For shareholders, the Securities and Exchange Commission (SEC) can be the Grim Reaper. Just a hint of an informal investigation can send a stock price into free fall.
The SEC has been prolific and its targets high-profile: Verizon's (NYSE:VZ) overstatement of its number of phone lines; Titan's (NYSE:TTN) botched merger with Lockheed Martin (NYSE:LMT) because of alleged violations of the Foreign Corrupt Practices Act; Nortel Networks' (NYSE:NT) accounting gymnastics; and on and on.
The SEC is also targeting smaller companies. Last week, for example, the federal agency disclosed it is reviewing certain transactions of EasyLink Services (NASDAQ:EASY). The amount under dispute -- approximately $3 million -- shows the SEC is willing to take on lower-scale cases. Also, the transactions were conducted in 2000.
Of course, the year 2000 was another era, in which "barter" arrangements on advertising deals were standard practice. Just look at any Internet portal. But the SEC doesn't want to miss another potential major scandal or get upstaged by a New York attorney general. With a hefty budget, the agency has the resources and the willpower to take on many investigations.
What makes the story even juicer is that current SEC Chairman William Donaldson was a director of EasyLink during 2000. He was even on the audit and compensation committees. Could such a finance pro not see the accounting problems? Of course, the SEC announced that Mr. Donaldson will recuse himself from the review of EasyLink. In fact, the SEC has hired Daniel Nathan as special advisor on the review; he is the chief of the Commodity Futures Trading Commission's Office of Cooperative Enforcement.
In light of the meltdowns at WorldCom and Enron, it's no surprise that investors have a "guilty until proven innocent" attitude regarding any controversy with the SEC. Accordingly, the stock price of EasyLink plunged 15% on the news.
While there was much-needed reform for transparency in financials, it does make the environment dicey for investors -- that is, if your company happens to be a target of the SEC. Even if a company is vindicated, damage still can be measured in legal costs, distraction, and the tarnishing of its reputation.
Expect more investigations. After all, the SEC is looking back to 2000 for cases. Interestingly, there are likely to be more cases going forward because of the stringent requirements of Sarbanes-Oxley, especially section 404. This mandates comprehensive disclosure of internal controls, which could trip up many small and medium-sized public companies.
Fool contributor Tom Taulli is the author of The EDGAR Online Guide to Decoding Financial Statements. He does not own shares in any of the stocks mentioned.
