Tuesday, 28 January 2014

Reported Earnings-True Measure Of Stock Performance

Variability Of Earnings & Risk Assessment-
Anything that increases the variability of earnings (e.g., recession, write-offs or poor business decisions) increases the unpredictability of earnings and therefore increases the risk of the stock.
A focus on definitions of earnings other than reported earnings may cause investors to underestimate the risk of a company.
If investors value a company “ Up “ the income statement and as a result believe the company is of higher quality than it might truly be, the company’s valuation will be higher & the cost of capital lower.
Investors should generally prefer to value companies “ Down “ the  income statement in order to get a better assessment of the risks of the company and to be compensated correctly for those risks.
During the Technology Bubble when investors were valuing companies on price-to-sales ratios, investors had simply handed the tug-of-war rope to the companies without even putting up a fight.
Search For Grail-
There has been strong evidence amassed regarding the efficacy of incorporating reported earnings into stock selection and style rotation strategies , but investors continual search for the ‘ Holy Grail ‘ puzzles many.
It is yet to be found strategies based on any of these supposedly superior measures that outperform reported earnings, but investors’ disbelief and their searches for “New & Improved “measures continue.
The Results-
During the last several years, valuing companies “Down “the income statement would have clearly benefitted portfolio performance.
15-Year Annualized Return Of Selected Value Strategies
Low P/E – 15.8%
Low P/CF - 13.6% (Price To Cash Flow)
Low P/S – 11.4% (Price To Sales)

Average 12-Month Price Return Of Selected Value Strategies
Low EV/EBITDA – 12.3% (Enterprise Value To EBITDA)
Low P/E – 16.7%
Low P/CF – 14.8%
Low P/B- 13.7% (Price To Book Value)
Low P/S- 13%

One of the prime tenets is that reported earnings are the ultimate drivers of stock prices.
Focusing on definitions of earnings other than reported earnings may cause investors to underestimate the risk of a company.
A hypothetical “Tug-Of-War “exists between the investor and company over a company’s valuation. Companies generally attempt to guide investors to value their stocks as far up the income statement as possible in order to better mask variability.
Why search for a new “Holy Grail “? We have yet to find strategies based on any of these supposedly superior measures that outperform reported earnings, but investors’ disbelief and their searches for “New & Improved” measures continue.

Q1. Does low P/E wok across the markets equally?

Q2. P/E may work best in the US, but may be flawed when applied across borders. Enterprise value to EBITDA may work better. Your thoughts?

Q3. Were the ratios you used forward-looking or trailing?

Q4. If purchase of low P/E consistently works with and across markets, what does that say about the efficiency of markets? Why does the strategy work?

Monday, 27 January 2014

Ebitda- Can We Trust ?

Is Ebitda getting out of hand again? The same performance measure (earnings before interest, taxes, depreciation, and amortization) that corporate raiders cited to justify their takeovers in the 1980s is becoming alarmingly ubiquitous in mainstream corporate America today as an alternative to traditional bottom-line-based financial yardsticks. Your company has lousy real earnings growth? Not enough profits to cover interest costs? Your stock is ridiculously overvalued? No problem! Look at Ebitda, and everything looks okay. Ebitda supposedly gives a clearer picture of a company's operations by stripping out expenses that can distort how the business is really doing. But it can also trick investors into thinking a company is doing better than it really is. Ebitda has gotten so out of hand that Martin Fridson, Merrill Lynch's respected chief of high-yield research, recently went against the grain with a report headlined "Ebitda is not king." While he says it can be useful--especially in analyzing junk bonds--he believes that too many analysts are using it as the starting- and end-points of their analysis. Grouses Robert Olstein, who manages the Olstein Financial Alert fund: "Ebitda is like Alice in Fantasyland. It should be outlawed from securities analysis."

