAW also opposes a shift to a footprint calculation for autos, because, it says, dropping the fleetwide average would theoretically allow the Big Three U.S. automakers to leave the production of smaller cars to foreign manufacturers. In the current system, U.S. carmakers need to make small cars in the United States to balance out their many SUVs; a footprint system would render that balancing unnecessary.

In the Senate, Democrat Dianne Fein­stein of California and Republican Olym­pia Snowe of Maine have been pushing a 35-mpg (6.72–L/100 km) bill. But some senators who normally are attuned to the environment and concerned about the country’s ever greater dependence on foreign oil have been even more sensitive to the concerns of autoworkers. For example, New York Senator Hillary Rodham Clinton, also a Democrat, has gently spoken in favor of boosting fuel economy “responsibly without needlessly sacrificing safety or American jobs.” Meanwhile, fuel economy standards are much stronger in some other places, from Europe to China [see graph, “U.S. Fuel Standards Lag ”].

The auto industry has argued that it is too expensive, for both manufacturers and consumers, to adopt the engine and transmission technologies identified in the 2002 National Research Council report. Instead, they say that the way to conquer the United States’ addiction to foreign oil is to roll out more alternative-fuel vehicles, a vision the companies are propounding in print ads and Washington-read opinion magazines. The auto companies point out that there are already 8 million alternative vehicles on the road in the United States and that there will be 1 million more by the end of 2006.

Of that total, boast the companies, there are 21 different car makes—5 ­million vehicles in all—that run on E85, a mixture of 85 percent ethanol and 15 percent gasoline. But E85 is more expensive than ­gasoline, it provides inferior fuel efficiency, and it yields little if any reduction in greenhouse gas emissions. What’s more, “there is currently little customer demand” for E85 vehicles, concedes Reg Modlin, director of environmental and energy planning for DaimlerChrysler Corp., and there are only 650 service stations nationwide that carry E85. “Congress should help in accelerating the growth of ethanol production, distribution, and retail-sales infrastructures through tax incentives, capital depreciation allowances, or other fiscal instruments,” Modlin says.

Sponsorship of E85 infrastructure legislation has already begun: a couple of bipartisan teams have cropped up in Congress, paralleling the Boehlert-Markey partnership. The Biofuels Secur­ity Act, for example, would require major oil companies to increase the number of E85 pumps at their service stations by five percentage points a year.

In addition, the biofuels bill would create a new consumer tax credit for the purchase of “flexfuel” vehicles if the vehicles have no fuel efficiency loss from the use of E85 as compared to regular gasoline. “We understand that there is technology available—for example, a Saab flexfuel E85 vehicle on the market in parts of Europe—allowing vehicles to have no fuel efficiency loss when burning E85 in comparison to gasoline, and perhaps even some mileage gain,” says Senator Tom Harkin, an Iowa Democrat and a cosponsor of the bill.

Disputing that view is Susan Cischke, vice president of environmental and safety engineering at Ford Motor Co.: “We’ve heard from many people that all it takes to make a flexfuel vehicle is ‘a little tweak to the chip that runs the engine.’ I wish it were that simple, but it’s not.”

Big oil has big problems with the biofuels bill, mainly because of its five-percentage-point mandate, and with other ethanol bills, such as the “10 by 10 Act,” which would require refiners to blend at least 10 percent ethanol into each gallon of gasoline by 2010. Autos can use a 10-to-90 blend without any changes to an engine.

At the American Petroleum Institute, an organization in Washington, D.C., that represents the big oil companies, Ed Murphy, group director of refining marketing, says that the institute strongly opposes any bill that mandates installation of E85 pumps and tanks. He argues that even if 100 percent of service stations offered E85, consumers wouldn’t buy it because of its higher cost and lower performance. E85 proponents, Murphy complains, are engaged in “a cynical attempt to appear green.”

It appears, in any case, that the institute has little to worry about. Bob Dinneen, president of the Renewable Fuels Association, an ethanol industry group in Washington, D.C., says he has little hope, realistically, that Congress will enact any kind of biofuels legislation any time soon. “It is a fairly dysfunctional Congress right now,” he observes glumly.