Weekend thoughts: is accounting getting harder?

So far this year, the story of the stock market has undoubtedly been the rocket ships that crypto and AI stocks have turned into.

But, under the water, there’s another trend I’ve seen: more companies than I can ever remember are having trouble with accounting, internal controls, and covenant compliance, and it’s causing real impacts to their business.

The headliner here is obviously NYCB; clearly they had other issues, but their inability to file their 10-K and weakness in loan controls almost brought down a $100B bank until Steve Mnuchin stepped in with a $1B bailout at the last second.

But there have been plenty of other issues:

• Chemours (CC) couldn’t file their 10-K; it seems the issue is their senior management tried to game their working capital to hit free cash flow targets. The result is a late 10-K, a looming material weakness in internal control, and replacing the entire management team.

• CDMO forgot to register their convertible notes a few years ago; someone noticed and accelerated payment of the notes. Not only did that throw the company into a liquidity crisis, it’ll almost certainly result in some restatements and a weakness in internal controls.

  • Matt Levine had a nice breakdown of this trade. It was a very clever bit of reading the indentures; good trade for whoever did this….. though there is something a little icky about using a technicality in the indenture to profit while throwing a real company into a financial crisis.

• RILY couldn’t file their financials because of an investigation into their dealings with Brian Kahn.

• VYX couldn’t file financials because of fraudulent ACH transactions.

• ADM couldn’t file financials because of an investigation into intersegment sales.

I’m sure there are more (and earnings season isn’t even over yet, so I’m sure there will be more in the next few weeks!); these are just the ones that were top of mind / that I remember seeing. But even without more delays popping up, that is a lot of companies with some type of accounting issue or internal weakness!

What’s more, these are not all tiny companies that went public through reverse mergers or deSPACs; these are real, large companies. Buffett has previously praised ADM; NYCB is one of the largest banks in the country. VYX and RILY are both financial companies; you’d think those would pay particular attention to internal controls!

It got me wondering: is there something about today’s world that lends itself to companies having trouble maintaining proper controls? It just seems like these delays / issues have popped up way more this year than I can ever remember.

My working theory would look something like this: post-COVID, companies materially increased their remote work options. Increased remote work opened up a lot of new internal control / accounting vulnerabilities, and we’re only just now learning of them.

Is that right? I don’t know!

What about takeaways if I’m right (on the restatements happening more frequently going forward than historically); would there be anything actionable for investors to do?

Honestly, I don’t know. Accounting is the language of business; if you can’t trust the accounts, it becomes really hard to be an investor. Perhaps the answer is more time should be sent looking at simple businesses: ones where cash flow closely tracks earnings and yu’’re not relying on huge assumptions for the earnings. Perhaps a premium should also be placed on companies with large insider ownership and insider buying (or share repurchases), as those companies are effectively showing their trust/confidence in the earnings (though I’d argue those companies probably always deserve a premium).