SEC Stock-Swap Rule Could Hinder Profits

A recent Securities and Exchange Commission rule could force companies that merge by swapping stock to alter their accounting methods, resulting in lower per-share earnings in subsequent quarters.

The rule prohibits companies that swap stock in a merger from buying back those shares for six months. If the company had previously announced plans to buy back shares, there would be a two-year waiting period.

The rule was first published in January and codified in an SEC bulletin in March.

Currently, companies that merge by swapping stock often buy back some stock to lessen the dilution of their earnings per share, a common method of measuring performance.

The SEC rule could force more companies that merge to use an accounting method called “purchase accounting,” in which one company merges with another paying stock or cash.

The trouble with that method for some companies is that it creates “goodwill,” a premium paid to acquire a business that must be deducted from earnings over many years, creating a drag on profits. The pooling method of accounting used in stock swaps doesn’t create goodwill.

“When doing a cash deal, you don’t have as many shares outstanding. That’s the good news,” said Robert Willens, an analyst at Lehman Bros. Inc. “The bad news is your earnings are penalized because the cash you pay has to be written off against your earnings.”

The SEC gave a preview of the rule in January, when it stated that First Bank Systems Inc. couldn’t buy back shares for two years under its plan to acquire First Interstate Bancorp for $9.8 billion.

First Bank subsequently abandoned its offer, clearing the way for a rival bid by Wells Fargo & Co.

Some analysts feel the rule could lead companies to stop mentioning stock buyback plans before planned mergers to get around the SEC rule.