SEC: IBM withheld earnings info, misled investors

By Colleen Taylor, Contributing Editor -- Electronic News, 6/5/2007

IBM is set to pay the consequences for misleading its investors by withholding what the government considers crucial information.

The United States Securities and Exchange Commission (SEC) today announced it has settled enforcement action against IBM for making "materially misleading statements" in a chart concerning the impact that the company's decision to expense employee stock options would have on its Q1 2005 and fiscal year 2005 financial results. The misleading chart caused analysts to lower their earnings per share (EPS) estimates for the company, the SEC said.

The now-settled case, which was launched in June 2005, was far from being small potatoes in the eyes of the SEC. "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," Linda Chatman Thomsen, director of the SEC's division of enforcement, said in a statement.

The SEC found that IBM provided the misleading information during an April 5, 2005, conference call with analysts. The call was simultaneously webcast, and a transcript and the accompanying exhibits were filed with the SEC in a Form 8-K.

During the call, IBM announced that beginning in Q1 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. At the time, IBM expected that its stock options expense for Q1 would have a 10 cent impact on Q1 EPS results and estimated a 39 cent impact on its fiscal 2005 EPS results.

However, the SEC said, IBM did not disclose this information. Instead, IBM included a misleading chart in its presentation, which, to many analysts, conveyed that the EPS impact of IBM's stock options expense would be 14 cents for Q1 and 55 cents for fiscal 2005. After IBM's April 5 announcement, the majority of analysts reduced their EPS estimates by these amounts, the SEC said.

"IBM misled investors by failing to disclose information that would have allowed them to accurately determine the impact that the company's decision to expense stock options would have on its financial results," SEC Associate Director of Enforcement Scott W. Friestad said in the statement. "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."

The SEC's order finds that IBM did not disclose its expected stock options expense because it was concerned that analysts would add back to their EPS estimates any year-to-year reduction in the options expense instead of using the reduction to off-set an unrelated, previously announced increased pension expense. According to the order, management wanted to avoid this outcome because it would have increased the expected growth rate that analysts had set for IBM, which would have been difficult for the company to achieve because of the year-to-year increase in pension expense.

On April 14, 2005, IBM announced its Q1 financial results and disclosed earnings of 85 cents per share, which was 5 cents less than the amount that many analysts were expecting following the April 5 presentation. IBM also disclosed that its equity compensation expense was 10 cents per share for Q1, or 4 cents lower than what many analysts had understood IBM's April 5 misleading chart to have indicated it would be. IBM's stock price dropped $6.94 the next day, or over 8 percent, closing at $76.33, the SEC said.

The SEC found that IBM violated Section 13(a) of the Securities Exchange Act of 1934 and Rules 13a-11 and 12b-20 there under. Without admitting or denying the SEC’s findings, IBM consented to the issuance of the order, the SEC said, which requires the company to cease and desist from committing or causing violations of these provisions.

In a terse statement released today, IBM confirmed that it consented to the SEC's order without admitting or denying any wrongdoing. In addition, IBM noted that the SEC's order "contains no finding of securities fraud or violation of any antifraud provision of the federal securities laws and related SEC rules." Also, IBM said, no monetary penalty or fine was imposed in connection with the settlement.