Oaths won't cure reporting problems
Forcing CEOs and CFOs to personally sign companies' financial reports will help, but it's not a panacea for Wall Street.
By Larry Dignan
July 30, 2002
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Aug. 14 is supposed to be a time of reckoning for wayward corporate chieftains as they certify their companies' books, but don't expect their signatures to produce a quick miracle cure for Wall Street.
The Securities and Exchange Commission set Aug. 14 as the deadline for CEOs and chief financial officers to file a written statement under oath that a company's financial statements are correct. The order applies to a company's most recent proxies, annual and quarterly reports, as well as documents filed later, and makes top executives personally liable for the accuracy of those statements.
Specifically, CEOs and CFOs from companies with a market capitalization of at least $1.2 billion must swear that there are no lies or convenient omissions to pump up results, the SEC said in an order handed down June 27. Almost 950 companies are subject to the SEC order.
The SEC's decision has been cheered in many corners, including that of Federal Reserve Chairman Alan Greenspan, who told Congress that reforms "may not be able to change the character of corporate officers" but "can change behavior through incentives and penalties." Ideally, the SEC order would work like this: Companies would come clean in a relatively short "restatement season" and then move on under more conservative accounting. Corporate confidence would return and Wall
Street would regain its footing.
But what will actually happen is likely to be more drawn out.
Analysts don't agree on much about the Aug. 14 deadline, but there is a consensus that the SEC's order won't be a quick fix. Some investment strategists note the market's recent sell-off is related to the downpour of restated earnings about to
come.
"We believe the market's recent plunge is likely in anticipation of a rash of earnings restatements in advance of the Aug. 14 deadline for CEOs sign-offs," said CS First Boston strategist Thomas Galvin said in a recent research note. "It may be mid-August before the level of uncertainty regarding restatement activity becomes clearer."
Here's a crib sheet of some developments to watch for:
Restatement rush: Many market watchers anticipate a bevy of restatements as corporate executives get as conservative as possible before they take an accounting oath.
Since most annual reports, or 10-K reports in SEC parlance, were filed in March for companies with fiscal years ending Dec. 31 companies are likely to restate the first half of 2002. In his testimony, Greenspan said he expects the number of restatements to be "significant," but noted the barrage could cleanse Wall Street.
Paul Brazina, an accounting professor at La Salle University in Philadelphia, said it is in companies' best interest to take care of questionable accounting just before the SEC deadline.
"I anticipate a lot of restatements," he said. "It's an opportunity to clean up some things that could haunt them."
Slow crawl: Even if there is a barrage of restatements, analysts said the accounting landscape will change stocks--not to mention valuations--for awhile.
If CEOs and CFOs have to sign off on their results they are likely to be more conservative. That in turn will affect earnings estimates for future quarters and make stocks look pricier than they currently are.
"I believe this will play out for a couple years," said Raymond James investment strategist Jeffrey Saut. "I'm very skeptical that current estimates are correct."
Companies already are planning to voluntarily expense stock options, frowning on aggressive reserves and prepping to take a hit on their pension funds. Put it all together and Saut says "the whole thing smacks of price-to-earnings compression."
If you believe the current financials and estimates for the future, stocks are currently trading on par with historical P/E ratios, Saut said. But with a lot of restatements on deck, stocks are bound to look more expensive.
Spin cycle:: Although only the largest companies have to take an accounting purity oath, don't be surprised if companies excluded from the SEC's hit list take the plunge too.
For recent evidence look no further than Tyco. On its recent earnings conference call, executives said they would certify Tyco's financial results voluntarily. Tyco is excluded from the SEC order since it is based offshore in Bermuda, so why would it volunteer? Because it needs a shot of credibility, analysts said.
Nevertheless, there are a few caveats from Tyco. Notably, Tyco may miss the Aug. 14 deadline because it's conducting its own internal investigation into its accounting.
"Until we have the final results of the internal investigation, and know if there any restatements to proxies or any other materials, I think we're probably not going to be able to sign off," John Fort, Tyco's interim chief executive, told analysts and investors on a conference call.
"We want to be sure we have everything out of there before we attest to it," Fort said.
The payoff: It may take a while, but there will be a payoff. Analysts said more conservative accounting will become valued once again--a fact that's a bit of a shocker for investors who watched companies gain in the bull market from excluding everything but the kitchen sink in earnings reports.
"There will be an attempt to be more conservative and to be honest," said Saut.
Indeed, technology companies are beginning to follow the likes of Coca-Cola and Winn Dixie when it comes to expensing stock options. Amazon.com and Iomega announced that they plan on expensing stock options.
It's likely other companies will do the same to look credible.
There's a good reason conservative accounting will be popular again--Galvin said the clean companies will be rewarded with a premium. And in some cases, they are already being rewarded.
In a report, Galvin flagged companies with an abundance of one-time charges and gains, but did find a few that have consistently conservative accounting. Among the companies without special accounting items in the last decade: Bed Bath & Beyond, Charter One Financial, Family Dollar Stores, Paychex and Robert Half International.
"The market has rewarded these companies for their conservatism in a time of uncertainty," said Galvin.
Other companies may also gain amid the move to more conservative accounting. Among others, Pfizer, Pepsi and Clorox have announced share buyback programs ahead of the Aug. 14. Within the past month, at least 70 companies have approved buyback plans.
By Galvin's reasoning, companies that buy back stock ahead of Aug. 14 may be less likely to have accounting issues. "It seems unlikely that a company would announce a share repurchase only to restate earnings before the Aug. 14 deadline," said Galvin, noting companies buying back shares are "putting their money where their oath is."
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