The rolling financial and accounting scandals have IR specialists rethinking how they do their jobs.Although the last 12 months have seen an upheaval in nearly all areas of corporate communications, no PR disciplines have experienced the sea change that investor relations and financial communications have. While most experts agree that it's not unusual for a bear market to expose the excesses of the preceding boom, the last year has witnessed a string of scandals that have taken an unprecedented toll on investor confidence. During the last year, Enron, a company that made Fortune's "Most Admired Companies" list for six consecutive years, has become a synonym for corporate fraud. The venerated "Big Five" accounting firms have shrunk in size and stature, and are now derisively described as the "Final Four." And a trove of internal Merrill Lynch e-mails validated many people's suspicions that research reports churned out by Wall Street's brokerage houses are biased by conflicts of interest. It's easy to forget that these events occurred before the largest accounting fraud in corporate history was uncovered at WorldCom, which was perhaps the most jolting to investors because the sheer simplicity of the scheme should have made it easy to catch and almost impossible to execute. Add to this mix a dizzying stock-market decline that has erased more than $1 trillion in market value, and financial communications veterans are left scratching their heads when asked to put the current environment in context. "It's the highest level of skepticism on the part of investors and the media I have seen in over 30 years in this business," says Larry Rand, senior partner of financial communications firm Kekst & Company. "There is now a tremendous burden on corporations to support and verify everything they say. Even if you say to investors, 'One plus one equals two,' they will turn around and say, 'Show me how.'" Looking beyond the numbers According to corporate investor relations officers (IROs), the new climate of skepticism has led to a significant change in how investors are evaluating companies. After the cascade of scandals, investors ask as many serious questions about the people and procedures behind a company's financials as they do about the financials themselves. "Beginning with Enron, we have experienced a monumental interruption in how we conducted the usual IR practices," says Donald Eagon, VP of global communication and IR at Diebold, a manufacturer of ATMs and other electronic financial-services products. "In a given hour-long meeting with an [institutional] investor, 85% to 90% of the discussion now deals with the non-financial aspects of our company. We talk about things like the strength of management and corporate governance. It's about things that do not directly impact the income statement or the balance sheet - they want to know about the intangibles." Despite the headlines, many, if not most companies feel they have a good story to tell investors. Therefore, this new environment has compelled some to ratchet up their disclosure and, in the process, hopefully demonstrate that they have nothing to hide. That often means spending more time explaining accounting treatments and using regular points of investor interaction to provide more information than usual. "Our disclosure in our SEC filings is more robust than it was, and we continue to try to be more and more transparent," says Dianne Douglas, VP of IR at toy maker Mattel. "I think we were already headed in that direction, but given the environment, it's happening a little faster than it would have otherwise." Most other IROs agree, saying that these days there is no such thing as too much transparency. Investors always want more instead of less, and the financial communicators are happy to oblige to protect their companies' relationships with their shareholders. "Two quarters ago, our analysts conference ran about 35 minutes over schedule, but our CEO kept going because he wanted to answer each question," says Jeffrey Pina, VP of public affairs at Nova Chemicals. "He told the operator, 'If they have the courage to ask the question, we have the courage to answer it.' I think it says a lot to our investors that we'll sit there and answer every question they have." Other IROs say they have used ordinary investor events to discuss the various intangibles that have suddenly jumped onto Wall Street's radar screen. "We devoted part of an earnings call this year to talking about our corporate governance," says John Cygul, VP of investor and corporate communications at managed-care company WellPoint Health Networks. "We reviewed the fact that eight of our nine directors are independent, and we talked about the composition of our various key committees, such as the audit committee." It's the kind of effort that IR veterans say is suddenly an imperative in the current environment of skepticism and uncertainty. "At this point, it's about going out and telling people what you're doing in these areas," says Lou Thompson, president of the National Investor Relations Institute (NIRI). "You've got to be out there in a very proactive way. You can no longer assume that you can sit back and think you're okay just because you believe your company is squeaky clean on the accounting side, you have an independent board of directors, and an independent audit committee." Accounting for everything Accounting has also suddenly become another serious concern for many investors. Some IROs say they are now answering much more detailed accounting questions than they did in prior years. The investor concern comes after a series of accounting scandals have shaken the long-held belief that US corporate financials were beyond reproach. So far, most of the chicanery has stemmed from the misclassification of costs, as well as an overly generous treatment of assets. Some companies say they have attempted to find ways to simplify the process for their investors. "We focus people on cash - cash is real," says Mattel's Douglas. "People can look at the earnings and the cash flow, and there's an easy connection and it's very straightforward." Yet some experts say that in today's complex economy, it's not always