Two New Reasons Not to Buy Barnes & Noble

Today, Barnes & Noble announced an investigation by the SEC into the company's finances stemming both from the company's restatement of income earlier in the year and from an allegation by an employee that technology costs were improperly allocated among its groups for reporting purposes . While I've been a fan of Barnes & Noble and have advocated for its ability to dominate the physical book market, an investigation of this sort puts the brakes on all of that optimism.

Barnes & Noble's restatement of income
In Barnes & Noble's annual SEC filing back in July this year, the company restated its cost of sales and accounts receivable for 2011 and 2012, resulting in more retained income . The shifts resulted in a decrease of total liabilities in each year by more than $70 million. The company also removed $26 million worth of deferred taxes, combining to bump earnings up by over $100 million each year.

The net impacts of the shift were an additional $0.09 and $0.07 in earnings per share for 2011 and 2012, respectively. Neither shift resulted in positive earnings for the year, but both made the business look slightly stronger than it had previously.

Technology costs
In addition to the accounting issues related to the restatement, the SEC is investigating a whistle blower's claim that Barnes & Noble "improperly allocated certain Information Technology expenses between its NOOK and Retail segments for purposes of segment reporting. " That's not a lot of detail to go on, but probably means that the allegation has to do with costs form the Nook division being loaded into the retail division, in order to make the Nook seem more attractive to investors or potential buyers.

The allegation comes from a "former non-executive employee," and Barnes & Noble has said that it will cooperate with the authorities in the investigation . So far, the company has made no public statement beyond what's been filed in its recent 10-Q.

Two reasons to hold off on investing in Barnes & Noble
Apart from the obvious -- an SEC investigation -- the news highlights two reasons to hold off on buying into Barnes & Noble right now. First, the stock has become speculative, to the extent that buyers and sellers are reacting to a partially formed news story. The investigation could result in charges or could exonerate the company, but no one has inside information as to what the final result will be.

Second, if it is found to have had accounting failures, then investing now means investing in unknowns. Not just that the outcome of the investigation is unknown, but that the actual past performance of Barnes & Noble isn't known. Investing in a black box is a horrible idea, and right now, Barnes & Noble has the potential to be a black box. As I said at the start, I've liked Barnes & Noble in the past for their physical stores, but that's not enough to overcome these current problems. Smart investors should hold off.