Lessons from Intuit in Options Accounting

Aug.21.06 | About: Intuit Inc. (INTU)

Last Wednesday, Intuit (NASDAQ:INTU) announced that their special committee had reached the end of its examination of the firm’s stock option accounting practices. Their examination covered the period from Aug. 1, 1997 to the present. Their conclusion: the coast is clear. No issues found. No restatement required.

The stock advanced $.42, or 1.4%, that day, and retreated a bit since then. That was far better than the S&P 500’s advance of .8% on the same day, and the Nasdaq’s comparatively tepid .4% advance.

That says a lot about the market’s relief at good news over backdating innocence. No aspersions cast here on the Intuit special committee - but while they “reported this conclusion to the Securities and Exchange Commission and the United States Attorney for the Northern District of California and will cooperate with any further inquiries,” their 8-K and press release didn’t indicate that the U.S. Attorney hasn’t concluded their investigation. When that one is done, then maybe the markets should really breathe easier.

Which brings me to another point: there’s been a lot of conjecture about the rate at which these investigations should take place. Intuit’s was pretty quick: they announced it on June 29, and they’re finished a month and a half later. Pretty quick compared to some of the stretched-out filings we’re seeing due to backdating investigations. Here are some things to keep in mind when it comes to the length of time it’s going to take to complete them. They may sound obvious, but a lot of people haven’t been giving much thought to them.

The farther back the investigations go, the more difficult it will be to evaluate the situation.
The farther back the problems, the more data there will be to evaluate, and the longer it will take to get that 10-Q or 10-K filed. There’s simply a larger universe to be evaluated in an examination that goes back to 1995 than one that reaches back to only 1999.

There’s more than just the option grants of the top five executives at stake. Sure, that’s what makes the headlines; options are an important part of executive compensation, and a lot of investors (and journalists) are severely honked off about executive pay right now. But the option plans often extend deep into the bowels of a company; that was always one of the “Unique Selling Propositions” about option plans. Giving the options on 100 shares to each member of the headquarters cleaning crew would “empower” them and make them have a stake in the outcome of the company’s future. When the time comes to clean up the accounting for the options, however, it’s much more of a headache to do your fact-checking on 10,000 employees as opposed to just five officers.

As noted in the press, many of the investigations involve tech companies.
There’s no revelation there; we all know that’s where the option action was. One particular trait of the tech companies: they really did believe in pushing the options out to all employees, not just the top dogs. You can find cases where the top dogs got a majority of grants, but for the most part, they gave them out more broadly than in other industries. As noted above, that leads to more backtracking work.

The systems and documentation in place during the periods in question were not likely “the gold standard.”
Remember that a lot of the transactions being investigated are in the pre-SOX 404 era: we know from the restatements and all the angst over getting internal controls whipped into shape that firms were not paying much attention to system details before then. Furthermore, since companies didn’t expect to report stock option compensation expense because they were using APB Opinion 25 accounting, they probably cared even less about reporting controls over such transactions. If so, chalk up another factor making the backtracking effort even more of a long, tough slog.

Bottom line:
Wall Street is a place where even instant gratification can seem like an eternity. And the backdating investigations have been a multitude of eternities as firms evaluate their situations. The longer it takes, the more that could be wrong - but not necessarily so. Just getting the facts, and getting them right, could be a horrendous task. And it’s one that firms will want to be ready for, come this year’s audit season. It would be very strange indeed, if auditors weren’t poking more into the records of option grants this year.