IBM Settles SEC Disclosure Case, but Not Fined
21 Corporate Crime Reporter 24, June 5, 2007

Has the Securities and Exchange Commission (SEC) decided to cut back on corporate fines in disclosure cases?

That question was raised today when International Business Machines (IBM) settled a disclosure case with the SEC.

But IBM was not fined.

This despite the fact that SEC enforcement officials said they found the facts of the case “troubling” and the company’s actions “not inadvertent.”

The IBM case comes just months after SEC enforcement staff was stripped of its initial decision making authority over corporate fines.

Under a new unwritten SEC rule, those decisions are now made by the commissioners.

Similar disclosure cases in recent years have resulted in corporate fines.

In February 2005, for example, an Irish pharmaceutical company, Elan Corporation, was charged by the SEC with failing to disclose material information about the company’s financial results.

Elan was fined $15 million.

In the IBM case, the SEC alleged that IBM made materially misleading statements in a chart concerning the impact of the company's decision to expense employee stock options.

The misleading chart caused analysts to lower their earnings per share (EPS) estimates for the company.

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

He called IBM’s actions “not inadvertent.”

When asked why then the company was not fined, Friestad said he could not comment on charging decisions.

When asked whether the new SEC rule stripping the enforcement staff of its decision-making authority over corporations had played a part in zeroing out IBM’s fine, Friestad said it did not.

IBM’s attorney, Elizabeth Grayer, a partner at Cravath, Swaine & Moore, did not return calls seeking comment.

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 Commission in a Form 8-K.

During the call, IBM announced that beginning in 1Q05 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 1Q05 would have a $0.10 impact on first quarter EPS results and estimated a $0.39 impact on FY05 EPS results.

However, 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 $0.14 for 1Q05 and $0.55 for FY05.

After IBM's April 5 announcement, the majority of analysts reduced their EPS estimates by these amounts.

The SEC investigation found 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.

SEC officials said IBM 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.

The SEC found that IBM violated federal securities laws.

IBM consented to an order which requires the company to cease and desist from committing further violations.


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