IBM, SEC Come to Terms Over Financial Gripe

IBM  settled with the Securities and Exchange Commission (SEC) today for issuing misleading statements about the impact of employee stock options on its 2005 earnings.

IBM said in a statement that, while it neither admits nor denies wrongdoing and will pay no fine, it will cease and desist from violating the reporting provisions of the federal securities laws.

The SEC said the misleading information came in the form of a chart that showed misleading statements for IBM’s first-quarter 2005 and fiscal-year 2005 earnings, causing analysts to lower their earnings per share (EPS) estimates for the systems vendor.

The SEC said 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 offset an unrelated increased pension expense.

IBM sought to avoid this because it would have increased the growth rate analysts had set for IBM, which would have been difficult for the company to achieve because of the increase in pension expense, the SEC said.

“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,” SEC Associate Director of Enforcement Scott W. Friestad said in the SEC statement.

IBM provided the misleading information during an April 5, 2005 conference call with analysts, announcing that beginning in Q1 2005 it would report stock options as an expense and advised analysts to adjust their earnings models for the change.

At the time, IBM expected that its stock options expense for Q1 2005 would have a impact of 10 cents on first quarter EPS results, and an impact of 39 cents for the full year.

But IBM did not disclose this information; instead the company included a chart which conveyed that the EPS impact of IBM’s stock options expense would be 14 cents for Q1 2005 and 55 cents for the year. After the announcement, many analysts reduced their EPS estimates by these amounts.

A week later, IBM announced earnings of 85 cents per share, which was 5 cents less than the amount that many analysts were expecting after the April 5 presentation. The company also disclosed that its equity compensation expense was 10 cents per share for the quarter, which was 4 cents lower than the misleading chart indicated it would be.

IBM first disclosed the investigation in an SEC Form 8-K for June 27, 2005, and formally became the target for the SEC’s scrutiny in this matter in January 2006.

Financial shenanigans regarding stock option expenses have been making the rounds of late. The SEC has stepped up its watchfulness after senior executives for more than 100 high-tech companies were found to have backdated stock options to give employees a financial pick-me-up. IBM was not among the targeted for backdating transgressions.

Just last week, the SEC settled stock-option backdating cases with Mercury Interactive and Brocade Communications Systems  totaling $35 million.