Ebitda has existed since the 1960s but only came into vogue with the leveraged buyouts of the 1980s. It became the valuation method of choice for highly leveraged companies in cable and media, where bona fide profits were hard to come by. The latest Ebitda wave appears to have no boundaries. It has become especially popular at companies with a taste for takeovers.
Coca-Cola Enterprises is one example: In its annual 10-K filing with the SEC, the giant Coke bottler goes so far as to say that "in the opinion of management, cash operating profit"--its term for Ebitda--"is one of the key standards for measuring our operating performance." A spokeswoman explains that Coke Enterprises sees itself as a cash-flow company. But to Jim Chanos, a short-seller with Kynikos Associates, looking at performance measures pretax and before major expenses such as depreciation and amortization is "just a lame excuse to get a lower multiple." Coca-Cola Enterprises trades at roughly 90 times reported earnings, or twice the price/earnings multiple of the Coca-Cola Co. However, it trades at just 14 times Ebitda.
Ebitda can also make a company look as though it has more money to make interest payments. A good example is Coinmach, a large operator of washing machines at apartment houses. In its third fiscal quarter, Coinmach had $6.8 million in operating income and nearly $12 million in interest expenses. The solution? Add back depreciation and amortization, and suddenly the company has $24 million--more than enough to cover the costs. And Coinmach encourages investors to reach that very conclusion. According to its third-quarter 10-Q, "Management believes that an increase in Ebitda is an indicator of the company's improved ability to service existing debt, to sustain potential future increases in debt."
But that assumes Ebitda is the same as cash flow, which it isn't, and Fridson says that saying so is a "scam," especially with big depreciation charges. "A capital-intensive company isn't earning a profit if its assets are wearing down from wear and tear," he says. Kathryn Staley, author of The Art of Shortselling, agrees. When a company has high interest or high depreciation, Staley prefers measures such as operating cash flow--from the cash-flow statement in the annual report, which, unlike Ebitda, is subject to generally accepted accounting principles--and return on assets. Such calculations would no doubt have pricked the Ebitda balloons floated by such notable blowups as Texas Air, Quality Dining, and Harcourt Brace Jovanovich.
Companies that prefer Ebitda, meanwhile, have plenty of caveats in their public disclosures--caveats such as "Ebitda is not intended to represent cash flows" and even (this from Coinmach's 10-K) that Ebitda is not determined in accordance with generally accepted accounting principles and, as a result, "is susceptible to varying calculations." But in the end, when it comes to Ebitda, the only caveat for investors should be caveat emptor.

Wednesday, 22 January 2014

Financial Sleuth

What's going on in the world of accounting, post-Sarbanes-Oxley?

Sarbanes-Oxley [the accounting-reform act passed in 2002] is one of a number of attempts over the years by the government to make it less likely there would be financial fraud. But if you think there's no incentive to play games with accounting today, then you're in a dream world. There's complacency, and that's when bad stuff happens.
Before we start discussing specifics, keep in mind, first, that these examples I give may not be a violation of the law or even a technical violation of the accounting rules. Second, auditors are important. I recently had lunch with a veteran auditor, and to any accounting problems I described to him, he replied: "Was it disclosed? If it is disclosed, then we did our job." A company might change its revenue recognition that took a loss to a profit—but the auditors' concern is disclosure. Who is sitting there reading footnotes? People are making their decisions on a press release or a database. In general, the auditors' focus is on a legalistic interpretation. So, if you tied up your neighbor and robbed his house, but you disclosed it in footnote No. 23, it's okay.
In the fiscal year ended June 2010, Ulvac, a semiconductor-equipment company, changed from straightforward revenue recognition, under which revenue is recognized when a product is sold and delivered, to percentage-of-completion accounting. The latter is part of generally accepted accounting principles (GAAP), but isn't meant for every company. It's more used by construction firms, among others, where parts of a project are completed over time. So this company, which always used an appropriate revenue recognition method, turns on a dime in a year when business is very weak and says: 'Now would be a good time to move to percentage-of-completion. Wow, we pick up revenue as the production process is ongoing. How cool is that?' 
This is a semiconductor-equipment maker. We are not talking about a five- year construction period for what it does. It helps Ulvac by allowing it to pick up revenue much earlier [then it otherwise might have]. In fiscal 2010, Ulvac reports that their sales are down 1% and profits up 38%. But the fine print in the footnotes says they changed their revenue-recognition, and that in the absence of that change, sales declined 21%, and they would have had a loss. It should say: 'We had a 21% decline in revenue from sales to customers, yet because we had a 20% increase in revenue from changing our accounting, we could still report that sales only declined 1%.' 

