On the heels of two recent SEC enforcement actions, Cleary's "SEC Cracks Down on Earnings Management" advises companies that provide earnings guidance to resist the pressures to bridge gaps between actual and projected numbers by taking actions that effectively obscure (at least temporarily) otherwise legally disclosable trends or uncertainties. Often characterized as earnings management, these actions may include, e.g., "pulling in" sales/revenues, reducing discretionary spending, deferring the start of a new project, or delaying an accounting charge - techniques that may mislead investors unless accompanied by adequate disclosure, which itself likely would deter companies from considering these types of practices.
The firm suggests companies providing earnings guidance "make sure that your disclosure committee is having frank and frequent discussions with management about exactly what, if any, earnings management tools are being used, whether these tools fit squarely within the company’s revenue recognition policies, whether the company’s auditors are aware of the scope and persistence of these practices, and, most importantly, whether the use of the tools is, intentionally or not, masking a trend of declining sales, a declining market share, declining margins, or other significant uncertainties."
See the WSJ's "Inside Under Armour’s Sales Scramble: ‘Pulling Forward Every Quarter’" and the SEC's release on Marvell Technology Group. This post first appeared in the weekly Society Alert!