SEC’s Jack Booted Thugs

It should come as no surprise that the game industry is under the microscope again, and as usual it's not a good thing. What is unusual is where the pressure is coming from this time around.

The industry has often been criticized in the past, normally with much fanfare. I personally remember Texas Senator Kay Bailey Hutchison at a hearing waiving a copy of Doom in the air and promising a first amendment fight to restrict game sales. This was in the days following the shootings at Columbine High School after it was learned that the kids who did the killings played Doom. At E3 that following year, most of the violent games were put behind closed doors and there was a palpable fear in the air that regulations may soon follow.

Game Industry News even offered to sponsor a forum at the show about violence in computer games to get the topic more out in the open, but we were turned down by show organizers who preferred to keep things quiet that year.

And the IDSA, the trade group that represents most of the companies in the industry, seems to be constantly fighting battles to overturn local laws forcing arcade owners to put curtains around violent games or stipulating jail time for store owners if a minor purchases violent computer games from a local shop.

But these fights are all very well documented, and of course the Constitution of the United States is almost always in the industry's corner. So though these fights occur all the time, they are winnable. Or they just seem to disappear once the fervor of the moment dies down. We are just talking about games here after all, not weapons of mass destruction.

This week however a threat has emerged from a different and much scarier corner. The Securities and Exchange Commission has launched an investigation into the accounting practices of the game industry. And if you don't think the SEC is a powerful foe, why don't you ask some of the formerly rich vice presidents at Enron how fast the SEC can bring somebody down.

We are not saying anyone did anything wrong. The investigation apparently just started and hopefully they will find nothing wrong and we will all go back to work. But if the SEC is sniffing around, there must be smoke somewhere.

The SEC has "requested information" from some of the largest companies in the industry. Activision, Midway, Acclaim and THQ have all been told to hand over their financial records. Only Activision was willing to say what the investigation was about. In a disclosure statement they said that it was "focused on certain accounting practices common to the interactive entertainment industry, with specific emphasis on revenue recognition."

We talked to inside sources at one of the companies involved to get a deeper meaning. They were willing to chat, but asked that their identities be withheld. Basically there is a common practice in the industry that when a game is shipped by the distributor to the stores, that it is reported as revenue. Where there are problems is if the game does not sell very well, it is returned by the stores. Then you have a situation where you have reported sales figures, but did not actually sell the game because it was returned. Publishers are supposed to estimate the number of returns on their statements and revise those numbers if necessary.

THQ may actually be to blame for bringing attention to the industry. Last summer they were forced to revise their revenue statements for seven quarters because of problems with returns. So this could just be a case of the SEC taking a look to make sure the other companies are not making mistakes on their estimates. We asked the SEC to comment, but they declined.

So there is really not much for us to do but sit back and wait. Our hope is of course that the SEC will find nothing wrong and if they do, it will be something minor and the companies can issue corrective statements, much like what happened with THQ. The fact that the largest company in the industry, Electronic Arts, has apparently not been asked for its records is more proof that this may just be a fishing expedition by the SEC.

It is worth noting however that if companies are found to be fudging their records, especially if it is a conscious effort to deceive, that it is a crime against not just their stockholders, but against the industry in general. Since the anti-game lobby has sprung up, the industry has done an admirable job of circling the wagons to keep the wolves at bay. Between first amendment fights and more responsible advertising plus the inclusion of ESRB ratings on just about every game, the industry has done a lot to become more responsible even as the violence level in most games increases.

But to open the industry up to financial criticism is really unforgivable. We can't really protect ourselves from that. Remember that Al Capone was a very violent man who killed a lot of people, but what brought him down was not murder, but the fact that he did not pay his taxes. Almost everything is forgivable when money is not involved.

With that said, I do want to say that I believe that the companies involved are doing nothing wrong. We have worked with most of them for over six years and have been tracking their stocks on the GiNDex for just as long. If there was really an industry-wide effort to deceive, I am pretty sure we would have heard about it before now. The fact is that almost everyone we have ever encountered in the industry has been a top notch professional and honest to boot. That stock prices are only down slightly, even with an ongoing SEC investigation, shows that most investors probably feel the same way.

Let's just stay the course for now and see if the SEC comes up with anything. My bet is that they don't, though GiN will be sure to stay on top of the story as it develops.

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