Another example

At the beginning of 2011, Rakuten disclosed that it had changed its depreciation method from the straight-line method to the declining-balance method. Over the life of the asset, depreciation will basically be the same number. Straight-line depreciates an equal amount to each period; the other takes bigger deductions in the early years, and small ones later on. In U.S. dollars, that change added $13 million to Rakuten's operating profit, through a lower depreciation expense. Is there any place in the GAAP rule book that says: 'Thou shall never change your depreciation method?' No. But, in my interpretation, that stinks. It had nothing to do with selling additional products or having stronger margins.

Let's move to China.  
China Yurun Food Group is a meat company that is taking gains on asset acquisitions, instead of on asset sales. You can't do that in the U.S. or under International Financial Reporting Standards (IFRS).
When you buy a company, if you pay more than its fair market value, you have to put goodwill on your books; conversely, if you pay less than fair market value, you put negative goodwill on your books. If you buy the asset at a big discount to fair market value, the negative goodwill is not going to be picked [as a gain] immediately under U.S. accounting rules. But in Hong Kong, they let companies pick up that negative goodwill immediately, as operating income.

Yurun drove a Mack truck through that accounting [loophole]. It appraised asset values much higher than what I believe is a reasonable fair market value. In fiscal 2010, Yurun made three acquisitions using appraised value at what I believe were inflated fair market values, and they took an immediate gain of 186 million Hong Kong dollars (about $24 million). They understood that the accounting allowed them to book a gain, which represented the difference between what they paid—in most cases, a tiny number—and what the appraiser says it's worth. [The company] got a good deal on all of these acquisitions, and accounted for it with negative goodwill. What the assets are really worth, we don't know. It's as if you bought a condo in Miami for $400,000, and it was worth $1 million before the housing crash.
So, on the day you buy it, you [report that you've made] $600,000. But you don't book income, whether it is sales revenue or investment on securities, on the day you buy the asset; you do it on the day you sell it. The most logical way to express it is that there is a connection between revenue and income when cash comes to you, not when cash is being spent. The more the appraiser says this thing is worth, the more enormous the opportunity for gains. This [type of] accounting is also used in Japan.

How about some domestic examples?

Green Mountain Coffee Roasters(GMCR). In past quarterly statements, such as the third quarter of fiscal 2010, the company made a point of things like 11 consecutive quarters of 40% net sales growth and 24 quarters of double-digit growth. If you do some compounding, the numbers start to get enormous.
There were two important changes in the footnotes describing its accounting policies over the past five years or so. In 2007, Green Mountain recorded revenue when the product was delivered to the customer. Then, it gave rebates; For example, if you buy 1,000 of those little K-Cups, they may give you a 5% rebate. They accounted for rebates as a reduction from gross sales. Fine. Then, when they started having difficulty getting to that magical 40%—this is my interpretation—the revenue-recognition wording in the footnotes became longer; in some cases, revenue was recognized upon shipment. That's not the same thing. Then, instead of treating the rebates as a reduction to sales, in some cases it was treated as an operating expense. Now, my friendly auditor will say: 'They disclosed it all.' But investors would say: 'That stinks.'

Because it flatters sales growth?
When you are telling me the business is still booming, but in order to make that assertion, you changed how you are accounting, that's just not fair play. Is it illegal? No. The auditors signed off on it. But the auditors are part of the problem.
For the fiscal year ended September 2011, Green Mountain reported net income [at] a shade over $201 million before items, up from almost $80 million [a year earlier]. Compare that to the cash flow from operations from that same year. Both measure the business's profitability. Cash flow from operating activities was $790,000 in fiscal 2011, versus a negative $2.3 million in 2010. That is a huge difference. The quality of earnings here looks suspect, because the cash flow should follow along with the net income.

