June 18, 2015

Analyst Research: Earnings-Predicting Quality Going Down?

Here’s an excerpt from this blog by Cooley’s Cydney Posner:

Here’s an interesting report from Bloomberg on a soon-to-be-published study that concludes that stock analysts are actually worse at predicting corporate earnings now, after a number of regulatory actions to increase transparency and prevent research analyst conflicts of interest, than they were prior to these actions. In the wake of the dot-com crash and the Enron scandal, Congress, regulators and SROs enacted laws and adopted rules designed to increase transparency, improve corporate disclosure and prevent analyst conflicts, e.g., SOX (2002) and various conflict-of-interest rules adopted by the exchanges. While the study found an improvement in forecasting in the early 2000s right after adoption of these rules, the improvement was short-lived. The study showed that forecast accuracy significantly declined over the longer term despite the reduction in analyst conflicts of interest.

Also see this article entitled “9 ways companies fool you with earnings.” And don’t forget that Regulation A+ takes effect tomorrow, June 19th. As noted in this blog, the SEC has denied Montana’s request to stay it’s implementation…

Are Non-GAAP Disclosures Coming Under Renewed Scrutiny?

Here’s an excerpt from this blog by Cooley’s Cydney Posner:

A new study from the Associated Press, discussed in this AP article, shows a strong resurgence in the use of non-GAAP financial measures, most often reflecting numbers that are more favorable than GAAP numbers. The AP analyzed results from 500 major companies, based on data provided by S&P Capital IQ, a research firm, showed that the spread between GAAP and non-GAAP earnings has grown substantially over the past five years. For 21% of companies, non-GAAP profits reported in the first quarter were higher than net income by 50% or more, compared with 13% five years before. Although 72% of the companies had non-GAAP profits that were higher than net income in both the first quarter of this year and five years earlier, adjusted earnings were 16% higher this year compared with 9% five years ago. In the study, 15 companies “with adjusted profits actually had bottom-line losses over the five years.“ Moreover, the article contends, “the financial analysts who are supposed to fight corporate spin are often playing along. Instead of challenging the companies, they’re largely passing along the rosy numbers in reports recommending stocks to investors.”

Typically, the non-GAAP adjustments eliminated charges for layoffs, failed business operations or other restructuring charges, declines in the value of patents or other intangible assets, or charges related to employee equity comp. Whether or not these exclusions are fair, properly presented or even help investors see the financial results “through the eyes of management,” they are once again drawing the attention of critics. Indeed, former SEC chief accountant Lynn Turner is quoted in the article as contending that “companies are still touting ‘made-up, phony numbers’ as much as they did 15 years ago, perhaps more….” And one investor was quoted as finding the data “more confusing than it’s been in a long time, and the reason is all the junk they put in the numbers” and complaining of the time wasted “sifting through the same ‘nonsense’ figures…. confronted back in the dot-com days.”

In 2013, the head of the SEC’s Financial Reporting and Audit Task Force indicated at an AICPA conference, as reported by the WSJ, that the SEC was looking at the use of these non-GAAP measures “with an eye toward possible enforcement cases.” In particular, they were reportedly concerned about “mislabeling,…when companies use common, well-defined terms to refer to their own performance measures” and “trends and patterns that could indicate a risk of fraud, such as cases in which a company shows high reported earnings but has lower earnings for tax purposes, or when a company has a high proportion of transactions that are kept off its balance sheet.” While no big splashy cases have yet materialized as a result, frothy markets tend to invite the attention of concerned regulators, especially regarding issues that have attracted press scrutiny.

Political Spending Disclosure: House Bill Would Bar SEC From Adopting Rules

Yesterday, the House Appropriations Committee approved the “2016 Financial Services and General Government Appropriations” bill, which includes some items that don’t pertain to funding the SEC. [It’s a shocker that Congress would do that!] In addition to not giving the SEC an increase in funding (as I’ve blogged before), Section 625 of the bill prohibits the SEC from adopting a rule that would require public companies to disclose their political spending. We’ll see if that provision survives as this bill winds its way through the sausage machine..

Meanwhile, as noted in this article, over 20 advocates sent a letter to President Obama requesting that the upcoming SEC Commissioner be filled by folks who support corporate political spending disclosure rulemaking. And this article cites a new report – and petition – that supports the view that the next new Commissioner shouldn’t have ties to entities that the SEC regulates…

– Broc Romanek