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The Day The SEC Became A Wall Street Analyst
By Brady Willett
IBM does not 'comment on rumors' – the SEC never confirms of
denies an investigation unless a blue chip stock is getting hammered
On April 11 IBM was down almost 10% at its worse level but
rebounded to close down only by 5.42%. The healthy dose of pessimism that hit IBM's stock price was that SEC Insight (the newsletter) reported that the SEC might still be investigating IBM.
Up until the close of the session everything was ordinary: IBM's share price was fluctuating, and an IBM spokeswoman said, "We don't comment on rumors". However, after the closing bell rang something
miraculous took place -- the SEC said that, "Regarding the reports of a preliminary inquiry by the SEC into IBM, the SEC staff opened an inquiry and closed it without action shortly thereafter."
There are two related problems with the SEC making this statement:
1) The SEC has rarely, if ever, done this before (or commented on rumors in an attempt to calm the markets - stock(s)).
2) The announcement sets a precedent which will not be followed – a precedent which will most certainly confuse many investors in the future.
In sum, if the SEC does not wish to accused as being an arm of the PPT maybe they should stop accepting after hours phone calls from Rubin and Greenspan? Think about it: what the heck is the SEC
doing looking at and commenting on daily stock quotes? These men and women (the SEC) are supposed to exposing fraud, coming up with new accounting policies, and in the case of Harvey Pitt making
pointless speeches at luncheons. The SEC should not be pumping up stocks like Wall Street analysts.
So what happens if the SEC launches a new investigation into IBM a
year from now? Well, the SEC will be sure to keep this information private even if IBM rallies by 5% three hundred sessions in a row.
Side Note: If I ran IBM I would be buying all my accountants Lexus's and telling them to juice up earnings this quarter (April 17 release). After all, there is no way that the SEC will investigate IBM in the
foreseeable future for fear of being disgraced by their policy contradictions.
April 11, 02
GE CRASHES... Almost |
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In the last 40 years GE's share price has crashed by 10% or more in a single session only twice. Today was nearly the third time:
GE Drops of 10+%
19-Oct-87 |
-17.48% |
17-Sep-01 |
-10.69% |
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Almost... |
11-Apr-02 |
-9.27% |
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Suffice it to say, GE share price drops of 10% or more are extremely rare. Moreover, share spikes of 10+% are equally as rare: this feat
has only been attained twice -- both times shortly after drops of 10%.
GE Gains of 10+%
24-Sep-01 |
+12.4% |
21-Oct-87 |
+11.4% |
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Historical GE price fluctuations would suggest that GE will bounce
higher sometime in the near future. However, given that GE was rebounding from The Crash in October 1987 and from 911 in late 2001, today's drop is somewhat fascinating. To be sure, GE didn't
drop by 10% today because of unexpected market events (portfolio insurance going bust in 1987 and 911 terrorism). Rather, GE dropped because it missed a revenue target ($30.52 billion versus
expectations of $31.67 billion), and when including all charges earnings dropped year-over-year for the first time in 7 years.
With this in mind, it is safe to say that GE's revenue miss is what took
its perfectly priced stock down a notch and helped cast doubt as to how strong the economic really is. Declining revenues during an economic rebound? This shock to GE's stock price is unlikely to
dissappear until at least June (or 2Q02).
Accounting For FASB 142
Rule 142, which was past last June, states that goodwill will no longer be amortized. Rather, goodwill (officially beginning Jan 1, 02) will be written down when it exceeds fair value and expensed against
earnings. This new rule has already caused a landslide of quarterly write-downs and two of the weakest stocks today (GE, YHOO) were both hit in 1Q02, writing off $1.05 billion and $10.5 million respectively.
The story behind the massive goodwill write-downs arriving this quarter is in interesting one. Moreover, judging by the impeccably bad timing of rule 146, arriving just when investors are expecting earnings
to improve, it is a rule that may create a scapegoat for many investor to vent their frustrations at.
Here is what the FASB has to say about on the topic of goodwill:
"From 1996 through June 2001, the Board issued four separate documents for public comment, held over 60 public meetings, and conducted public hearings, field tests, and visits. The Board also
analyzed and discussed more than 500 comment letters received from a broad constituency." FASB.
In fact, the FASB was under pressure well before 1996 to look into
pooling of interests (an earnings inflating goodwill game). Nevertheless, that the FASB took more than 5 years to actually conjure up rule 142 is somewhat appalling.
This just in: if the FASB had bothered to stop pooling of
interests many years ago the estimated 'trillion' dollars that is about to be erased from corporate Americas balance sheets would not have been there to be erased!
Question is, who honestly thought the Cisco's of this world were buying out hundreds of companies at ridiculous prices because they were a good 'value'? (not to just pump up earnings). Apparently, the FASB did...
Wall Street Wisdom
When a company announces a massive goodwill writedown this
quarter Wall Street will be sure to play down the phenomenon and refer to the loss to earnings as a non-cash charge. However, remember that Wall Street did not mention the 'non-cash' pooling
gains when they were pumping up earnings during 1999-2000. As such, when you see analysts on television screaming 'non-cash - no problem!' -- remember that he or she probably didn't even mention
the 'non-cash' gains taking place a few years ago.
Do Accounting Regulations Determine 'Value'?
It would appear that accounting rules depict what the 'value' of corporate America is. For instance, when it comes to the Nortel's
and JDS Unphase's of this world their 'value' (at least so far as investor perceptions go) ebbs and flows by accounting standards. In other words, pooling giveth these companies value while rule 146
taketh the value away.
I don't necessarily agree with this type of analysis. After all, many companies are solid whether or not they report $1 in manufactured
earnings or 50 cents in honest earnings (free cash-flow being the most reputable number). However, when investors bid stocks up on manufactured earnings this causes potentially severe problems if the
accounting standards allowing earnings manipulation to take place are ever changed. Goodwill is an example of such a problem.
With this in mind, do accounting standards control the value of
corporate America? Consider the quote below:
"…when implemented in 1994 FASB Interpretation No. 39 on netting of assets and liabilities -- called "FIN 39" -- increased the
total assets of some of the largest banks by billions of dollars each and by around $100 billion for the banking industry as a whole. Later in 1994, another FASB interpretation on netting of repurchase
transactions -- FIN 41 -- caused billion dollar decreases in assets at some of the money center banks. Thus, sometimes even obscure accounting standards can have a significant effect on the "bottom
line" of financial institutions."
Governor Susan M. Phillips - Accounting and auditing standards and bank supervision October 24, 1996
Indeed, obscure accounting regulations can swing balance sheet totals higher or lower, goodwill can wipe out billions in 'assets' in the blink of an eye, and expensing stock options (being discussed right
now) can crush corporate earnings. In sum, while accounting standards may not control the strict 'value' of corporate America they do control the book value and market price of stocks. Furthermore,
when considering that most investors today equate market price with 'value' - then yes, accounting regulations determine value.
New Accounting Rules Dangerous To Stocks
Pooling of interests and unexpensed stock options helped the bull
market run because they inflated earnings. As such, logic tells us that investors are not so sanguine to ignore these things as (if) their impact on earnings is reversed. Logic hit Yahoo and GE today -- and
so long as stock options may soon be expensed and goodwill is no longer being pumped up or amortized almost no company is safe tomorrow.
Brady Willett
BWillett@fallstreet.com
www.wallstreetwishlist.com
April 15, 2002
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