Any other examples?
A recent interesting change to accounting rules was related to earn-outs [payments to the seller] in acquisitions. In the accounting, the acquirer debits intangible assets and credits something called a contingent consideration liability, which is the present value of what you expect to pay for the earn-out from the acquisition. It's a soft number, because in the case of drug companies, for example, buying research and development, you don't know if you're going to be able to get the regulatory approvals [for these products to come to market]. There are many hurdles along the way.

 Mylan(MYL), a generic drug maker, in December acquired the rights to a Pfizer (PFE) inhalation technology platform for $348 million. The deal included rights of negotiation for certain Pfizer compounds in various stages of development. Acquirers on a regular basis reassess whether that number is correct. In the fourth quarter, Mylan recorded an earn-out liability of $376 million, most of which is related to the Pfizer deal. That was enormous, compared with the cash it paid in the acquisition, about $22 million. If the numbers were flipped, where they paid close to $400 million, and then there could be another 5% on the table or 10% for the earn-out, that would seem to be reasonable. But here, almost everything is non-cash.
What's the advantage of that?
Let's take a hypothetical scenario: A year from now, approvals don't come, or there are delays. Mylan knocks the contingent consideration liability down to $300 million, from $376 million. Perfectly reasonable.
What's the bookkeeping entry? You have to reduce your contingent consideration liability by $76 million, and you put that amount as a credit to income. You have created, out of thin air, a possibility of bleeding back into income some $376 million. You control the timing of it. Mylan obviously ran this through with the auditors. It is a stupid accounting-rule change.
I'm teaching people to watch for these earn-outs, and look at their accounting for the contingent liability. This could be the big abuse in the next few years, because abusive practices very often stem from accounting changes.

So, what's the lesson?
Don't let your guard down. If you are buying individual securities, you have to do some work. If you don't have the time or the interest or the expertise, buy an index.

What's your perspective now that you are back in the business? Will the next big accounting scam be outside the U.S.?
Frankly, there will be big ones in every market. It's partly human nature. It becomes more and more difficult for the auditors to stop, because the accounting rules across the world were largely written 50 years ago, in an industrial society. As the business models have changed, the accounting rules haven't really been rethought for certain type of transactions.
My goal is to find the companies where there is a disconnect between the underlying economics and how the company presents them, using whatever accounting they choose. Many times, it is completely legal, and in accordance with the rules. But the auditors interpret the rules a certain way, and don't have the imagination to just ask: "Does this reflect the underlying economics of the company?"
Here is how the auditors look at the world: They think of themselves and their legal liability issues first; if it's in the rule book and disclosed, you are covered. Second, they think of their clients. The client asked them to do something, and they want to please the client. A very distant third is they may occasionally ask: How does this look from the perspective of the investor? Investors would be astounded if they realized that this is how the party that is supposed to protect them views the world.

