Lately, there have been a slew of positive corporate earnings from the first quarter of 2014. These are encouraging, leading many to be optimistic that our economy is strong. Yet, I do not trust the corporate earnings.
My mistrust is not because I think the financial executives are fraudulent, making up figures to put on their financial statements. We have seen that happen before, but I suspect it is rare. Instead, I don’t trust corporate earnings because there is simply too much creative accounting allowed in corporate America. In other words, the numbers can be “fudged” near the end of the quarter to manipulate the short-term figures.
I have 16 years of experience as a financial planner and registered investment advisor. I have seen many ups and downs in our economy and in the stock market. The companies that imploded in 2001 (including Enron, Worldcom, and Tyco) brought blatantly fraudulent corporate behavior to our attention. Next, we had the financial crisis of 2008, which included unethical behavior by many people in the mortgage, banking, and investment industries. Even our government officials were telling us everything was fine a few days before September 15th, when Lehman Brothers was allowed to go bankrupt and Merrill Lynch was quickly sold to Bank of America. This started a rapid downward spiral for the US economy. When the US stock market turned the corner in early March of 2009, the S&P 500 had lost 54% from its high in October of 2007.
Should we be so naïve as to assume corporate America is now totally ethical? I think that would be an unwise reaction. I do not know exactly how the financial figures can be altered, but I know that creative accounting techniques are widely used when preparing financial statements. The ultra short-term focus is damaging to individual investors, and I believe it is also damaging to our economy.
It is time that our Congress took some positive steps. Let’s start with putting the individual investor first (above corporate profits and the millions of dollars being spent on lobbying by the financial industry to convince Congress to not make any drastic changes). Next, let’s put some accounting and financial rules in place that will prevent altering quarterly financial statements. Next, let’s require that all financial advisors (including brokers, insurance salespersons, and bank employees) be held to a fiduciary standard, and that all corporate executives be held to high ethical standards.
We need reforms, and we need them now. After all, most investors assume another major financial crisis is coming. It is not a matter of if, but a matter of when.