The Securities and Exchange Commission is investigating how a number of companies calculated assumptions for their post-retirement benefits to determine whether they manipulated the bottom line, according to BusinessWeek.
The magazine reported that the commission has identified a few dozen companies “whose assumptions seem aggressive” and that it has sent letters to a half-dozen seeking documents that would explain the basis of those estimates. Stephen M. Cutler, director of the SEC’s Enforcement Division, told Business Week that his department is “looking to see whether managers are adjusting their assumptions with an eye to enhancing the earnings and balance-sheet numbers investors care about. That could be fraud.”
The original few dozen companies have pension plans large enough that changes in those assumptions could affect their earnings significantly. It’s also true, however, that pension accounting requires companies to make a number of estimates. And differences in the investment mix and the age of workers and retirees could result in wide differences in assumptions made by many companies.
The magazine also stressed the SEC says it has no evidence of wrongdoing.
An article in The Wall Street Journal reported that one focus of the SEC is the discount rate that companies use to calculate future pension liabilities. Companies typically use a rate based on high-grade corporate bonds to calculate their benefits liabilities, wrote the Journal, which noted that a mere half-percentage-point change could result in a $1 billion swing in a large pension plan.
As a result, a company might set an unrealistically high discount rate to lower its projected liabilities. Such an assumption, added the paper, could also make the company’s balance sheet look better, generate accounting gains that boost income, and possibly enhance executive compensation.
The SEC has issued guidelines for setting these assumptions, the Journal noted, but companies still have some leeway about how they apply the set of assumptions.
The paper also wrote that the SEC confirmed it is looking into the use of assumptions in retiree health plans to affect earnings. The Journal pointed out that companies can raise or lower the liabilities and costs for their retiree health plans by using a “health care trend” assumption — a company’s estimate of future inflation, based on a number of undisclosed measures.
A company could raise its liabilities by using high inflation assumptions and low discount rates. It could then change those assumptions and cut benefits, enabling it to generate accounting gains that could be used to lift quarterly earnings.