Checking Out IBM's Options

Like most of us at Fool HQ, I strive to invest in companies that boast high-quality management that won't point the finger elsewhere when problems arise. For the most part, I had considered the folks at IBM (NYSE: IBM  ) among this class. Until yesterday.

Big Blue is the subject of an informal investigation by the Securities and Exchange Commission over the company's stock options-expensing practices. The SEC wants to know whether the company's rhetoric about options expensing before its first-quarter 2005 earnings report accurately represented underlying circumstances, in relation to its earnings shortfall.

It's important to note that IBM isn't under investigation for violating securities laws. But that doesn't mean this isn't a serious inquiry. To the contrary, IBM may have dramatically misled investors. Follow along, please.

It all started with this press release on April 5. The release stated that IBM would, for the first time, treat stock options as a business expense in its results. Later that day, the Associated Press reports, Chief Financial Officer Mark Loughridge told analysts that first-quarter 2004 options expensing would have lowered net income by $0.14 and then indicated that this year's first-quarter hit would be similar.

It didn't turn out that way. When IBM announced its results fewer than 10 days later, options expensing accounted for only $0.10 per stub. That's right -- $0.04 per share just disappeared. More importantly, IBM announced a total of $0.84 per share in net income, well below analysts' revised target of $0.90.

It's clear to me that IBM did nothing wrong according to the letter of the law. But that's not the point. It was at best ethically ambiguous for Big Blue to try to pin disappointing results on options expensing when the truth was that the company had a bad quarter. A corporate titan such as IBM should know that investors understand that bad quarters happen. It needn't have played this game.

But what's done is done. Regardless of the outcome of the investigation, one thing is clear: Management was more interested in spinning you than winning you over on the merits (or lack thereof) of the last quarter. Is that the kind of people with whom you want to invest your money? Not me, thanks.

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Fool contributor Tim Beyers doesn't understand why we can't just expense options ad move on. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what's in his portfolio by checking Tim's Fool profile, which is here. The Motley Fool has a disclosure policy.

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