Intuitive Surgical, Inc. (ISRG)

• In our opinion, the shares of Intuitive Surgical deserve a sizable market discount for the potential risk this company's disclosure practices introduce to investors.
• Prior undisclosed internal and SEC investigations were found concerning the "potential manipulation of the number of procedures".  Procedures are a metric regularly touted by management.
• The long-serving auditor (since 1996 - 18 years) declined to stand for re-election in February. 
• A more recent undisclosed SEC probe, potentially dating back to at least Dec-13, was confirmed as on-going in July.  

Maintained on Watch List

Facts of Interest or Concern:

No disclosures of SEC investigative activity were found in this company’s SEC filings back to 2011. The internal investigation by ISRG into the number of procedures (discussed below) was also not disclosed.

• 21-Jul-2014:  In response to our administrative appeal, the SEC confirmed an “on-going enforcement proceeding” for this company.  We first learned of possible investigative activity involving ISRG in Dec-2013, over 8 months ago. We first wrote on the possibility of an undisclosed SEC probe in a Watch List Update on 04-Jun-2014.  The SEC refuses to disclose details about this investigation. 
   
• 19-Dec-2013, 04-Feb-2014, and 23-Apr-2014: The SEC cites the "law enforcement exemption" of the FOIA as basis to deny public access to the detailed records we sought on this company.  As a matter of law, they are acknowledging some sort of investigative activity.  These SEC responses combine to suggest the investigation confirmed in Jul-2014 has been running since Dec-2013, perhaps longer (over 8 months).  We filed administrative appeals to challenge these three denials.  A single response to all three appeals was received in Jul-2014 (see above). 
   
• Feb-2014: Ernst & Young declined to stand for re-election as auditors for ISRG.  They were the company's auditor since 1996 (18 years). No reason was found.
   
• Oct-2011 to Feb-2013:  There was an undisclosed SEC investigation of almost 16 months into the number of procedures.  An SEC letter obtained by Probes Reporter that was sent to counsel for ISRG in Oct-2011 refers to a company internal investigation into, “potential manipulation of the number of procedures reportedly being conducted using the Company’s da Vinci Surgical Systems” [emphasis added, excerpt below, full document posted].
  
  
  
  We do not know when the ISRG internal investigation began, why it started, or how long it lasted.
  
  Importance of "Procedures" as a Metric for ISRG
  
  The words "procedure" or "procedures" appear 73 times in the transcript for the ISRG earnings conference call that took place in Oct-2011.  In the most recent earnings conference call, in Jul-2014, these words appeared 81 times.  By contrast, in the Jul-2014 earnings call for Ford Motor Company (F), words beginning with "auto" or "truck" appeared 34 times.
  
  The Role of a Whistleblower
  
  For the 2011-2013 investigation into procedure numbers, the SEC relied in part on information from a whistleblower that the agency declined to identify.  The SEC also provided us with a letter sent to the company in Jan-2013 informing it that the investigation was over and no enforcement action was recommended.  That letter and an SEC “Case Closing Report” from Feb-2013 are posted.  As is standard practice (which we think harms investors and violates the FOIA) the SEC denied public access to a report that summarizes what took place in this closed probe.
   
• Key personnel at the time of the investigations in 2011 are still there today.  According to the proxies filed Mar-2011 and Mar-2014, there have been no changes in the persons filling the roles of Chairman, CEO, CFO, General Counsel, Audit Committee Members (and their respective positions on that committee), and EVP - Worldwide Sales and Marketing.

Our Take: 

Now that investors know an internal investigation and protracted SEC probe into potential manipulation of procedure numbers was kept from them in the past, they have every reason to be wary of the undisclosed SEC investigation we recently confirmed at ISRG.  This is true even though, again, we do not know what the recent matter is about.  We do know the same people are in charge today.  

Anytime an auditor declines to stand for re-election is cause for concern, especially a long-serving one.  Given this company's SEC investigative history, and present-day risk in this area, the departure in February of Ernst & Young should certainly raise an eyebrow.  Again, E&Y was in place since 1996.

As noted above, references to “procedures” appear repeatedly in company conference calls.  To our view that makes this a material metric.  The fact management did not disclose the company’s internal investigation or the 16 month SEC investigation into potential manipulation of this closely-followed metric is not likely to sit well with investors.  It shouldn’t. 

We do not necessarily criticize management for not initially disclosing the existence of the internal investigation.  It could have been unfounded; gone nowhere.  If anything, some might argue management and the board should be applauded for taking this metric seriously.  We agree, to a point.

Once the SEC became involved both its probe and the internal investigation should have disclosed.  This wasn’t some arcane pension expense calculation the SEC was looking into.  It was an investigation into potential manipulation of widely followed, closely scrutinized metric regularly cited by this company.  That it took a confidential source to bring this to the attention of the SEC – and the SEC took the source seriously enough to open what became an investigation of nearly 16 months – should give investors pause.

Finally even when the SEC closes investigations without taking enforcement action, as happened here, there still can be consequences for investors later.  Just as the instinct is to pull your foot off the gas when seeing a police car on the highway, SEC pressure can trigger similar reflexes inside public companies. 

For example, SEC scrutiny of a public company can bring about internal changes in practices, accounting, internal controls, and/or even additional auditor scrutiny. Any of these could result in negative surprises to investors later.  Companies once seen as high fliers can inexplicably start missing earnings as transactions that might previously have been booked without question are now subjected to new standards.  Companies can also lose the ability to forecast as well as was perceived in the past.

Again, a lot of bad things can happen even when the SEC closes an investigation without taking enforcement action.  We say the prudent investor should expect it.

To learn more on our process and what our findings mean, click here.

Notes: The SEC did not disclose the details on investigations referenced above. The SEC reminds us that its assertion of the law enforcement exemption should not be construed as an indication by the Commission or its staff that any violations of law have occurred with respect to any person, entity, or security.  New SEC investigative activity could theoretically begin or end after the dates covered by this latest information which would not be reflected here.