Market's Real Psychology Test Comes Aug. 14

By then, CEOs and CFOs at big companies will have to swear to the accuracy of their financials.
Author:
Publish date:

Whether Aug. 14 will mark an end to the bear market remains to be seen, but there's little question the date is taking on growing psychological importance to investors.

That's when the chief executives and chief financial officers of the roughly 950 largest U.S.-based companies will be required to swear under oath that their financial statements going back to the last annual report are accurate and complete. The requirement will apply to companies whose revenue totaled at least $1.2 billion in their most recent fiscal year.

The

Securities and Exchange Commission

has indicated that several firms have already complied and that the results would be published "as soon as possible." But the SEC has also cautioned that some of the information might not be made public until after the deadline.

Dennis Hynes, chief investment strategist at RW Pressprich, said the market has been in a state of "suspended animation" as investors wait to see if any companies will restate their numbers or disclose any accounting irregularities as a result of the mandate.

"People are afraid to make any real investments until this is resolved," Hynes said. "Once all the bad news is out, it could be a catalyst for the end of the bear market."

Getting on Board

The SEC said some companies have been seeking ways to reduce the certification standards or otherwise modify the instructions given by the agency, but experts say most companies will ultimately comply.

"I would think that if they don't, they risk creating a public relations nightmare for their company and for their stock," said J. Boyd Page, a securities lawyer at the firm of Page Gard Smiley & Bishop.

Executives who choose not to certify their financial results must provide a statement to the SEC explaining why they can't. While such a move wouldn't necessarily signal that something is fundamentally wrong, observers say it could be seen as an admission of guilt.

Robert Lamm, a securities lawyer at Gunster Yoakley & Stewart, said the SEC order should help to restore confidence in the markets because it sets in motion enduring changes to the way companies report their numbers.

"This is a one-time certification, but it is also a precursor to a permanent rule that the SEC has put out for comment that would require CEOs and CFOs of all public companies -- with some minor exceptions -- to provide these certifications on an ongoing basis," he said.

Lamm said a sworn statement should encourage executives to adhere to both the letter and the spirit of the law. In addition, the SEC is attempting to set up securities compliance programs at companies to ensure that their filings are complete in all material respects.

In Reality

The stock market has been a painful place for many investors to be this year, as accounting scandals at companies like

Enron

and

WorldCom

, insider trading allegations at the likes of

ImClone

(IMCL)

, and aggressive bookkeeping speculation around names like

GE

(GE) - Get Report

and

Tyco

(TYC)

have had Wall Street and Main Street on edge and the major averages in a tailspin.

Since the beginning of the year, the

Dow Jones Industrial Average

has lost 19%, and the

S&P 500

has fallen 27%. The

Nasdaq

has dropped 37%. While the executive certification of results might help slow the downward trend, not everyone is expecting a rally to begin overnight.

"It is a confidence-building measure," said Edmund Cowart, a fund manager at Eagle Asset Management. "But Aug. 14 is not a magic date when the curtains part and everything is clear. These dates that people wait for, like Y2K, tend to pass without anything really happening."

Lou Holland, president of Holland Capital Management, agrees. In fact, he said concerns about corporate accounting have largely been factored into the market.

"Most of the bad ones have already been fleshed out," he said. "What's important is how well the economy improves over the next few months. That's the driver of whether you're going to make any money over the next year."

Other observers say they are skeptical the certifications will have a lasting impact on the market because they are largely symbolic. After all, executives typically sign their financial statements and are already legally responsible for the results.

"As far as new culpability, I don't think this is anything," said Edward Ketz, a professor of accounting at Penn State's Smeal College of Business. "It potentially can go a long way in comforting the public, but as far as substance, it's virtually nothing."

Meanwhile, some experts question just how effective the SEC can really be in stamping out corruption. Howard Friedman, a securities law professor at the University of Toledo, said if a CEO is intent on committing a crime, forcing him or her to certify financial statements isn't going to make much difference.

"If the CEO is already responsible for fraud, if they instituted the fraud, this isn't going make them come clean about it," he said.

Chains of Command

Because CEOs are still largely reliant on their subordinates to do the necessary due diligence, it's possible that he or she simply doesn't know what's going on, Friedman said.

Still, some experts say the new order, which requires executives to read their financial statements and attest to their truth and reliability, makes it harder for chief executives to shift blame, or claim that they didn't know their financials were erroneous.

"Do I think fraud is a thing of the past? No, but if someone is going to do it, they're going to have to think about it more, and that, of course, is going to make prosecution easier," Lamm said.

Added Page, "I don't think any of us have a magic wand where everyone will be as confident as they were a couple of years ago, but it's the type of thing that is a step in the right direction."