Accounting & Tax

Restatements Rise on SEC Initiative

A study by FEI links rise in restatements with former SEC chief Levitt's crackdown on "managed earnings." StaffJune 7, 2001

The Wall Street Journal reports that, according to a study to be released this week, the number of corporate earnings restatements skyrocketed during the past three years, driven in large part by stepped-up enforcement efforts at the Securities and Exchange Commission.

The study by the research arm of Financial Executives International, a professional group in Morristown, N.J., found there were 157 financial restatements last year, compared with 207 in 1999 and 100 in 1998. The three-year total of 464 was higher than the previous 10 years combined, during which the average annual number of restatements was 46.

The study linked much of the rise in restatements to former SEC Chairman Arthur Levitt’s initiative to crack down on “managed earnings” over the past few years, says the Journal.

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But another factor driving the increase was the heightened pressure on corporate executives to meet investors’ demands for strong performance during the height of the bull market. That pushed some management teams to stretch accounting rules to the breaking point, ultimately prompting restatements, FEI president and CEO Philip Livingston told the newspaper.

Even so, the study noted that fewer than 1% of all publicly owned companies had restated their financial results in any given year since 1995, “indicating that the overall quality of financial reporting is high.” The most frequent causes for restatements: improper revenue- recognition practices, followed by improper inventory valuations and inadequate allowances for bad debts.

Another common reason: excessive charges for “in-process research and development” expenses, which were popular in the late 1990s among high-tech and drug companies that used them following acquisitions to boost earnings by shifting future costs into large instant write- offs.

The study noted a sharp climb in restatements starting around September 1998. That month, Mr. Levitt delivered a major speech criticizing “accounting hocus-pocus” in the wake of massive restatements earlier that year by Waste Management Inc., Sunbeam Corp. and Cendant Corp. Since then, the SEC has issued accounting bulletins aimed at countering revenue-recognition practices that violate generally accepted accounting principles. And it has begun requiring restatements even to correct items that, until two years ago, would have been deemed too immaterial to merit them, says the Journal.

The study was based on data collected and analyzed by Min Wu, a graduate student at New York University’s Stern School of Business. It also found that restatements resulted in total market-value losses of $31.2 billion in 2000, $24.2 billion in 1999 and $17.7 billion in 1998, measured by the declines in companies’ stock prices during the three trading days after a restatement. The No. 1 loss: Microstrategy Inc.’s $11.3 billion three-day decline after a restatement.

View FEI’s Power Point presentation of the study.