SEC Focuses on Makers of Video Games
The Securities and Exchange Commission is conducting an apparently broad investigation of accounting practices in the video game industry, according to SEC filings by three game publishers, including two in Southern California that produce some of the industry’s most popular titles.
Activision Inc. of Santa Monica, publisher of the popular “Tony Hawk’s Pro Skater” games; Calabasas Hills-based THQ Inc., which publishes the “SpongeBob SquarePants” series; and Acclaim Entertainment Inc., headquartered in Geneva, N.Y., said they received requests for information from the SEC.
The companies, which publish games for machines such as Sony Corp.’s PlayStation 2 and Nintendo’s GameCube, said they were cooperating with the probe. Activision declined to comment further. Acclaim and THQ couldn’t be reached for comment late Friday. An SEC spokesman declined to talk about the investigation.
In its filing, Activision said, “The investigation appears to be focused on certain accounting practices common to the interactive entertainment industry, with specific emphasis on revenue recognition,” or when companies choose to record sales on their books.
Game industry analyst Michael Pachter of Wedbush Morgan Securities in Los Angeles said he believed the SEC was trying to determine whether the firms have been deliberately understating revenue, giving themselves the flexibility to artificially inflate earnings at some future occasion if the business were to take a turn for the worse.
The focus of the probe could be reserve funds set up as cushions against returns of unsold games or demands by big retailers for rebates when the games can’t be sold for as much as anticipated. A firm selling $100 million worth of games during a quarter might book only $90 million as revenue, reasonably setting aside the other $10 million as insurance for these eventualities, Pachter said.
In a July 1 report, Pachter wrote, “We believe that overall reserve balances should grow in line with revenue growth, and that quarterly additions should generally offset actual charges during the preceding quarter.” Instead, he noted, all of the four biggest companies he follows -- Activision, THQ, Take-Two Interactive Software Inc. and industry leader Electronic Arts Inc. -- have been increasing their reserve funds faster than their reported revenue.
At Activision, for example, game sales actually declined by 16%, but the company beefed up reserves by 42% as well, he noted.
Pachter said that raises the question of whether the companies are turning the reserves into “rainy day” funds: When revenue falls below expectations, the companies can simply draw down their overstuffed reserve funds as demands come in from retailers for rebates, “smoothing” revenue to make their business appear less volatile.
In their stepped-up scrutiny of corporate accounting, securities regulators have paid close attention to revenue recognition. A company that improperly accounts for sales could overstate its profit, boosting its stock price and enriching insiders and other big investors.
Last year, Take-Two, which publishes the popular “Grand Theft Auto: Vice City” game, said the SEC opened an investigation after the company restated seven quarters of financial results because some sales weren’t recorded properly.
Acclaim settled charges three years ago that it improperly recorded $18 million in revenue in 1995. Co-founder Gregory Fischbach resigned as CEO in early June.
Henry Hu, a professor of corporate and securities law at the University of Texas at Austin, noted that the SEC opens many investigations without finding wrongdoing or bringing charges. However, he said, “the fact that it’s a formal investigation and that it’s of the whole industry tends to suggest that the SEC is not simply on a lark.”
The SEC hasn’t charged any of the gaming companies with wrongdoing.
News of the SEC inquiry came after the market closed, but shares of video game publishers dropped in after-hours trading. Activision fell as low as $11 after closing at $12.46 in regular trading, although it later recovered somewhat. THQ, which closed at $17.70 in regular trading, fell to $17. Acclaim dipped to 64 cents after-hours after closing at 68 cents in regular trading.
Electronic Arts fell as low as $74.85 after closing at $76.42 in regular trading. And Take-Two fell to $27.25 after closing at $27.64. All trade on Nasdaq.
Activision and THQ will report results next week for their most recent fiscal quarters. Both companies reported losses for the previous period.
Activision’s sales have more than doubled since 1998 as improvements in video-game graphics have attracted new customers. The industry has benefited from improved gaming consoles from Sony, Nintendo and Microsoft Corp., which makes the Xbox.
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Times staff writers Walter Hamilton and Alex Pham contributed to this report. Bloomberg News was used in compiling it.
