WASHINGTON - As if companies don't already have enough bad news to give investors, the SEC is now asking them to come clean on the extent to which their pension funds are dragging earnings.
SEC officials, in informal discussions with members of the American Institute of Certified Public Accountants, have put accountants on notice that they expect companies to alert investors about significant "declines in the value of investment securities or pension plan assets" and their impact on earnings.
SEC officials also have suggested companies reveal any large increases in pension liabilities. The companies would do so in the section of the annual report that contains management's discussion and analysis of financial conditions and results of operations.
That is the section of the annual reports where companies are required by SEC rules to discuss trends, events, or uncertainties that will have a "material impact" on their financials. Current accounting rules don't require companies to say much about their pension fund assets or liabilities beyond recording them in footnotes to their financial statements.
Profit centers no more
The SEC's suggestions come at a time when pension funds have morphed from profit centers into cost centers. Pension funds have begun to drag down earnings because of the decline in the stock market and the steep fall in interest rates, which resulted in higher pension liabilities.
Underfunded pension funds hit a company's financial statements in two ways: They affect cash flow if the plan sponsor needs to contribute more money to the pension fund to make up the shortfall, and they reduce a company's reported earnings because accounting rules require companies to take their pension income or pension cost into account in their income statement.
"It should affect the stock price," said Nathaniel Guild, partner of Short Alert, a Charlotte, N.C., investment research firm. "It's going to reveal problems people have been trying to hide"
Howard Schilit, president of the Rockville, Md.-based Center for Financial Research and Analysis, said the SEC's move should help allay fears of investors, already nervous about accounting legerdemain following Enron Corp.'s collapse. "The SEC wants investors to get more disclosure when there is a contingent liability or an unusual source of income," he said.
The AICPA alerted its members about the SEC's directive last month in a white paper discussing the "impact of the current economic and business environment on financial reporting."
Chuck Landes, director of audit and attest standards at the AICPA in New York, said the SEC is going beyond requiring companies to discuss lower returns on pension assets. Mr. Landes said companies also should be prepared to tell investors about expected increases in pension liabilities and the impact of that increase on plan sponsors' liquidity and future operations.
"What we are suggesting in our white paper is the MD&A disclosures need to be clear and transparent and not just simply a regurgitation" of disclosures in footnotes to the financial statements, he said.
The accounting industry and the SEC, he said, are "advocating discussing the full impact" so investors can make "informed decisions" about a company.
But Keith Ambachtsheer, president of K.P.A. Advisory Services Ltd., a Toronto pension research and consulting firm, is concerned some companies might be eager to blame their poor financial results on their pension fund.
"When pension funds are making a positive contribution to earnings, people are not going to want to talk about it very much, but when the pension fund is dragging earnings, the tendency is going to be say that `our basic operations are fine, it's just the pension fund pulling earnings down."'
Several blue-chip corporations already have warned investors. Northrop Grumman Corp., Los Angeles, began cautioning last summer that its 2001 earnings would be considerably lower because of a drop in its pension income. The company saw its earnings shrink to $427 million or $4.80 a share in 2001, a 32% drop from $625 million or $8.82 a share in 2000, largely because of "substantial decreases" in pension income to $337 million in 2001 from $558 million in 2000.
The Washington Post Co., Washington, which for years has discussed candidly the substantial contribution of its pension fund to its bottom line, saw its pension income jump to $76.9 million in 2001, or 34.9% of operating income of $219.9 million, from $62.7 million in 2000, or 18.4% of its operating income of $339.9 million that year.
However, the company expects its pension credit will be $20 million to $25 million less in 2002 because the media conglomerate lowered the assumed rate of return on pension assets to 7.5% from 9% the previous year and reduced the interest rate it uses to discount pension liabilities to 7% from 7.5%.
Daniel J. Lynch, the Post's treasurer, declined to be interviewed.