Tuesday, 21 January 2014

1999-IBM's Accounting Method Faces Scrutiny

Does an accounting strategy make the world's largest computer maker look more efficient than it really is?
On first blush, this year's results at IBM suggest it has become a tightly run ship. With revenue growing just 12% to $63.4 billion for the nine months to Sept. 30, operating income rose a heady 53% to $8.9 billion. A major factor: Reported operating expenses fell by more than $1 billion.
Louis Gertsner, IBM's chief executive, cited "strong expense management" as helping to fuel third-quarter gains -- and as a reason to expect better results to come. IBM's shares, which fell $1.6875 to $106.1875 at 4 p.m. on the New York Stock Exchange Tuesday, have nearly recovered from the drubbing they received after the earnings announcement last month, when revenue failed to meet analysts' expectations.
But some accounting specialists and analysts, scrutinizing the footnotes, now are raising questions about IBM's unusual treatment of one-time gains. At issue: IBM booked about $4 billion in such gains from the sale of its Global Network business to AT&T Corp. during its second and third quarters. The gains were included in selling, general and administrative expenses, or SG&A.
Translation: Reported costs were lowered. And reported operating income was raised.
The issue is important on Wall Street. This is because operating income --which excludes taxes, interest and other items that have little to do with success in making and selling products or services -- is often more important to investors than net income, and widely regarded as an indicator of how well management is running the shop.
In a new report, accounting watchdog Howard Schilit says IBM should be "roundly criticized for its policy of bundling one-time gains and other nonoperating activities into operating income." SG&A expenses, he says, should be "just that" -- and shouldn't include one-time charges or gains that don't reflect operating performance. Mr. Schilit's reports on such matters have a close following among money managers.
An IBM spokesman says it has been putting one-time gains and charges into SG&A since about 1994 and categorizes such items as "general" expenses.
IBM, Armonk, N.Y., has disclosed the dollar value and impact on earnings per share of the charges in the text accompanying its earnings releases, the spokesman said. The gains in both the second and third quarters were partially offset by unrelated charges, such as write-downs of other assets also included in the SG&A line.
Instead of the $8.9 billion IBM reported in operating income for the first nine months, Mr. Schilit estimates it would have reported $6.5 billion without the AT&T gains and other one-time items reflected in the SG&A line. In the third quarter, he estimates the boost to operating income was $758 million.
The IBM spokesman declined to comment on the analysis.
IBM's practice of defraying operating expenses with gains makes it difficult for investors and analysts to quickly work out the company's true performance, said Gary Helmig, an analyst with SoundView Technology Group. But he says it doesn't matter to the bottom line -- and thus, isn't that important.
But that isn't necessarily the bottom line with federal regulators. According to Securities and Exchange Commission regulations, companies should include gains from material asset sales in a line-item called "non-operating income" that sits below operating income, says Paul Kepple, a senior accounting fellow at the SEC. The $4 billion gain IBM booked "would seem to be material," and thus should "generally" be treated as a nonoperating item, Mr. Kepple adds.
Meanwhile, the Financial Accounting Standards Board, the body to which the SEC delegates accounting standards, doesn't offer guidance about the proper place to record such gains as asset sales, according to Robert J. Laux, a FASB industry fellow. But Mr. Laux says companies generally break out such items below the operating income line.
Mr. Helmig says after IBM released its third-quarter results last month, he suggested to company officials they break out the figure so it would show operating income minus the one-time gains and charges. He says he received no response. The IBM spokesman declined to comment.
The gains and offsetting charges are explained in footnotes and management discussion sections of IBM filings with the SEC. But Mr. Schilit, who runs the Center for Financial Research and Analysis, a Rockville, Md., accounting-research organization, says without a discrete line item for such one-time items, investors could have a hard time evaluating IBM's financial performance. Mr. Schilit calls IBM's practice "pretty unusual" and says it doesn't conform to what most other companies do.
IBM's practice "muddies the water," Mr. Schilit says, and causes investors to "lose confidence when we look at the company's operating income in future periods."
He predicts some investors might be more skeptical when reading future IBM earning releases, asking themselves: "Is that really the company's operating income?"

1998-America Online's Fancy Accounting Methods

Not for the first time, high flying America Online is using fancy accounting methods, creating dollops of extra earnings that carry the stock higher.

The provider of on-line services has assured analysts that it has its auditors' blessing for a controversial, seldom-used sale-leaseback transaction that accompanied a $430 million asset swap in January. America Online also has persuaded Wall Street to accept an unusual rationale for treating some capital gains from stock sales as regular earnings. 

 Says Lennert Leader, chief financial officer, "The Internet group of companies is doing business in very new ways that have not been tested in terms of business norms and accounting. We really are out there on the cutting edge having to pioneer new territory."

For some, however, the issue rings alarm bells. In 1996, America Online had to write off $385 million of deferred marketing costs, erasing many quarters of past profits. In 1997's fourth quarter, after AOL adopted what it called gold-standard accounting policies, the Securities and Exchange Commission forced it to make $32 million of accounting adjustments.

"Having fessed up, it seems to me they would be the last type of company that would want to raise red flags again. But this leaseback transaction does raise flags," says Paul Brown, chairman of the accounting department at New York University's Stern School of Business. He is co-editing a textbook that will feature America Online's earlier mishaps.

This year's leaseback transaction will contribute five cents out of 19 cents a share of estimated profit for the June quarter, calculates CIBC Oppenheimer analyst Henry Blodget. But he adds, "In our opinion, it's not an example of them cooking the books."