that simple. Investors tend to vary the yardsticks, or "metrics," they use to value companies, depending on the industry. For instance, a sales-oriented business, such as a toy manufacturer like Mattel, may want to gauge its health on the basis of cash intake, while a subscription business, such as a cable-TV company, may prefer growth in number of subscribers. Experts say that accounting troubles may prove the most vexing part of the current scandals. They say that since trusting corporate financials will always entail some leap of faith by investors, it's critical that companies maintain credibility in all aspects of their business practices. "The whole system we operate under is based on trust," says Gary Kraut, president of IR firm GA Kraut & Company. "The problem is if a company shows itself to be untrustworthy in any area, then the numbers are not going to be believed." Yet some consultants are saying the bear market and the overall negative tone of investor confidence may mean that corporate America could be in for yet another type of corporate upheaval. "Proxy fights [over investors' say in the business' operation] are going to continue to pick up steam next year," says Kekst's Rand. "With stock prices down, proxy fights are a fairly inexpensive way for dissident shareholders to try and gain some measure of control on a company. That business has already begun to pick up." The financial scandals and other changes have also put a new spotlight on the question of whether IR and PR should be part of the same function. In short, the concept is that in today's world there are no distinct communications audiences, and therefore when a company talks to one constituency it should assume that other audiences are listening as well. For example, when a company aims a PR effort at regulators, it is safe to assume that shareholders are listening. And when a corporation aims its PR at customers, it's a decent bet that its employees are listening. This notion, however, hasn't always been true. "Just five years ago, if you put something out on Business Wire, as opposed to PR Newswire, it reached a very different audience," says Howard Zar, Porter Novelli's IR director. "BW was basically for your IR releases, while PRN was for all other PR releases. That's changed, and now everything goes to everyone at the same time." Comms convergence Some companies have embraced convergence in a major way by placing all communications functions under one overarching communications umbrella. These true believers say that this model makes more sense than ever given current investor sentiment and concerns. "I've got several years under my belt with the convergence model, and I must say it has far surpassed my expectations," says Diebold's Eagon, who heads both PR and IR at his company and reports jointly to the CEO and CFO. "Today, as you sit down with your shareholders and their questions focus more and more on the non-financials, you must be adept at handling those type of questions. It has been my experience that if you are purely on the financial side, it is difficult for you to go beyond the financials and delve into the non-financial aspects of the story." Other corporations have been hesitant to fully embrace the all-communications-under-one-roof model, yet there is almost universal recognition that there needs to be serious and consistent coordination of the PR and IR functions. "While on paper IR and PR are separate here, we work closely together," says Mark Aaron, VP of IR at Tiffany & Company. "It's because we have always felt that it's important to deliver one voice and one message from the company." Yet despite the obvious benefits of melding IR and PR, several obstacles face the convergence model at the corporate level. First, there are usually different reporting lines for each function. IR generally reports to the CFO, while PR typically reports to the CEO or chief marketing officer. Secondly, IROs usually have to master detailed knowledge of their company's financial statements, which can cause a certain amount of haughtiness on the part of IR folks towards their PR colleagues. "I have a degree in math and an MBA," says one IR consultant. "I'm not saying that what PR people do is easy, but I think it would be tougher for them to learn my job than for me to learn theirs." That sentiment is not uncommon among IROs and IR consultants, who command higher salaries than most other corporate communications professionals. Yet others feel that such an attitude is myopic. "There are lot of people that feel since they are smart enough to understand the financial statements and talk to Wall Street, they can also run a strategic communications program," says NIRI's Thompson. "But that includes dealing with a whole set of new issues, like branding, reputation, and everything else that goes with strategic communications. We are not talking about PR taking over IR or vice versa. But in the future, I think you'll see professionals that blend the two disciplines running the show at most companies." Regulators feeling the heat The scandals have also increased pressure on regulators. In August, the SEC continued its push for so-called current disclosure, adopting a rule change to accelerate reporting periods. Over a three-year period, the SEC will shorten the deadline for filing annual reports from 90 to 60 days and quarterly reports from 45 to 35 days after the relevant period ends. It's a move that will inevitably affect many IROs, who in recent years have become an important part of the SEC filing process. While some IROs lament the change as onerous and unnecessary, others support it, contending that it fits nicely into a system of disclosure that will help restore investor confidence. "What we are now seeing is the SEC trying to a develop a disclosure system that informs investors, as opposed to one that provides minimal disclosure to basically avoid legal liability," says Thompson. "It's an effort to get the lawyers to back off and to allow the companies to better communicate with their shareholders." ----------------------------- Throw away the cookie cutters On the agency side, the bear market has not been an easy haul - especially for