SAN FRANCISCO - Richard C. Kovacevich has a dispute with the accounting rules, and he wants people to know about it.
"There's a lot of funny accounting going on that I believe hand-ties management in doing what's in the best interest of stockholders, and certainly gives information for stockholders that is simply untrue," the Wells Fargo & Co. chairman and chief executive said Wednesday during a spirited interview at his San Francisco offices.
Venture capital investing - and rules governing its accounting - are the basis of his frustration.
Over the years Wells Fargo made venture capital investments in private companies - most of them in the technology sector - that ultimately converted into big public stock holdings when they were acquired by publicly traded companies. The banking company reported big gains because of that trend, including gains of $721 million in the fourth quarter of 1999 and $885 million in the first quarter of last year.
Then, the Nasdaq stock market bubble burst, taking the value of Wells Fargo's public stock holdings down with the rest of the market. By early last month Wells management acknowledged that this drop was, in accounting parlance, "other-than-temporary." Last week Wells reported a $1.1 billion writedown for the second quarter for its public and private investment portfolio.
That's called an "accounting phenomenon," Mr. Kovacevich said.
Of course, Wells Fargo was not alone in its suffering. PNC Financial Services Group Inc., J.P. Morgan Chase & Co., and other financial companies also reported big writedowns in their direct investment portfolios.
However, Wells is one of a few banking companies that uses an accounting method allowing it to hold public securities on its balance sheet in a category called "available for sale." Theoretically, that accounting treatment insulates the income statement from market-related fluctuations, because it eliminates the need to constantly mark investments to market value.
But 1991 guidance from the Financial Accounting Standards Board, called EITF 91-5, still requires Wells Fargo to make income statement adjustments if its stake in a private company is exchanged for public securities. At the time of the exchange, which for Wells occurred when some private companies were acquired by public companies, it had to record the value of those shares on the income statement. When the values of those shares declined, it had to record the writedown, again on the income statement.
That put the company in the same camp this quarter as some big technology companies with venture capital arms. Microsoft reported a writedown of nearly $4 billion in its securities portfolio.
"We have expressed and continue to express that we think this is not good accounting, that it's not consistent with the way we have run the portfolio in the past," or the way Wells runs it now, Mr. Kovacevich said in the interview.
In fact, sending this message to the accounting profession will be one of the first jobs of the new chief financial officer, Howard Atkins, who will take the reins Wednesday after five years at New York Life Insurance Co.
(Wells Fargo's current chief financial officer, Ross Kari, announced his resignation and is planning to join a venture-backed wealth advisory firm next month. The company said the change is unrelated to the second quarter venture capital writedown.)
The crux of Mr. Kovacevich's complaint with EITF 91-5 is that Wells Fargo never should have been forced to show even the gains from investments on its income statement until it sold the securities.
Those unrealized gains belong on balance sheet instead, he said. When a gain is recorded on the income statement for "most investors, especially the unsophisticated, they really think you made money."
The current accounting rules make reporting misleading, said Mr. Kovacevich, because Wells never lost real money - just what he calls "funny money."
For example, it invested $11 million in Cerent Corp., which was acquired by Cisco Corp. in the fourth quarter of 1999. After selling a "few hundred million" shares in Cisco stock last year, the value of Wells Fargo's holdings in the company is about $230 million, Mr. Kari said. In other words, the investment is still in the black.
But Wells Fargo had to write down the value of the investment from the level recorded in the fourth quarter of 1999, when its private equity investment converted to publicly held Cisco shares.
Mr. Kovacevich argues that if a company must include the value of its public securities holdings on its income statement, then those "marked-to-market" values should reflect what the company could get if it were to sell those shares that day and take into account any restrictions it has on selling the stock.
For instance, Wells asked investment banks how much it would get for its stock in Redback Networks, which it inherited when Redback bought Siara Systems. If some investor would buy the whole lot, which was unlikely, the deal would have come at a great discount - perhaps as much as 70%. But accounting regulations defined the holding's marked-to-market value as the number of shares times their trading price, with any discount hovering around 10%.
Mr. Kovacevich challenged skeptics to call the company's auditors "if you want to verify how resistant we were to writing this stuff up."
The American Bankers Association hasn't heard much noise from its members on accounting for venture capital investments. The banking industry fought the underlying thrust of FAS 115 towards fair value accounting, but mostly because banks hold debt securities.
"We didn't want mark-to-market accounting" for securities that might be sold at some point in the future, but not immediately, said Donna Fisher, director of tax and accounting.
And for the most part, Wall Street analysts separated the big gains banking companies made in their venture capital investments during the bull market of the late 1990s in trying to get at their core earnings.
But after Wells issued a pre-earnings announcement of a venture capital-related charge on June 6, many analysts acted as though the business were a core business, and they reduced their earnings estimates for the year.
Mr. Kovacevich has been at pains to point out that Wells Fargo offset large venture capital gains a year ago with one-time expenses, like spending on Internet or merger integration.
Some analysts aren't buying it. In a research noted subtitled "Another Headache-Inducing Quarterly Report - Normalize This!" following Wells Fargo's second quarter earnings report, Nancy Bush of Ryan Beck & Co. wrote: "The loss of $1 billion-plus is never a small matter, whether it's a non-cash charge or not. (VC gains sure financed a lot of cash spending last year)."
