The Securities and Exchange Commission wants to put the kibosh on creativity--at least when it comes to the way public companies report their earnings.
In an address yesterday, SEC chairman Arthur Levitt said that corporations increasingly are cutting corners when making financial disclosures.
"Too many corporate managers, auditors, and analysts are participants in a game of nods and winks," Levitt said, according to a transcript of the speech posted on the SEC's Web site. "In the zeal to satisfy consensus earnings estimates and project a smooth earnings path, wishful thinking may be winning the day over faithful representation."
Levitt's remarks, made before an audience at New York University, carry special weight for high technology companies, which make up one of the fastest-growing--and most volatile--segments of corporate America. America Online, for example, recently agreed to drastically lower the amount of a write off related to two mergers following two months of negotiation with the SEC officials (See related story).
Bill Lerach, a San Diego attorney who has filed dozens of stock fraud lawsuits against high-tech companies, said Levitt's speech is long overdue.
"I've been criticizing Levitt for sitting there and not doing anything while this has been going on before his eyes," said Lerach, a name partner at Milberg Weiss Bershad Hynes & Lerach who recently penned an article blasting corporate accounting practices. "It's about time he said something about what is a massive upsurge in financial accounting fraud in the last two years."
Levitt took aim at five practices in particular. They include:
"Big bath" charges, in which a company improperly reports a one-time loss to mask low earnings
Using unrealistic assumptions to create "cookie jar reserves" that companies can dip into during slow periods
Intentionally recording "immaterial" errors into corporate financial earnings to gloss over problems
Recognizing revenue before it is actually collected
Creative accounting of acquisitions, in which companies write off all or most of the price as "in-process" research and development, a practice Levitt called "merger magic."
Levitt called for accounting and disclosures rules to be improved, but did not outline any specific measures his agency would introduce in order to curb accounting corner-cutting. "This is a financial community problem," he said. "It can't be solved by a government mandate."
In AOL's case, the company had told analysts that it intended to write off a substantial portion of the $316 million it paid to acquire Mirabilis and NetChannel. But after two months of negotiations with SEC officials, AOL yesterday said it would write off just $70.5 million, or 22 percent, of the cost.
Lerach ranked high-technology companies as the second-worse offenders of accounting fraud, just behind the for-profit health care industry, and said the problem appears to be getting worse.
"There has historically been a very serious problem with [high-tech companies'] financial results, but I think it's intensifying now that the Asian slowdown has gotten traction," Lerach said. "They have so many ways to [manipulate earnings reports], it's not even funny."
Lerach added that the recent merger mania among technology companies has made fraudulent acquisition accounting an even more prevalent problem.
Not everyone, however, believes the high-tech industry is rife with fraud. Dan Bergeson, an Bergeson, Eliopoulos, Grady & Gray attorney who represents Silicon Valley companies, said accounting irregularities are clearly the exception rather than the rule.
"You have, in fact, restatements that occur periodically, but not by any stretch of the imagination [in the numbers] Mr. Lerach describes as a big problem in Silicon Valley," said Bergeson, who often finds himself defending suits filed by Lerach. "Bill Lerach has always been one who has prayed on the Valley precisely because of the fast-moving nature of the business."