It's Pretty Grim (hint) over there

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Interpublic Group of Cos. added the specter of criminal activity to its financial problems last week when it disclosed accounting errors stemming from employee wrongdoing including falsifying records, misappropriating assets and "inappropriate customer charges and dealing with vendors."

The "employee misconduct" was disclosed in Security and Exchange Commission filings in which Interpublic said it would restate its earnings from 2000 to 2004, the second such restatement for the holding company. Despite speculation to the contrary, the company also said it will make its Sept. 30 deadline for updating its financial information, heading off a potential delisting action by the New York Stock Exchange. Interpublic expects to file its delayed financial statements for the first and second quarters of 2005 as well.

But that good news was clouded by the revelation of potential criminal behavior, primarily at overseas operations. The specific nature of the misconduct wasn't immediately clear, but, according to an executive familiar with the situation, it's believed to involve fewer than 100 people primarily at operations in Eastern Europe, including McCann Erickson's offices there.

What is misconduct

The company offered very few details about what the misconduct included. "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," said a company spokesman in a statement. "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."

The company also wrote in its 8-K filing: "As a result of these investigations, financial statements are being made and remediation plans have been or are in the process of being developed to address internal control and policy issues. In all cases, culpable employees have been terminated or are in the process of being terminated or are otherwise no longer with the company."

Analysts who follow Interpublic said that criminal activity could lead to shareholder lawsuits and cause a variety of other problems, including a lack of confidence on the part of clients. "Value can be eroded in a company when your people are at risk and when you have to pay out on lawsuits," one analyst said. "That all absorbs resources."

Earlier this year, Interpublic, as it deals with the SEC investigation, named its fourth CFO since 2002, when it restated five years of earnings.

Those ongoing struggles were already a factor in Bank of America's decision to take its $600 million marketing account to Omnicom Group from Interpublic, where it had been handled by a group of about 15 agencies. BofA is one of a handful of high-profile-client defections in the past six months that also includes Lowe's $315 million advertising and media account and GM's $3.5 billion media-buying business, though neither of those marketers identified bookkeeping issues as a factor in their decisions.

Just last week, Merrill Lynch took the rare step of downgrading Interpublic's stock to a "sell" rating. The firm maintained its negative outlook this week. Wrote analyst Lauren Rich Fine in a research report, "While the bulls may find the news that [Interpublic] is going to file by the Sept. 30 deadline encouraging, we take the view that there is heightened risk concerning IPG's historical profitability and, more importantly, its future earning power in the wake of recent account losses."

The main accounting issues leading to the restatement are accounting for revenue, acquisitions and lease expenses, attributed by and large to weak controls and a decentralized operational structure.

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