SEC crackdown is "unfair"
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February 1, 1999
Firms Say SEC Scrutiny
Of Earnings Goes Too Far
By ELIZABETH MACDONALD
Staff Reporter of THE WALL STREET JOURNAL
Has the Securities and Exchange Commission gone too far in cracking down on so-called managed earnings?
Companies for years have used various accounting techniques to prevent sharp swings in their quarterly profits, hoping to keep investors happy and their stock prices rising. But the SEC believes many companies are going too far -- taking excessive reserves or write-offs in order to manipulate their results and hide the real health of their businesses. The agency points to a number of widely publicized accounting fiascos in the past year, including those at Cendant Corp. and Sunbeam Corp., to bolster their claim that abuses are becoming more common.
High-Technology Firms Are Upset Over SEC Crackdown on Write-Offs
As a result, the SEC in recent months has been taking a hard look at corporate earnings and, in some cases, forcing companies such as SunTrust Banks Inc. of Atlanta to restate their results. Late last month, the agency said it may target as many as 150 companies for review to see if there are any accounting violations in their 1998 earnings.
Second-Guessing Accounting
The growing crackdown has sent a chill through corporate America, prompting executives and company treasurers to second-guess their accounting methods and even change the way they manage their money. Perhaps most striking is that many executives, who in the past haven't shied away from criticizing the SEC, are reluctant to air their complaints publicly, fearful that their company will be targeted next. But whether it is privately or publicly, many company executives believe the SEC itself may have gone too far.
"The SEC shouldn't punish the whole financial community for the sins of a few," says Philip B. Livingston, president and chief executive-elect of Financial Executives Institute, a group of top corporate officials.
"They're throwing their weight around," agrees William J. Roberts, senior vice president and controller at Bank One Corp. in Chicago.
Bank One, for example, says it has been scrupulously double-checking its accounting for similar items that the SEC has recently targeted for inquiry, such as write-offs for assets that decline in value, restructuring charges and reserves for bad credit. The bank has been particularly nervous because these items show up in its fourth-quarter 1998 report, Bank One's first filing as a combined company following the $18.6 billion merger of First Chicago NBD Corp. and Banc One Corp.
A finance executive at Merrill Lynch & Co., while generally supportive of the SEC's program, worries that the agency my be second-guessing even legitimate accounting methods. If the SEC does "a lot of scrutiny of the minutiae of individual judgments that go into the financial-reporting process, then that would be a problem," says the executive, who didn't want to be identified.
The SEC contends that it needs to take strong steps to combat the growing abuse in earnings statements. The agency's chief accountant, Lynn Turner, says that it was told by companies, auditors and stock analysts last fall that the situation was getting out of hand.
'Inadequate Disclosure'
"There was a growing trend of unacceptable earnings management that we and others had identified, as well as inadequate disclosure," Mr. Turner says. "So, before it became systemic and widespread, we wanted to nip it in the bud."
For example, the agency says, a growing number of companies are setting aside ever-fattening amounts in so-called reserves, funds that can be used later to goose earnings when business slows. SEC officials also believe that more companies are taking huge, unjustified write-offs for things like equipment that have supposedly declined in value, when these assets haven't dropped in value at all, in order to make earnings glow in subsequent years.
But what especially bothers the SEC is that companies repeatedly and inappropriately stuff expenses for items such as year-2000 computer costs and even audit fees into restructuring charges, when they only are supposed to be taking these one-time restructuring charges for things like closing a factory or laying off workers.
In November, SunTrust Banks reduced its loan-loss provision by $100 million and restated its earnings for the three years ending Dec. 31, 1996, after the SEC questioned the level of the reserves as being much larger than what other banks normally set aside. But the bank said it has never borrowed or has ever been accused of borrowing from its reserves to pad earnings. Indeed, the bank is known for its conservative practices and pristine asset quality. Some corporate executives say the SEC made the unusual, preemptive move to make sure the bank wouldn't be tempted to do such padding later.
Just a month later, in a case that stunned executives across the country, the SEC filed a civil complaint against W.R. Grace & Co. in federal court in Miami. The agency claimed that the Boca Raton, Fla., company, among other things, improperly directed its main health-care subsidiary to release about $1.5 million from its reserves into earnings in order to meet earnings targets. But executives say that $1.5 million amount was immaterial given Grace's $103 million in net income for that quarter, and that accounting rules let them book immaterial items.
Question of Principle
The SEC argues that it was a question of principle. "Does anyone think that it's acceptable for a company to intentionally book an error in its financial statements just for the purposes of making earnings targets?" asks the SEC's Mr. Turner.
Some executives applaud the SEC's efforts to maintain clean bookkeeping. Others remain fearful. "I am concerned that it will damage the credibility of corporate management in the eyes of investors," says Pat McConnell, a senior managing director at Bear, Stearns & Co.
Some acknowledge the SEC has to walk a fine line between questioning financial reporting and maintaining investor confidence. "I don't think the SEC has overreacted so far; it just has to be careful not to," says Greg Jonas, managing director of financial assurance at Arthur Andersen.
In the end, the SEC's Mr. Turner says: "As long as companies report the results of their operations on a basis consistent with the accounting rules, they're going to be fine; we're not going to put additional focus on them."
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