By Alex Sloley
The Securities and Exchange Commission, the all powerful US financial regulator, has instigated a severe and wide reaching crack down on the technology sector’s favorite accounting dodge, the write off of ‘in process’ research and development. And even though the exact details of the SEC’s plans are still hazy, the implications for merger and acquisition activity in the technology sector are extreme. In September, the SEC’s chairman Arthur Levitt gave a remarkable and unexpected speech entitled ‘The Numbers Game’ in which he called for aggressive action to be taken against what he termed accounting hocus pocus. Specifically, Levitt cited the widespread use within the technology sector of merger magic or the immediate write off of a huge percentage of an acquired company’s value as a charge to in-process research and development. The benefit from such a write off is the avoidance of future earnings degradation from the amortization of goodwill. And the benefit is so marked that every company in the US now seems to be applying this method to account for acquisitions. Soon after Mr Levitt’s speech, or possibly sometime before it, companies which had recently used this technique began to receive letters from the SEC questioning recent quarterly filings. And despite the explicit threats in Mr Levitt’s September speech, little or no public information was forthcoming from the SEC about this move. When questioned directly, a spokesperson for the SEC said she could neither confirm nor deny that such letters had been sent. The self titled investor’s advocate was being bizarrely secretive about the whole process. However, significant companies within the technology sector suddenly began to receive warnings, usually via their auditors, that drastic changes were afoot. Among the first companies to inform investors about these warnings were Cabletron Systems Inc and Lernout & Hauspie Speech Products NV. It now transpires that at some point in September, the SEC’s chief accountant, a Mr Lynn Turner, sent a letter to the American Institute of Certified Public Accountants or possibly to the Financial Accounting Standards Board, proclaiming that the old rules governing in process R&D no longer applied. He said that from hereon in, all filings with the SEC which contained incorrectly apportioned R&D write offs, would be rejected, forcing the company concerned to have to restate its reported earnings downwards. Two companies which have recently completed acquisitions, namely America Online Inc and WorldCom Inc, have both been forced to hastily re-appraise their previously calculated R&D write offs to avoid the SEC’s wrath. The problem, according to one professional advisor on software mergers who wished to remain nameless, is that the SEC has not yet made clear what the new rules are. Companies have commonly been writing off around 60% to 70% of an acquired company’s value as a one time R&D charge. Some sources estimate that by the time the SEC is finished with this process, this figure may be restricted to as little as 10%. What is also unclear is whether the ‘new rules’ will apply retroactively, forcing companies to restate past results already filed before the cut off date (thought to be September 15 1998). The general feeling among professional accountants contacted by ComputerWire is that a full blown historic witch-hunt is not what the SEC is planning, but this is by no means certain. The reasoning behind the SEC’s actions it to protect investors by ensuring more transparent accounts. However, the negative impact these changes will have on the reported earnings of acquisitive companies could severely restrict the merger activity that has contributed so significantly to these same investors wealth.
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