At issue is how America Online should account for the sale of its ANS Communications network-services unit to WorldCom in January. Essentially, America Online swapped ANS for CompuServe's on-line division, which it valued at around $280 million, plus nearly $150 million in cash. It also contracted to use ANS's services for another five years.

If ANS had been sold outright, America Online would have had to report an outsize one-time gain of roughly $380 million, which, of course, wouldn't have helped future earnings. Analysts generally disregard one-time gains in valuing stocks.

But by treating the transaction as a sale-leaseback, the company can spread the gain over five years, getting it into operating income. Profit thus will rise about $76 million a year, or 20 cents a share. It is common to sell and lease back hard assets such as buildings or railcars. But several accountants said they had never heard of anyone doing that with a whole company.

In fact, SEC rules allow the sale-leaseback of an operating company if -- as America Online is doing with ANS -- the seller continues to use the operating company's services. "The sale-leaseback transaction is somewhat unique, but our auditors advised us that this is mandatory accounting," Mr. Leader says.

Another issue is how analysts should treat America Online's stock profits. In the quarter ended Sept. 30, AOL showed four cents a share of gains on the sale of stock in Internet search firm Excite that it held in its portfolio. The gains were treated conventionally, as nonrecurring earnings that didn't add to operating profit.

But in each of the two latest quarters, America Online encouraged analysts to include in their earnings calculations two cents a share of gains on the sale of stock and warrants.

How come? In doing business and forging alliances on the Internet, AOL sometimes takes a company's stock as payment. It took stock instead of cash in a marketing agreement with Excite about a year ago. AOL quite reasonably considers such stock-sale gains "payment for services rendered," says Friedman Billings Ramsey analyst Ulric Weil, an AOL bull.

Financial officer Mr. Leader notes AOL didn't report any capital gains as part of operating income. But it did try to educate the Street that certain stock sales would be a normal event -- used, he says, "to offset investment losses and other expenses."

Unluckily for the many bears, America Online remains richly priced. At 77 3/8 Tuesday, its stock trades at 86 times estimated profit of 90 cents a share for the coming fiscal year starting in July.

Says analyst David Simons of the Internet research firm, Digital Video Investments: "Bullishness tends to have a blind eye about quality of earnings."

Monday, 20 January 2014

Not Quite The Last Word

When a company is accused of wrongdoing, who can it call to help repair its reputation?

These days, the answer has often been Gary G. Lynch, the former director of enforcement for the Securities and Exchange Commission. In 1994, Kidder, Peabody & Company chose Mr. Lynch, who is now a lawyer at Davis Polk & Wardwell, to look into whether one of its bond traders, Joseph Jett, created $350 million in phony profits. Bausch & Lomb Inc. recently asked him to investigate some questioned accounting practices. And in July, Mr. Lynch completed an investigation for Mattel Inc. into accusations that it was inflating its earnings.
The hiring of an outside lawyer to conduct an independent investigation is seen as a signal that a company accused of wrongdoing is committed to getting to the bottom of the situation. And Mr. Lynch, whose high-profile career at the S.E.C. involved bringing cases against Michael R. Milken and Ivan F. Boesky, lends a company not just his expertise in finding the facts but a golden reputation for integrity.

''Gary has an enormous degree of credibility with government officials,'' John M. Liftin, a senior vice president and general counsel for Kidder, said. ''They believe him. They trust him.''
But as much as companies would like the public to believe otherwise, Mr. Lynch's reports, which cleared top executives at Kidder and Bausch & Lomb, and exonerated Mattel, are not necessarily the last word. Critics note that Mr. Lynch was representing Kidder in a case against Mr. Jett even as he was conducting his fact-finding inquiry. Bausch & Lomb's board kept Mr. Lynch's report under wraps. So did Mattel, whose accusers objected that Mr. Lynch too readily shared information with Mattel during his inquiry.
While there is no evidence that Mr. Lynch failed to uncover the truth in these cases, experts say that independent investigations like Mr. Lynch's, even the most thorough and objective, are still no substitute for Government inquiries or court proceedings.
''There are certain inherent limitations on any effort,'' Richard C. Breeden, the former S.E.C. chairman, said.
Mr. Lynch strongly defended the quality of his work. ''I've worked very long and hard over a number of years to earn my credibility,'' he said. Although he declined to discuss the inquiries in detail, saying he was not authorized by his clients to do so, Mr. Lynch said that he would never do anything to ''tarnish or compromise'' his reputation.
Mr. Lynch is just one of several former Government officials whom companies have hired in hopes that these people's good names will help restore sullied corporate images. The group also includes Lynn Martin, a former Secretary of Labor; Griffin G. Bell, a former Attorney General, and Harvey Pitt, a former counsel at the S.E.C.

