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Panelists Discuss Earnings Guidance, Accounting Issues 

At the Practising Law Institute's recent conference on corporate governance, panelists debated the pros and cons of issuing earnings guidance and current accounting issues. Program moderator James Doty, a partner with Baker Botts LLP, noted that the Chamber of Commerce has suggested that companies cease to give guidance out of concern that it leads to a short-term focus. James Daly, an associate director in the SEC's Division of Corporation Finance, replied that more information is better and he would not advocate a position that less guidance is helpful.

David Becker, a partner with Cleary, Gottlieb, Steen & Hamilton, said that investors want earnings guidance and he believes companies will respond to that demand. He noted reports that Pfizer had reinstated the practice, apparently in response to investor demand. Company managements would probably prefer not to give guidance, he said, due to the risk. Gwenn Carr, senior vice president and secretary of MetLife, Inc., agreed that it is difficult for large companies to avoid giving earnings guidance.

Mr. Doty noted that petroleum producers recently have said that the SEC's rules for reserve accounting are archaic and that they should be allowed to present information on probable reserves. The SEC has advised, however, that the issue is not on the agency's "radar screen." Mr. Doty suggested that the SEC's regulatory framework permits companies to make up their own minds on how to present the information.

Mr. Daly said he did not think the oil companies wanted to report lower numbers. He suggested that one must look with some skepticism at both theory and practice. The panelists agreed that the judgments must be reasonable, and that it is human nature to try and put the numbers in a positive light.

During a panel discussion on accounting and internal control, Teresa Iannaconi of KPMG LLP, said that all firms want to avoid restatements due to the potential for increased liability and reputational damage. She cited reports that restatements may have exceeded 1,000 in 2005, which would reflect an increase of about 50 percent a year since 2003. A thousand frauds or earnings management situations are not the cause, she said. Most restatements are highly technical, but they still expose the parties to all of the negatives.

Leasing is one of the largest problem areas in restatements, according to Ms. Iannaconi. She predicted that about a quarter of the 2005 restatements will be leasing-related. Mr. Becker noted that the rules for lease accounting are clear, but a widespread practice had developed of reporting other than what was required. Ms. Iannaconi observed that there is no exception in the literature. She said the inappropriate accounting was partly an issue of something that was not material which became material and partly a case of "everyone is doing it so it must be OK."

Fannie Mae increased awareness about derivatives hedging, Ms. Iannaconi continued. Some companies were using a shortcut method which was very specialized and inappropriate under the circumstances. Eight companies have reported using the incorrect accounting so far, and Ms. Iannaconi said there will be more. She added that not everybody is a crook, but not everybody reads the literature carefully. Section 404-related work also uncovered many mistakes that had been hidden, she said.

The next major restatement problem will involve stock compensation, in Ms. Iannaconi's view. A significant amount of judgment is involved and there is much of room for error. While the SEC has said it has no vested interest in restatements, it will not ignore bright lines and it will not waive GAAP. Mr. Becker's advice was to document the methodology used to avoid concerns that it was reverse engineered, apply the methodology consistently and disclose the methodology completely.

Revenue recognition is not a new issue, according to Ms. Iannaconi, but it continues to drive many restatements. Most of the enforcement actions in the past year relating to revenue recognition have dealt with fraud. Although revenue recognition frequently is not a critical accounting policy, Ms. Iannaconi said the SEC seems to want disclosure about it. In response to an audience question about whether the SEC is concerned about the timing of revenue recognition in overseas sales, she said the SEC is overwhelmingly concerned. Mr. Becker added that, among the top things not to say to the SEC right after "everybody does it," is "it's only a matter of timing."

Ms. Iannaconi also addressed the guidance issued by the PCAOB last May on Auditing Standard No. 2 in an attempt to bring greater efficiency to the audit process. While she believes the PCAOB is sincere, the accounting firms are not quite ready to step back, she said, because they all have received deficiency letters. None of the letters say the auditors should be doing less rather than more, she noted. The guidance offers some measure of relief, but not to the extent that everyone wants to reduce the scope of the audit and increase efficiency.