By DAVID MOON, Moon Capital
October 17, 2004
It's tough when they change the rules in the middle of the game and don't
send out a memo. Ask the two SunTrust executives who were just placed on
administrative leave for errors in its last two quarterly reports. A year
or so ago, these same 'errors' would have earned plaudits from Wall Street, and
possibly SunTrust's senior management.
On October 11, SunTrust announced that its Chief Credit Officer and
Controller would be taking involuntary 'vacations' because the company
incorrectly reported its earnings in the last two quarters. Interestingly,
however, SunTrust did not exaggerate its earnings; it understated them.
Folks at Enron and WorldCom got into trouble for telling people they made more
money than they actually did. SunTrust appears guilty of the
opposite. So what's the big sin?
Everything in life is about timing.
For years, investors rewarded companies that reported smooth, predictable
earnings increases. It was almost an art form. If a mature company
could report a steady five percent earnings growth each year, it gave investors
a sense of safety. Investors hate surprises. If a company can
eliminate (or reduce) surprises, investors sleep a bit better, consistent
companies are awarded higher P/E multiples and everyone makes a bit more
The well-known secret on Wall Street, however, is that companies often had to
manipulate their numbers (usually non-cash expenses) a bit to create an
artificially smooth earnings trend. For a bank, this is particularly
easy. Banks have to make estimates of how many borrowers are going to
default on their loans. By playing games with these estimates, a bank can
shift some earnings or losses from one period into another. This really
isn't earnings fabrication as much as it is just changing the timing of the
recognition of the earnings. Eventually, these timing games work
themselves out. Yes, it is misleading, but it was the type of mirage
preferred by Wall Street ' until recently.
Neither the company nor any analysts have suggested that the SunTrust
earnings misstatements were intentional or intended to 'save' some earnings that
it could use in a future quarter when operating results might be a bit
soft. But it sure has the look of internal manipulation. (A
SunTrust press release places the blame on 'errors in input data.') If it
is artificial manipulation, the bank has good company. For years,
Coca-Cola would massage its earnings by selling a bottling company or two when
it needed a little extra quarterly boost. GE is guilty. Retailers
can play games with inventory adjustments to accelerate or postpone earnings
changes. Even Fannie Mae, the huge government sponsored enterprise, has
recently been under attack for misstatements similar to SunTrust's.
'Errors in input data' are more common than you might imagine.
SunTrust's only sin is probably one of timing. A practice that was
silently lauded two years ago now draws the wrath of audit committees and the
SEC. The top executives at SunTrust appear to be reacting out of an
overabundance of caution; there certainly isn't anything wrong with
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).