Public Companies and Guidance

Many public companies provide guidance to the street.  The term has generally come to mean the disclosure of the company's internal projections to analysts and other market professionals although as a practical matter it can include any attempt to influence of "guide" analyst forecasts.  While there was a time when most guidance was provided selectively and informally, Regulation FD sought to put an end to the practice. 

The deliberate disclosure of guidance triggered disclosure to the market. See Exchange Act Release No. 43154 (August 15, 2000)("When an issuer official engages in a private discussion with an analyst who is seeking guidance about earnings estimates, he or she takes on a high degree of risk under Regulation FD. If the issuer official communicates selectively to the analyst nonpublic information that the company's anticipated earnings will be higher than, lower than, or even the same as what analysts have been forecasting, the issuer likely will have violated Regulation FD.").  As a result, guidance often appears in SEC filings, available to the public.  In the trial of Joe Nacchio, guidance on the expected earnings for the year appeared in a current report on Form 8-K.  The report is on the DU Corporate Governance web site.

According to theWall Street Journal, 34% of the Fortune 500 issue quarterly guidance.  Moreover, research provided by Thomson Financial indicated that in 65% of the cases where companies gave guidance they surpassed analyst expectations (compared with 63% of the companies not providing guidance).  Another 24% of those providing guidance met analyst expectations compared with 11% for those not providing guidance.  

It is probably the case that companies cannot be so cleanly divided.  At least some of the companies that do not formally give guidance (that is, provide projections that are disclosed in a public filing) probably still direct analysts on a more informal basis.  Informal advice may be harder to detect but will not prevent liability.  Companies that provide sufficient information to become "entangled" in the forecast made by the analyst can be liable if the forecast lacked a reasonable basis. 

Nonetheless, the data from Thomson Financial does suggest that companies giving guidance may deliberately understate their anticipated earnings and may be engaging in earnings management designed to meet analyst expectations.  That 25% of the companies providing guidance meet analyst expectations (versus 11% of those that do not) at least suggest the possibility that they are engaging in accounting practices designed to meet these expectations. 

This is something that the Commission has confronted on numerous occasions.  See In re Huntington Bancshares, Exchange Act Release No. 51781 (admin proc June 2, 2005)("In addition to the four restated items, Huntington misstated a special non-operating reserve for restructuring its Florida banking and insurance operations, and its auto residual value or "leakage reserve," enabling the Company to meet analysts' expectations and triggering executive bonuses.").  Moreover, in the 1990s, the Commission ran into the practice of "cookie jar" reserves, piles of revenue that could be brought into earnings whenever needed, often to meet analyst expectations.   

Lest anyone think this is an historical problem, the Commission's recent case against Conagra suggests otherwise.  The case involved improper use of reserves.  As the SEC release disclosed:

• "from at least as early as the first quarter of fiscal year 1999, ConAgra fraudulently used an Estimated Liabilities reserve account as a 'cookie jar' reserve, using it to offset millions in current period operating expenses. These reductions of excess reserves in 1999 caused ConAgra to overstate its annual reported income by 15% and its earnings per share by over 10 cents per share."

The practice of issuing guidance has been criticized but mostly because it ostensibly promotes a short term perspective on earnings.  The more important objection is that it encourages improper accounting treatment.  Companies providing guidance are under considerable pressure to make sure that the numbers meet street expectations.  The fact that only 34% of the Fortune 500 provide guidance (at least according to the WSJ article) suggests that companies can avoid giving guidance without damaging relations with the analyst community.  But to the extent that it is designed to meet analyst forecasts, this use of guidance will, in a post-SOX environment, have a greater risk of detection and more severe consequences.