Peeling away financial reporting issues one layer at a time

Big Bath Accounting is Alive and Well at Merrill Lynch, Citigroup and GM

In yesterday’s post, I wrote about Merrill’s big bath charge.  Two other recent news items confirm that not much as changed since Arthur Levitt declared war on earnings management games almost 10 years ago: the big bath accounting charge still lives on.  Merrill’s gets a seven on my proprietary 10-point chutzpah scale, which is pretty tame compared to these two examples of financial reporting gone mad.

Citigroup — 9.0 on the Chutzpah Scale

The Citigroup press release of November 5th doesn’t necessarily raise questions about the appropriate size of its writedown (yet), but the timing is so ham-handed it’s not even a bit funny.  Citigroup is saying that the entire writedown to be taken in the fourth quarter of between $8 and $11 billion is entirely due to events that took place this past October.   Here’s a trenchant snippet from Jonathan Weil’s recent Bloomberg column:

"It’s as if we’re supposed to believe that all this stuff at Citigroup happened after September [the last month of its third quarter] ended, notwithstanding the $8.4 billion of bad subprime mortgage stuff at Merrill Lynch & Co. that happened before September ended. [Hey SEC, a smoking gun!] And we’re also supposed to believe Citigroup’s brass didn’t have a clue any sooner." [emphasis supplied]

Even granting that the accounting may be apporpriate (a big stretch), the SEC should be looking at the adequacy of MD&A in earlier periods for both Citigroup and Merrill. As Lynn Turner pointed out in an email I received from him, Regulation S-K, Item 303 and numerous Commission interpretations (most notably, Financial Reporting Release No. 36) are anything but subtle in their exhortations to management that they owe investors an informative, forward-looking discussion of uncertainties that are reasonably likely to affect future earnings, liquidity and financing.  I haven’t looked myself yet, but I’m betting there is hardly a breath of discussion of the fomenting sub-prime meltdown in the third-quarter 10-Q of either one of these pillars of financial strength and probity.

General Motors — The Winner with a Perfect 10

General Motors announced on November 6th that it will establish a $39 billion valuation allowance on the deferred tax assets arising from net loss carryforwards of prior years.  I suspect a big bath for two reasons.  First, $39 billion is a huge allowance to emerge in one quarter, especially if zero was the answer in the prior quarter. Are we to believe that everything went to hell in three months?  Again, what did MD&A say? Second, I’m ever watchful of the big bath motive to take a charge that is more than necessary in one period for the purpose of goosing earnings in future periods.  I hope I don’t insult your intelligence when I point out that $39 billion is a staggering amount.

But, IF (ha ha) the accounting is right, it means that it is now literally a coin flip whether GM will be able to generate enough future taxable income from the right sources to realize in tax deductions the newly reduced book value of the net deferred tax asset.  But that’s not what GM writes in the press release.  I was taught that murdering your parents and pleading for mercy from the court because you’re an orphan is the ultimate act of chutzpah, but this statement from the press release comes awfully close to establishing a new benchmark:

"…the establishment of a valuation allowance does not reflect a change in the company’s view of its long-term automotive financial outlook… GM continues to believe that its new product introductions, combined with the new GM-UAW labor agreement,once fully implemented, will significantly improve GM’s competitive position in the U.S. and better position the company to utilize tax benefits in the U.S. and Canada in the future."

Huh?  If that’s what you believe, then why was it necessary to write down the value of the deferred tax asset?  Where in FAS 109, the applicable accounting standard does it say that you are supposed to ignore evidence?  Answer:  it doesn’t!!

Message to SEC Chair Christopher Cox:  your reputation will sink to shill status if you don’t act quickly to reign in the blatant financial reporting shenanigans being perpetrated on the investing public by these icons of the U.S. economy.  I suggest your read the SEC’s enforcement action against Sony (AAER 1062), which resulted in landmark fines and remedies, and then ask yourself whether these cases are any different.


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