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SEC wants earnings to comply with its rules and it won’t take no for an answer

http://www.marketwatch.com/story/sec-wants-earnings-to-comply-with-its-rules-and-it-wont-take-no-for-an-answer-2016-11-29?siteid=bigcharts&dist=bigcharts


Published: Nov 29, 2016 7:03 p.m. ET

Regulator has started to send letters to companies that do not comply with its new guidelines on earnings
Everett Collection
Ben Affleck in 2015’s “The Accountant.”

By
CIARA
LINNANE
CORPORATE NEWS EDITOR


TOMI
KILGORE
REPORTER AND EDITOR


FRANCINE
MCKENNA
REPORTER

Earlier this month, MarketWatch sent this PSA to investors: If you see something fishy in a company’s earnings release, say something, because the Securities and Exchange Commission is listening.

Our call to action was part of our reporting on how the regulator is ramping up scrutiny of companies that report quarterly earnings in a way that is not just confusing but could also be misleading for investors, often highlighting results that do not comply with Generally Accepted Accounting Principles, or GAAP.

In May, the SEC mandated new reporting guidelines in an attempt to slow the proliferation of non-GAAP numbers and rein in the worst offenders. A full 90% of S&P 500 companies reported non-GAAP numbers in 2015, up from about 70% in 2009, and the spread between the two has widened significantly in the past few years. Non-GAAP earnings per share were higher than GAAP EPS by an average of 25% in 2015, compared with a variance of just 6% in 2013, according to William Blair.

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In other words, companies are going to great lengths to make their earnings look better than they are.


Read: Here’s how investors are duped each earnings season

0:00 / 0:00
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Apple CEO Tim Cook reaped a $36 million windfall from selling a block of compensation stock that had previously been restricted, according a new SEC filing. WSJ's Lee Hawkins explains. Photo: Bloomberg

The SEC allows companies to use non-GAAP numbers to supplement their reporting, but they must give equal or greater prominence to GAAP numbers and explain how the two are reconciled.

See also: How the biggest companies in the S&P 500 use made-up earnings numbers

The issue was the focus of a panel discussion on recent trends in non-GAAP reporting in early November that was hosted by New York University’s Stern School of Business and included MarketWatch’s transparency reporter, Francine McKenna, and SEC Associate Director Kyle Moffatt. Moffatt confirmed that regulators are starting to turn the screws and said companies that are not complying with the new guidelines could expect comment letters in the coming weeks.

Read about: MarketWatch judges these earnings releases to be a cut above the rest

One investor group responded to MarketWatch’s reporting last week, when it sent a formal letter of complaint to the SEC, asking the regulator to conduct a probe of T-Mobile US Inc.’s TMUS, +0.75% accounting practices. CtW Investment Group works with pension funds that are sponsored by unions affiliated with a federation known as Change to Win, and focuses on shareholder activism around corporate governance.

The investor highlighted how T-Mobile’s aggressive revenue recognition from sales of its equipment installment plans may have inflated GAAP earnings by about $122 million in the period stretching from the fourth quarter of 2014 through the first three quarters of 2015. It also criticized the company for giving greater prominence to non-GAAP numbers than GAAP numbers in its earnings releases, as MarketWatch had written after the company reported third-quarter earnings in October.

See: T-Mobile’s accounting slammed by investor group in letter to SEC

Other companies criticized by MarketWatch over accounting methods have also by now received letters. General Electric Co. GE, -0.64% for example, posted a first-quarter earnings release in April that included four separate numbers for earnings per share, and it led with non-GAAP disclosures.

Dont miss: From a wrist slap to jail time: how the SEC deals with dodgy accounting

By July, when it was reporting on the second quarter, GE had cleaned up its act a bit, but still included a GAAP EPS measure that was adjusted to exclude discontinued operations. The company received a comment letter from the SEC, cautioning that earnings per share from continuing operations “[did] not appear appropriate.” Through the third quarter, it had continued to include that metric as a GAAP number.

See: GE’s earnings report may not be wrong, but it may still mislead investors

Also: GE’s earnings report can still frustrate investors, reporters

When MarketWatch pointed this out, in July (and again in October), GE responded: “GE reports EPS for its earnings from continuing operations, earnings from discontinued operations and net income. These measures are calculated in accordance with U.S. GAAP and reported in accordance with SEC regulations.”

The very first company to receive a letter from the SEC task force was a joint venture between two of the biggest U.S. solar manufacturers, First Solar Inc. FSLR, -3.73% and SunPower Corp. SPWR, -3.65% . That letter addressed nonstandard metrics in a filing relating to a secondary stock offering.

Read our story here: SunPower joint venture gets the first letter from SEC’s new task force

Then there’s FedEx Corp. FDX, +0.15% which attempted to get ahead of the regulator in reporting its fiscal fourth-quarter earnings in late June, as MarketWatch reported in July.

The SEC sent a letter in September, sending the company back to the drawing board in terms of its presentation of GAAP and adjusted numbers.

See: FedEx takes a second look at accounting after SEC letter

Other developments include:

• Brown-Forman BF.B, +0.51% flipped the earnings table in its first-quarter release and emphasized “underlying” metrics that did not comply with GAAP.

• Tesla Motors Inc. TSLA, -3.34% was firmly taken to task by the SEC over what it called “individually tailored” numbers, which are strictly forbidden. In fact, it took four letters from the SEC, three from Tesla’s lawyers, five amendments to a filing and at least one conference call before the regulator was satisfied.

• The SEC fined Credit Suisse AG CSGN, +0.15% $90 million for misleading investors through the use of its net-new-assets metric for assets belonging to high-net-worth and ultrahigh-net-worth individuals, contradicting its own publicly disclosed methodology.

• ConocoPhillips COP, -2.79% failed to disclose revenue numbers in its second-quarter earnings season, which will be required under new SEC guidelines.

• Microsoft Corp. MSFT, +0.79% added more details to its second-quarter earnings after the SEC criticized it for lacking detail on some customized numbers that adjusted revenue from previous quarters.

• Square Inc. SQ, -0.56% announced its earnings in a glossy shareholder letter that contained more prose than numbers, making it tougher for investors, and journalists, to make sense of it all.

• Valeant Pharmaceuticals International Inc. VRX, -1.61% has come under fire for an array of issues. Among them, the company used a rare accounting maneuver to obscure the true details of its many complex deals. In particular, it showed how much it pays for companies over fair market value and how it adjusts that amount over time without hitting prior income statements.

* Finally, some media companies use the very made-up financial metrics that their own reporters criticize. The New York Times NYT, -0.39% , for example, has highlighted the use of made-up financial metrics that have resulted in “phony-baloney financial reports,” but itself is partial to non-GAAP numbers. In its press release accompanying first-quarter earnings The New York Times Company says that the measures “provide useful information to investors.”

The S&P 500 SPX, +0.13% has gained about 8% on the year so far, while the Dow Jones Industrial Average DJIA, +0.12% is up about 10%.

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