''Sometimes you do have to choose a name player to regain the credibility that has been stolen from you by the alleger,'' said Peter B. Frank, the vice chairman of Price Waterhouse L.L.P., which has helped companies look into charges of wrongdoing.
But critics say that a good name alone is not good enough. Shareholders and prospective investors are left at a loss to assess the quality of any inquiry, they say, unless important information about how an investigation was conducted and how the conclusions were reached is also disclosed. ''The idea that somehow the name alone is the answer is foolishness,'' said Neil V. Getnick, a lawyer in New York who has helped draft a series of guidelines for independent investigators.

''An investor,'' agreed Ralph V. Whitworth, a prominent shareholder advocate, ''can't find comfort in just the reputation of the investigator.''
Problems can arise because management may seem to have too keen an interest in the outcome or the investigator may appear to have a conflict that could affect his conclusions. Inquiries also vary greatly in quality, depending on the resources and latitude given the investigator.
''A lot of what is called an independent investigation is really advocacy,'' said Edwin H. Stier, a lawyer in Washington and in Bridgewater, N.J., who has conducted many of these investigations.

Mr. Lynch said he did not dispute the idea that his findings must often stand up to someone else's scrutiny, either that of regulators or of private plaintiffs' lawyers. ''In many instances, the results are tested in one way or another,'' he said. ''That's certainly their job to do it.''
Each of Mr. Lynch's investigations illuminates different points in the broader debate.
In the Kidder case, Mr. Lynch raised eyebrows because he conducted his investigation at the same time he was representing the brokerage in its arbitration case against Mr. Jett. ''The role of advocate and umpire is in tension,'' said John C. Coffee Jr., a professor of securities law at Columbia University.
Kidder, which was then a subsidiary of General Electric, filed an arbitration case in April 1994 with the New York Stock Exchange, asserting that ''Mr. Jett had been engaging in a scheme that created phantom profits.'' As Kidder's lawyer in the case, Mr. Lynch was required to serve as an advocate for the firm's views, which were that Mr. Jett acted alone and that Kidder was the victim of his actions.
Mr. Lynch said there was never any pretense that his inquiry, which he concluded that July, was purely independent, since Kidder had hired Davis Polk to represent it in the case against Mr. Jett. He described the inquiry as ''thorough and objective.''
And Mr. Liftin, Kidder's counsel, dismissed arguments that Mr. Lynch was wearing two hats at the same time. ''We don't think there was any conflict of interest,'' he said. ''I never took any of that seriously.''
Like any outside counsel, Mr. Lynch's investigation of Kidder was handicapped by his inability to subpoena documents or force the parties involved to talk and to punish them for lying. Mr. Jett, for example, refused to be interviewed.
Some questions arise, however, from what was left out of Mr. Lynch's 85-page public report. He concluded that Mr. Jett acted alone. But some interviews, disclosed in subsequent S.E.C. proceedings, at least raised a doubt about whether others at Kidder knew what Mr. Jett was doing and countenanced his actions. For example, according to notes from a Davis Polk interview, David Bernstein, who served as an assistant to the head of the fixed-income division, described the trading profits as ''not really false profits, rather advanced profits.''
''We didn't view it as false, just accelerated,'' he was quoted as saying.
The lawyer for Mr. Jett, Kenneth E. Warner, said, ''My client is an innocent man, and the report was grossly unfair to him.''
Mr. Lynch stands by his report. ''There is nothing in any of the interviews that is inconsistent with the facts,'' he said. And the S.E.C., which conducted its own investigation, essentially supported Mr. Lynch's conclusions and found that Mr. Jett's superiors were not responsible for anything but a lack of proper supervision. It has been two years since Mr. Lynch finished the investigation, and, he said, ''the conclusions in the report hold up extremely well.''
Mr. Lynch estimated that his firm billed Kidder for roughly 10,000 hours of work on the investigation, which, if billed in a conservative range of $200 to $300 an hour, would mean that Kidder may have spent $2 million to $3 million for legal services.
In contrast to the Kidder report, the Bausch & Lomb case raises questions about whether outsiders can trust an inquiry that remains largely cloaked. Mr. Lynch, who was brought in last fall to conduct an independent inquiry concerning accounting irregularities, reported directly to a special committee of the board, which was made up of independent directors. When he completed his investigation, most of what the public was told was contained in a few paragraphs in a company news release.
''The Special Committee found no evidence that any executive officer of Bausch & Lomb participated in or was otherwise aware of the irregularities that led to the restatement or any other irregularities within the scope of the Special Committee's review,'' the April release said. Earlier, the company restated its 1993 and 1994 financial reports.
But experts question whether such limited disclosure is enough. ''A report has value,'' Mr. Stier said, ''only to the extent that it can withstand attack from all conflicting opinions.''