those firms that haven't changed with the times. IR consultants say that their corporate clients have become more sophisticated in recent years. Much of the tactical functions of corporate IR are now executed by products offered by vendors and designed to handle much of the legwork that used to be the domain of the IR firms. For instance, for years one of the primary reasons small- and mid-cap companies sought out an IR firm was for help in locating and targeting institutional investors. These IR firms had compiled valuable Rolodexes of investors and it cost the client an agency retainer to gain access to those deep pockets. Some vendors now offer, through the internet, extensive and searchable databases of institutional investors. "Now much of the targeting that was exclusively the domain of the investor relations houses is generally available to most companies," says Howard Zar, director of IR for Porter Novelli. "As a result, companies are finding they can form their own direct relationships with investors." In this environment, the role of an IR consultant is more about helping map out strategy. In other words, most consultants acknowledge that the days of servicing each account with the same pre-fabricated IR program - often referred to as "cookie cutter" IR consultancy - are over. "Everyone's looking for a more customized IR program that can produce tangible results and add immediate value," says Hulus Alpay, director of IR at Makovsky & Company. "For a significant amount of time during the internet boom, companies were going to IR firms and asking for the same off-the-shelf package. It was what everyone else was using, and it didn't make sense to ask for something different when it was almost always working." In addition, these financial communications agencies are being battered by the near disappearance of the transaction business (IPOs and M&As) that fed them during the boom times. The IPO market had provided a seemingly endless stream of new clients for these shops. The firms would help walk companies through the IPO process, which was often management's first introduction to Wall Street investors. It also meant showing the corporate IR team how to handle the tactical components of IR, such as quarterly earnings announcements. After a while, however, the corporate IR folks would usually gain their footing. "The average life span of one of our clients was about 18 months," says an IR consultant who worked for a major IR firm during the 1990s. "That's about how long it took after the IPO for the company to realize it had outgrown us." A new crop of IR agencies seems to be de-emphasizing the tactical aspects of their work in favor of strategic counsel. "There are a lot of tactical functions we can do, but companies aren't calling us in to do that stuff," says Chris Hodges, partner at Ashton Partners, a Chicago-based IR firm. "They're not paying our fee so we can do their blast faxing. There are plenty of firms that used to charge for that kind of stuff. That's where an agency's reputation gets hurt." Instead, agencies say that while they are still executing some of the IR legwork for their clients, the clear trend is toward offering old-fashioned advice and strategy. ------------------------------------- Spotlight falls on sell-side research In April, New York attorney general Eliot Spitzer unveiled a series of damning internal Merrill Lynch e-mails - many authored by fallen dot-com wunderkind Henry Blodget - that showed how research by brokerage houses can be compromised by their quest for investment-banking fees. That revelation spotlighted one of the most controversial aspects of IR - brokerage, or "sell-side," research. For years, many investor relations officers (IROs) had accepted that sell-side research was a critical part of their communications with the investment public - both institutional and individual. This was true even as most institutional investors realized the conflicts inherent in the research. For small-cap companies, sell-side research reports, or "coverage," could help put a company on investors' radar screens, while for very liquid large-cap companies the sell side provided a bullhorn to a diffuse and dynamic shareholder base. Yet the conflicts inherent in Wall Street's research and ratings practices were widely known, and many already saw its credibility as a ticking time bomb. For instance, only 1% of the 33,000-plus stock ratings published in 2001 - an incredibly bearish year by almost any measure - were "sell" ratings, according to Thomson Financial. "To me, this was one of the worst sides of all the issues that came up during the last year," says Lou Thompson, president of the National Investor Relations Institute (NIRI). "The notion that you live or die by sell-side research is a notion of the past, but it's hard to convince people of that because we have done it for so long." Yet even skeptics acknowledge that sell-side research continues to have its place in the IR mix. The emerging consensus appears to be that such analysis is a necessary evil that will always play an important - if diminished - role. Despite the damage done to the analysts' collective reputations, for many small companies getting analyst coverage is still a crucial part of gaining credibility. For instance, analysts provide the widely watched "First Call" quarterly earnings estimates that many investors use to benchmark a company's financial performance. Without these estimates, it can arguably become difficult for investors to monitor the performance of a company. "If you're a small company and you don't have any analysts from a respectable firm covering you, it basically means you don't exist," says Howard Zar, director of IR for Porter Novelli. "You need some certain level of a benchmark - it's sort of like a Good Housekeeping seal of approval." Some IROs at larger companies feel the sell side should not be used as a crutch or a shortcut to talking directly to investors. "The sell side can still play a role," says Donald Eagon, VP of global communication and IR at Diebold. "Yet I think it is more important for IROs to hone in on how they can target the street, rather than how they can target the sell side."