Re:Balance -- Jim Peterson

“Beware the Ides of March” – This Year, Who Should Care?

Political and other careers have ended sharply on the 15^th of March, ever since Julius Caesar ran into the assassin’s knife on that date in 44 BC.

This year in America, consequences for the Republicans and the republic in general will flow from the winner-take-all presidential party primaries in Ohio and Florida – and, sadly, perhaps blood as well, if the sorry spectacle at last week’s cancelled Trump rally in Chicago is replicated.

On the business front, eyes as well as ears will be lent to the promised release of twice-delayed fourth-quarter earnings by Valeant Pharmaceuticals – whose stock price is off by 75% since last summer, stabilized last week in the high 60s although without pre-opening news at this writing on Monday morning.

As addressed at length in today’s New York Times and Financial Times, among many others, the company faces a catalog of issues – its revenue recognition, accounting measures and cash flow, along with its basic pricing, business and management model and strategies.

I had written back on January 16 on the timing and effects of CEO Michael Pearson’s suddenly-developed illness and leave of absence – from which he is reportedly recovered enough to be back on the job, for the moment at least. And I was pleased to contribute to the FT’s discussion of Valeant’s use of adjusted earnings measures:

“Many companies argue that shareholders should focus on adjusted figures, which strip out one-off costs and non-cash accounting charges, to judge the performance of the underlying business.

“However these adjusted numbers require investors to place their faith in the company managers who make the adjustments.

“’When a company starts introducing other terms like ‘adjusted’ you have to ask the question adjusted for what and adjusted by whom,’ says Jim Peterson, accounting specialist and author of “Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms”.

“In the case of Valeant the adjusted earnings have raised concerns because of how sharply they have differed from the picture presented when generally accepted accounting principles (GAAP) are used instead.

“While this is not necessarily a bad thing, it has led some analysts to argue that it is impossible to fully judge Valeant’s underlying profitability.

“’Once you’re away from GAAP metrics you can fiddle it any way you want. A bane of the users of financial statements is the tendency of companies to use their own metrics to present whatever picture they like,’ says Mr. Peterson.”

The Ides of March saw the knives drawn literally in the Roman Senate, as they will be figuratively for US Senators Ted Cruz and Mark Rubio tomorrow. Michael Pearson and his board at Valeant would be well advised to consult their auguries on what the day portends for them as well.

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are welcome, and subscription sign-up is easy and free, both on the Main page.

And information on my book – “Count Down” -- kindly cited by the FT -- is available here.

A New Entry in Charlie Munger’s Daily Journal

The usually sharp-tongued Francine McKenna was the very vision of under-statement in her Market Watch for March 3, describing the auditor merry-go-round at the Daily Journal Corporation (DJCO), the odd public company controlled by Charlie Munger – himself better known as the long-time advisor, consigliere and general-purpose wheelman to investor legend Warren Buffett.

In September 2014, Munger had loudly replaced EY with BDO, intolerant of successive annual auditor letters criticizing the internal controls and identifying potential weaknesses at the Daily Journal and snarling, about what he called an “audit from hell,” that EY had been “like the doctor who wanted to cure the nosebleed by fishing around in the groin.”

BDO promptly proved itself no more tractable, in Munger’s view – sacked on this February 17 after two years of “material weakness” letters, to be replaced considerably down the audit firm food chain by the Squar Milner firm.

Slightly re-wording Oscar Wilde’s Lady Bracknell:

“To lose one auditor may be regarded as a misfortune; to lose two looks like carelessness.”

Or something else. Twice within two years, it’s a double-barreled validation of the diminished role of independent auditors, at least as seen by Munger as board chairman and major shareholder.

That is, the language of the Daily Journal’s next auditor’s report will look precisely the same, whether signed by EY, BDO or Squar, wherever they may fall on the profession’s size tables.

Of the Squar Milner firm it expresses no disrespect to note that its handful of offices in southern California (plus an outpost in the Cayman Islands showing one resident), 19 audit partners and $ 55 million in annual revenue make it approximately 1/500^th the size of EY, third largest of the global Big Four and reporting 212,000 world-wide employees and $ 29 billion in 2015 revenue.

The lack of auditor value as perceived by a company chairman as confident and self-regarding as Munger should come as no surprise. The greater point is that the public holders of the 38% of the Daily Journal’s stock not in the hands of insiders also showed their complete indifference.

That is, the company’s stock price in the week of BDO’s firing and Squar’s arrival held rock steady at the news ($ 189 - $ 190, and since risen to $ 194) – just as it had done 18 months earlier (between $ 181 and $ 182) with the firing of EY.

Put somewhat differently, the entire episode makes plain again that the identity of the audit firm placing its name to the commodity language of the traditional “pass/fail” report as required by the SEC is a matter to which investors attribute no value at all.

Those continuing to extol the value of privately-provided assurance, at least in the form currently prescribed by the world’s securities regulators, are just as entitled to their views as is Munger.

As the evidence continues to mount, however, that their position is belied by the real behavior of the participants in the capital markets – Munger providing the latest example – a more valuable exercise would involve a fundamental re-examination of the premises underlying that self-serving proposition.  

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are invited and welcome, and subscription sign-up is easy and free – both at the Main page.

And please see here for access to and a synopsis of “Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms”—my recently published book where these and other concerns for the large-company audit model are fully explored.