In fact, Mr. Lynch did not actually write a report. Bausch & Lomb's board, which continues to be under investigation by the S.E.C., chose to have Mr. Lynch explain his findings orally. In general, such oral reports ''would have much less utility,'' Richard H. Walker, the general counsel for the S.E.C, said.
Neither Bausch & Lomb nor Mr. Lynch would comment on why there had been no written report.
''I've never seen a blue-ribbon panel do an investigation, make a report and then have nothing in writing,'' said Matthew Fusco, a lawyer who represents some shareholders in a suit against the company.
The other question that arises in such cases is just how independent the investigator is from management. In the Mattel case, Mr. Lynch reported to the board's audit committee about his investigation of charges by a former employee, Michelle Greenwald, that the company improperly accounted for certain transactions. When he finished in July, the committee issued a news release stating that the inquiry ''found no evidence that Mattel accounted for sales and costs associated with sales in a manner which is inconsistent with generally accepted accounting principles.'' and that the company's accounting of certain royalty payments also conformed to those principles.
But questions were raised by Mr. Lynch's decision to forward quickly to Mattel officials a letter from Joel M. Kozberg, Ms. Greenwald's lawyer, outlining concerns about the investigation and referring to additional evidence. Mr. Lynch denied doing anything improper at the time, and Mattel said the letter was sent to it simply for follow-up. ''We saw this as entirely appropriate,'' said a company spokesman, Glenn Bozarth.
But Mr. Lynch's move, critics say, raised questions because the letter appeared to have been sent without Mr. Lynch's first examining it. ''It's something that should not happen,'' Barbara Ley Toffler, head of Arthur Andersen & Company's consulting business on ethics, said in an interview earlier this year.
The company released Mr. Lynch's findings a few days after receiving the letter.

Since details of the investigation were never disclosed, it is also unclear how Mr. Lynch arrived at his conclusions. There appears to be some contradictory evidence, including a summary of a slide presentation given by a Mattel executive, which describes two quarters of results as ''manufactured,'' according to an internal memo obtained by The New York Times. Another internal Mattel document called for the company to develop better systems to account for product-related costs associated with certain sales tactics.
While companies can always choose to conduct an internal inquiry, hiring an outside lawyer for an independent investigation calls for further safeguards, experts say. Not only is it important to emphasize the investigator's need for independence and an array of skills, as called for in the guidelines set forth by Mr. Getnick, but companies are also likely to find that investors and other interested parties will expect a fair disclosure of much of the evidence found during the inquiry.
''The most important thing,'' Mr. Pitt, the former S.E.C. counsel, said, ''is to restore confidence, both internally and externally.''