Did IBM Show Analysts a Phony Chart?

Big Blue settles an SEC complaint that the company deliberately used an inaccurate chart in a 2005 conference call, misstating the impact of stock-option expensing.

International Business Machines Corp. 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 an 8-K with the SEC, caused analysts to lower their earnings per share estimates for the company, according to the Commission. According to press reports at the time, IBM CFO 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, according to the SEC. The SEC alleges thatIBM estimated internally that expensing stock options would impact first quarter earnings negatively by 10 cents a share, and cut full- year 2005 EPS results by 39 cents. However, the SEC alleges that the company did not disclose that information.

It accused Big Blue 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, management wanted to avoid that reaction by analysts because it would have increased the expected growth rate they had set for IBM, creating a target that would have been difficult for the company to achieve because of the increase in the pension expense.

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.

“The facts here are particularly troubling because the disclosure decision was driven, in part, by management’s perception of how the news would be interpreted by analysts,” said Scott W. Friestad, SEC associate director of enforcement.

“Information regarding a company’s earnings is one of the most important factors that many investors consider in making an investment decision, and it is essential that the information companies provide be clear and accurate,” added Linda Chatman Thomsen, director of the division of enforcement.

In June 2005, CFO.com reported that the SEC had launched an informal investigation into IBM’s first-quarter earnings disclosures. Although the documents did not provide any additional details about the probe, that report had speculated that the investigation may relate to a controversy set off by the company in April.

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