Fund's Brass Failed to Inform
Key Panel About Improper Deal
With Ernst, Its Outside Auditor
By JONATHAN WEIL and
JOANN S. LUBLIN
TIAA-CREF, a longtime standard bearer for the corporate-governance movement, now has a governance mess of its own, sparked by two trustees' improper business deal with outside auditor Ernst & Young LLP and a decision by the investing titan's top brass not to promptly inform the fund's powerful board of overseers about the problem.
The conflict centers on a contract that the two TIAA-CREF trustees entered into with Ernst in August 2003 to jointly sell valuation services for corporate stock options, in violation of federal auditor-independence rules. Last week, the two trustees resigned, amid pressure from the Securities and Exchange Commission's office of chief accountant. Separately, the SEC's enforcement division has opened an inquiry into the events surrounding the violation, people familiar with it say.
TIAA-CREF Chairman and Chief Executive Officer Herbert M. Allison Jr. knew about the independence violation as of Aug. 9, when Ernst first notified the company and the SEC. However, before late last week, he had informed only one of his six fellow members on TIAA-CREF's star-studded board of overseers about the matter. The panel is one of three boards at TIAA-CREF that share control of the nation's largest pension system, which manages $326 billion of assets for 3.2 million people.
TIAA-CREF's general counsel, George Madison, on Friday said the other two boards' trustees were told in August and that, under TIAA-CREF's unique corporate structure, Mr. Allison wasn't obligated until last week to notify the full board of overseers. Messrs. Allison and Madison did tell Stanley O. Ikenberry, the president of the board of overseers, in September. But Mr. Ikenberry didn't tell the other overseers either, among them, former SEC Chairman Arthur Levitt.
Instead, Mr. Ikenberry's colleagues were left in the dark until Thursday, one day before TIAA-CREF disclosed the violation in SEC filings. Corporate-governance activists long have pushed for companies to disclose any significant bad news as early and widely as possible.
Through a TIAA-CREF spokesman, Mr. Allison said: "I, along with my management team, continue to work for the best interests of the participants and our institutions to strengthen TIAA-CREF for the competitive challenges we are facing." He declined to comment further.
The saga marks yet another embarrassment for Ernst and its chairman and CEO, James Turley. In April, the SEC suspended the Big Four accounting firm from accepting new audit clients for six months because of a 1990s business venture with audit client PeopleSoft Inc. Under the SEC's auditor-independence rules, accounting firms aren't permitted to form business ventures with audit clients, including their officers, directors or trustees.
The SEC's chief accountant, Donald Nicolaisen, last week told TIAA-CREF that Ernst could complete its 2004 audit, but that he would be very upset if it rehires Ernst for its 2005 audit, people close to TIAA-CREF said.
"As soon as it was clear it was a serious matter with potential to rise to the attention of the SEC, we should have been told," William G. Bowen, an overseer who is president of the Andrew W. Mellon Foundation in New York and a former president of Princeton University, said Saturday. Mr. Levitt, who crusaded as SEC chairman to strengthen the nation's auditor-independence rules, on Friday said he is "deeply disturbed about the failure of management and our chairman to inform all members of our board of overseers promptly."
Mr. Ikenberry, a former University of Illinois president, said he believed the "matter was being appropriately managed by the responsible bodies" at TIAA-CREF. However, he said of the other overseers, "I think in retrospect, because it's taken longer than we expected, it very likely would have been useful for them to know, to be advised of this earlier." Mr. Ikenberry said the board of overseers yesterday hired former U.S. Attorney General Nicholas Katzenbach to conduct an independent review of the matter.
Other overseers declined to comment, including Franklin D. Raines, chairman and CEO of Fannie Mae, whose accounting practices are under SEC investigation.
Mr. Turley, through Ernst spokesman Charles Perkins, confirmed statements by TIAA-CREF officials that he met with the two departed trustees, Stephen Ross and William Waltrip, on Jan. 21, 2003, for a pitch of their business proposal. Mr. Turley said he told the pair he had no interest in pursuing a business relationship.
Mr. Turley said he first learned four months ago that the two trustees' company, Compensation Valuation Inc., had signed a contract with Ernst's valuation-services unit. He said he didn't recall whether he was aware at the time of the January 2003 meeting that the two men were TIAA-CREF trustees.
Mr. Turley recalled that one of two other Ernst partners at the January 2003 meeting had suggested that Messrs. Ross and Waltrip contact another Ernst partner who wasn't there. Eventually, Mr. Perkins said, the two trustees came in contact with yet another Ernst partner, and the deal was struck. Ernst provided $1.33 million in financing to CVI, according to TIAA-CREF's SEC filings Friday. CVI, whose majority shareholder was Mr. Ross, ceased operations on Aug. 20 and was dissolved on Nov. 17.
In a statement, Ernst said that, at the time the contract was signed, the firm's "independence procedures were not comprehensive enough to catch the fact" that Messrs. Ross and Waltrip were TIAA-CREF trustees. The firm said it has "aggressively re-examined" its policies and procedures, made improvements and is "confident that such a mistake would not occur today."
TIAA-CREF said neither Mr. Ross nor Mr. Waltrip disclosed their Ernst relationship on their officer-and-trustee questionnaires for 2003 or 2004, which contained questions about whether either had an affiliation with Ernst. Mr. Ross, a finance professor at Massachusetts Institute of Technology and a director at Freddie Mac, and Mr. Waltrip, a former chairman and CEO of Bausch & Lomb Inc., didn't return phone calls.
The unique complexities of TIAA-CREF's corporate structure are at the heart of the controversy over whether Mr. Levitt and other overseers should have been notified sooner.
TIAA-CREF does business as a collective unit under an annually renewed contract between two legally separate companies -- the Teachers Insurance & Annuity Association, a New York-chartered life insurer, and the College Retirement Equities Fund, an SEC-registered investment company whose owners are the fund's participants.
TIAA and CREF each has its own separate board of trustees and audit committee, to which Ernst reports. Mr. Allison has been CEO and president of both TIAA and CREF since November 2002, hired by their respective trustees. The nonprofit CREF, with eight trustees, has its own chairman but no separate board of overseers.
Mr. Allison also is a TIAA trustee and chairman of TIAA, as well as a member of the TIAA board of overseers. TIAA's seven-member board of overseers is a nonprofit corporation that owns all of TIAA's stock and annually elects TIAA's 14 trustees. Historically, the TIAA board of overseers has been kept abreast of all major developments at TIAA-CREF.
TIAA-CREF said Ernst became aware of the two trustees' business relationship with the accounting firm in June, when Mr. Ross made a passing remark about it to the Ernst audit partner for TIAA-CREF, while standing on a buffet line at CREF's annual meeting. TIAA-CREF said its chief financial officer, Betsy Monrad, also heard Mr. Ross's remark. The audit partner notified Messrs. Allison and Madison about the violation on Aug. 9.
The full boards of trustees for both TIAA and CREF, and Mr. Ikenberry, were notified soon afterward. Mr. Madison said the other overseers didn't need to be told sooner, because "there wasn't yet a resolution or a direction from the SEC." The TIAA and CREF boards of trustees "were the ones that had to address this issue," he said, explaining that the TIAA board of overseers is "basically a holding company."
The other TIAA overseers are Alair A. Townsend, publisher of Crain's New York Business, and Harvard Medical School professor Samuel O. Thier. Ms. Townsend declined to comment. Dr. Thier didn't return phone calls.
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