WASHINGTON - Corporate America has received a New Year's greeting from the SEC that it doesn't want.
For the second consecutive year, officials at the Securities and Exchange Commission have told companies they must spell out to investors the extent to which their earnings have come from their pension funds, instead of profits on operations.
The warning also follows informal discussions between Rep. Bernie Sanders, I-Vt., and SEC officials about his concerns over the failure of some of the nation's largest corporations to disclose the impact of pension income on their corporate earnings. The warning comes in time for the 2000 annual report season.
Meanwhile, some of the nation's largest corporations could see their pension income start shrinking at the end of next year. That's when most companies reach the end of a 15-year period they were allowed to write off the differences between their pension assets and their pension liabilities after adopting Financial Accounting Standard 87 in the mid-1980s.
Caterpillar Inc. could be the first to feel the pinch; others include AT&T Corp., Boeing Co., Philip Morris Cos. Inc., General Electric Co. and Honeywell, which is merging into GE.
"Now they are coming to the end of the rainbow," said Adam J. Reese, consulting actuary at Towers Perrin in Arlington, Va.
Fear investors misled
At the SEC, officials are worried some companies might be misleading investors about their financial health. Investors, they say, might not realize that income from pension funds is unpredictable at best, and should not be counted upon the same way as recurring profits from operations.
Accounting rules permit companies to take income from their pension funds into account in calculating their net income, and require them to disclose this information in footnotes to their financial statements. But the SEC wants companies with sizable pension income to report this prominently in the main body of the annual financial statements, not just in the footnotes.
In an Oct. 13 letter to accountants - who prepare financial statements for corporate America - Lynn E. Turner, the SEC's chief accountant, wrote that large changes in the market value of pension assets could affect a company's pension costs and therefore its cash flows, both immediately and in future years. He also noted that some companies might have lowered their pension costs by converting their traditional pension plans into cash balance plans. What's more, because companies with cash balance plans typically offer participants lump-sum payouts, their need for cash is different from that of companies with traditional defined benefit plans.
"We believe that such events, like any other event giving rise to a material impact on current or future results of operations and cash flows, should be discussed in the MD&A," Mr. Turner wrote, referring to the section of the annual report in which management discusses and analyzes financial conditions and results of operations.
The section is where companies must tell investors about events that could have a "material" impact on a company's income, liquidity or capital resources, as well as one-time changes that could affect a company's financial results.
Companies that fail to obey the SEC's directive or provide inadequate information about their pension income will be asked to redo their annual financial statements, Mr. Turner's letter states.
SEC officials declined to comment on Mr. Turner's directive.
But Brian J. Lane, partner in the Washington office of law firm Gibson, Dunn & Crutcher, suggested that any company that does not properly disclose its pension fund's contribution to the bottom line in its 2000 annual reports has a greater likelihood of being rebuked by the securities regulator than in earlier years.
"In the last few years the IPO market was so hot that the staff of my old division could only review initial public offerings, and now that the IPO market has ground to a halt, the staff is reviewing 10-Ks for the first time in years," said Mr. Lane, previously director of the SEC's division of corporation finance.
IBM Corp., in particular, which reported $638 million in pension income in 1999 but did not disclose that in its MD&A, has come under scrutiny from investors and shareholders. In fact, shareholder employees of the Armonk, N.Y.-based computer giant are proposing the company give investors better information about its operating profits and clarify the extent to which its pension income contributes to its bottom line.
But, in a Dec. 4 letter to the SEC, Stuart S. Moskowitz, senior counsel at IBM, noted the company already discloses its pension income in a manner consistent with accounting rules.
Mr. Turner's letter also reminds companies to ensure that the assumptions they use to measure their pension liabilities "reflect the best estimate." Some investment analysts had expressed concern that the rate of return companies are assuming they will earn on their pension assets is too high (Pensions & Investments, Aug. 7).
Among the companies whose pension income could shrink when their transition assets fade away is Caterpillar, Peoria, Ill, which reported $85 million in pension income in 1999, of which $23 million was attributable to the amortization of its transition assets. The company has only $18 million left to write off next year, which means its pension income could drop by $5 million next year, without taking into account any other factors.
* Boeing, Seattle, reported $125 million in pension income in 1999, of which 85% or $106 million was attributable not to investment earnings on its pension assets, but to amortization of its transition assets. Boeing has only another $135 million left to amortize, which means its pension income could fall by $77 million in 2002.
* Philip Morris, New York, has only $24 million in transition assets left to write off. The company, which reported $99 million in transition assets in 1999, is amortizing its transition assets at the rate of $23 million a year, so its pension income in 2002 could fall by $22 million.
* Eastman Kodak Co., Rochester, N.Y., would have reported a pension cost of $117 million in 1999 had it not been for its transition assets, which it is writing off at the rate of $69 million a year. The company reported $48 million in pension expense last year because of underfunded overseas plans, according to a company spokesman. It had pension income of $19 million on its domestic plans.
* General Electric, Fairfield, Conn., has been writing off transition asset at the rate of $154 million a year, but sops up the last bit next year. The company reported $1.4 billion in pension income in 1999.
* E.I. du Pont de Nemours and Co., Wilmington, Del., saw 90% of its pension income come from the amortization of its transition asset of $150 million. But because those assets don't run out for more than three years, the company is unlikely to see an immediate increase in its pension expenses any time soon.
* IBM, which is writing off its transition assets at the rate of $145 million a year, has another $704 million to write off, or just under five years' worth.