NEW YORK As bad as recent Interpublic Group financial revelations have been, there has never been any indication of employee malfeasance. That changed last week as IPG disclosed, in an 8-K filing with the U.S. Securities and Exchange Commission, that the latest company restatement is due, in part, to "violations of laws," the "misappropriation of assets," "inappropriate customer charges" and "falsified books and records."
Weak financial controls are one thing; the specter of a more serious breach at the company leaves it vulnerable to difficulties ranging from a possible rash of new shareholder lawsuits to potential repercussions from clients at its operating units. And while insiders were eager to downplay the dollar amount involved—one source put it at 10 percent of a restatement that's expected to be in the hundreds of millions—the mere existence of such misconduct was problematic.
"What concerns me is when you have clients reading about this and hearing about employees misappropriating assets, they have to be wondering, 'Should I be doing business with this company?'" said Alexia Quadrani, an analyst at Bear Stearns. Echoed Merrill Lynch's Lauren Rich Fine: "My fear is that many clients may feel they cannot afford to do business with them or have an association with them."
That said, several financial observers contend that IPG's problems are already reflected in the depressed value of the stock, which closed Friday at $11.27, down 3 cents, in above-average trading volume of 4.5 million.
The latest round of bad news came in the wake of a string of major client losses this year, including media business from Nestle and General Motors, marketing services duties on Bank of America, and just last week, creative and media duties on Lowe's home centers. Since January, IPG agencies have lost at least $4.7 billion in billings from a handful of major clients alone, according to Adweek estimates.
Last week's admission of criminal activity by some employees kicked off a new round of talk of an IPG breakup, a scenario that has been dismissed by IPG CEO Michael Roth, who insists he is committed to enhancing shareholder value by improving operating performance. Said one senior executive at an IPG agency, "We keep thinking this can't get worse, but screwing up the accounting is one thing, engaging in criminal activity is a whole other thing. Clients have to be wondering if they should work with this company. We have got to be getting closer to that [breakup] scenario."
On Thursday, IPG said it will restate earnings for 2000 to 2004, due to problems in accounting for revenue, acquisitions and lease expenses. It will be the third restatement in three years at the industry's No. 3 holding company. The amount involved will be revealed by Sept. 30, with the company admitting last week that the "impact on our results of operations for all periods will be material."
While there's no set definition for "material," the word implies that the numbers will change significantly—at least 3 to 5 percent—and possibly enough that, if investors had the proper information, their opinions of the $6 billion company would have been different, sources said. Material changes also could trigger more shareholder lawsuits since those usually revolve around false or misleading statements. Sources inside IPG acknowledge as much.
IPG's filing said that "previously issued financial statements and preliminary, unaudited interim information released earlier this year, as well as previous disclosures concerning the nature or amount of the restatement, should no longer be relied upon."
While one source said lawsuits were "possible," the source added that "it's going to depend on whether and how much the stock drops." In other words, if the share price stays roughly the same after IPG finally reports its long overdue results, a shareholder may find it difficult to show damages.
In the 8-K, IPG attributed the restatement mainly to weak financial controls and a decentralized operational structure, which it had flagged in previous filings. The SEC has been probing IPG's accounting practices since 2002 and continues to do so.
IPG said the employee misconduct was uncovered in the context of its broader, sweeping review of financial controls and occurred primarily at agencies outside the United States. Internal investigations into the misconduct, which are nearly complete, resulted in firings and the development of remediation plans. "The instances in which we believe there was malfeasance do not involve current senior-level employees at any of our operating units or within the corporate group," a company representative said on Friday. "These cases took place in a small number of our locations, almost all outside the United States. The fact we are able to identify them demonstrates that we are making progress in enhancing our risk management controls."
Roth reiterated these points in an e-mail to IPG's 43,000 employees on Friday, adding, "We are also alerting local authorities, as is our responsibility." Roth also wrote, "The fact that we are able to find these issues at this time reflects the commitment that I wrote to you about yesterday—to a higher level of scrutiny and transparency." As for clients, Roth encouraged staffers to "tell them—as we have been—that meeting our financial filing date and dealing with accounting issues will not interfere with the quality of the work we do for them. Remind them that we are financially sound and have recently had meetings with our banks, who remain very supportive."
Earlier, IPG execs were eager to downplay the extent of the problem, saying the total dollar amount involved is a fraction of the overall restatement, which IPG has yet to quantify. IPG has identified 24 to 36 incidents involving 50 to 100 employees, primarily in a dozen countries in Eastern Europe, according to a source.
Those responsible were described as execs who ran relatively small agency offices, as well as department heads, such as the head of a production department or media services. IPG said last week that it has terminated most of those involved. Given the international reach of McCann Erickson, most of the involved offices are part of that network, said sources.
The SEC does not have criminal jurisdiction but can issue civil penalties such as fines. One exec said there's no evidence of a conspiracy or the involvement of top agency or IPG execs.
While IPG contends the revelations illustrate the thoroughness of the company's housecleaning, it may raise more questions than it answers, given the lack of detail in the 8-K. "It paints a picture of a big company that had no idea what was going on," observed Alan Gottesman, principal, West End Communications in New York, about last week's disclosures.
Although IPG is expected to eventually cut ties to PricewaterhouseCoopers, its independent auditor of almost 50 years, the company is not likely to do so until the SEC investigation is settled, said sources.
IPG will quantify the restatement when it reports long-overdue results for 2004 and the first two quarters of 2005. IPG said it "remains on track" to report those numbers by Sept. 30, "barring any unforeseen circumstances." IPG must meet that deadline or default on the terms of certain bank loans and potentially be delisted from the New York Stock Exchange.
The financial mess, naturally, is Roth's priority, and some execs last week noted that some operational initiatives are on hold until after Sept. 30. IPG has been kicking around the idea of realigning some agencies, including a possible merger of Lowe and Draft and a restructuring of its media assets, but "nothing is getting talked about until after they fix this mess," said one exec.
Clients contacted last week, such as GM and S.C. Johnson, would not comment.