Can investors trust tech companies?

RGBStock.com user woodsy

RGBStock.com user woodsy
(MoneyWatch) COMMENTARY Groupon announced (GRPN) Friday that its sales were lower and losses greater last quarter than it had reported last month. 

What happened? The daily deal giant had to increase how much money it sets aside for refunds, particularly for pricier offerings. Auditor Ernst & Young also said the company has a material weakness in its financial controls. (Some shareholder lawyers are already considering suing Groupon over the accounting glitch.)

The words "material weakness" obviously aren't ones that a public company likes to use or that investors want to hear. They mean that a firm's internal controls are inadequate to ensure accurate financial reporting. 


Groupon Tries to Make the SEC Happy, but Loses More Than Ever

Restatements aren't the sole province of high-tech, of course. Just last week, insurance holding company Atlantic American (AAME) restated some 2010 results because of an "other than temporary impairment" on certain equity securities it held. In March, Northwest Pipe (NWPX) restated 2009 results as part of an internal accounting probe. Chocolate company Barry Callebaut (BYCBF) also recently said it would restate its first-half fiscal year results. Still, the high-tech industry has seen a spate of accounting problems of late:

  • Groupon has been the poster child of poor accounting, with the company asking potential investors to ignore hundreds of millions in marketing expenses and counting as revenue money that went to merchants for the goods and services customers purchased. The SEC eventually made the company change its approach.

  • Energy management firm Telkonet (TKOI) restated results last month because of problems in calculating sales taxes.

  • Social-gaming company Zynga (ZNGA) suddenly changed the way it accounted for digital goods it sold to turn a quarterly loss into a profit.

  • Demand Media (DMD) had to undergo scrutiny of its accounting because, unlike many publishing companies, it wanted to spread its cost of creating or acquiring certain types of its content over a period of years, rather than booking such expenses on paying them. That makes a company's financial results look far better in the short term than they would otherwise seem.

  • Deloitte Touche Tohmatsu resigned as the auditor of Longtop Financial (LFT), a Chinese software company, last May because of falsified financial records.

  • Olympus (OCPNY) last fall was discovered to have hidden decades of losses by disguising them as unusually high prices for acquisitions, as well as record-setting advisory fees.

Also think about the accounting scandals that caused Congress to pass reform legislation such as Sarbanes-Oxley, which tightened reporting requirements for public corporations. Mixed in with the likes of Enron, Haliburton, and Bristol-Myers Squibb were Adelphia, WorldCom, AOL Time Warner, Homestore.com, Qwest, and Xerox -- all telecommunications and technology companies.

More for investors to be wary of

It's not that most or even many technology companies, whether major businesses or startups, are using accounting tricks to make themselves look better, let alone hiding shady practices. But when they happen with high-profile companies, it means investors are more likely to see the effects. It should be even more of a concern when people trade shares of pre-IPO companies -- which means corporations that aren't regularly filing public reports -- on secondary markets.

And, according to critics, the proposed JOBS Act will allow companies to secretly iron out differences with the SEC before they publicly file their IPOs. A company like Groupon or Demand Media might be able to make changes without the public ever knowing that there were questions about its accounting practices, even though the company could have to disclose the IPO filing 21 days before its "road show."

At a time when many corporations and politicians are pushing to reduce regulations on business, investors have to pay even more attention to details if they want to understand the risks they might be taking with their money.

Image: RGBStock.com user woodsy

  • Erik Sherman On Twitter»

    Erik Sherman is a widely published writer and editor who also does select ghosting and corporate work. The views expressed in this column belong to Sherman and do not represent the views of CBS Interactive. Follow him on Twitter at @ErikSherman or on Facebook.

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