Tangled Up at Big Blue: IBM Settles Expensing Suit

Disclosures related to expensing stock options in 2005 was at the crux of the controversy – the same facts and figures that led the SEC to question an IBM investor presentation.

International Business Machines agreed to pay $20 million to settle a securities class action lawsuit claiming that the computer company misrepresented its plans to begin stock option expensing, according to a joint announcement from two law firms and IBM.

The settlement is subject to final court approval, say the law firms of Labaton Sucharow LLP and Klafter & Olsen LLP., as well as Big Blue. “IBM disputes that it made any misrepresentations to investors, and denies all allegations of wrongdoing,” the press release states.

The settlement will resolve claims brought on behalf of shareholders who bought IBM common stock between April 5, 2005 and April 14, 2005. The investors alleged that they were damaged by misrepresentations and omissions made in IBM’s April 5, 2005, announcement that disclosed that the company would begin stock option expensing in the first quarter of 2005. In particular, the plaintiffs claimed that IBM misled them about the company’s expected financial results and the anticipated size of its stock option expense for the quarter.

On April 14, 2005, IBM announced that it had earned 85 cents a share for the first quarter — five cents less than what many analysts were expecting on the basis of the April 5 presentation. IBM also said its equity compensation expense was 10 cents a share for the quarter — four cents lower than what many analysts had understood from the earlier call. IBM’s stock price dropped $6.94 the next day, or more than 8 percent, closing at $76.33.

In June 2007, IBM settled Securities and Exchange Commission charges stemming from what the SEC said was misleading information provided in an April 5, 2005, IBM conference call that discussed IBM’s expensing of employee stock options. IBM neither admitted to nor denied the SEC’s charges, but agreed to be enjoined from committing or causing violations. No executives were named in the complaint, and the company was not fined.

The SEC accused the computer giant of making materially misleading statements in a chart that portrayed the impact on its first quarter 2005, and fiscal 2005 financial results from expensing employee stock options. The information, which was simultaneously webcast and filed as part of a Form 8-K with the SEC, caused analysts to lower their earnings per share estimates for the company, according to the Commission. Based on press reports at the time, IBM finance chief Mark Loughridge made the statements during the conference call.

During the call, IBM announced that, beginning in the first quarter of 2005, it would report stock options as an expense in its financial statements, and advised analysts to adjust their earnings models to account for the change, noted the SEC. The regulator alleged that IBM estimated internally that expensing stock options would negatively affect first quarter earnings by 10 cents a share, and cut full- year 2005 earnings-per-share (EPS) results by 39 cents. However, the SEC claimed that the company did not disclose that information.

Because of the perceived disclosure problem, the SEC accused IBM of including a misleading chart in its presentation, conveying to many analysts that the EPS impact of IBM’s stock options expensing would be 14 cents a share for the quarter, and 55 cents for all of 2005. IBM did not disclose those numbers, the SEC said, because the company was concerned that analysts would add back to their EPS estimates any year-to-year reduction in the expense, instead of using the reduction to offset an unrelated, previously-announced increased pension expense.

According to the SEC order, IBM management purportedly was trying to avoid that reaction by analysts because it would have increased the expected growth rate they had set for IBM — thereby creating a target that would have been difficult for the company to achieve because of an increase in related pension expenses.

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