Study: Restatements Up, But Sarbox Works

Financial restatements rise to record heights -- but decrease among Sarbox compliant companies.
Stephen TaubFebruary 28, 2007

Restatements surged to a new high last year. Companies with U.S.-listed securities filed 1,538 financial restatements in 2006, up 13 percent from what had been a record number in 2005, according to an annual study by Glass, Lewis. Out of that total, 118 restatements were made by foreign issuers.

All told, the number of companies that restated last year—1,244 U.S. companies and 112 foreign companies—filed 1,538 financial restatements to correct errors represent 9.8 percent of all U.S. public companies. In 2005, only one in 12 companies restated their financial results.

More interesting, in 2006, there was a 14 percent decrease in the number of restatements from companies that were mandated to comply with Section 404 of the Sarbanes-Oxley Act, “a sign that larger companies are making progress on cleaning up their books,” the proxy research firm asserted. However, restatements rose a whopping 40 percent among companies that haven’t yet been required to comply with Sarbox 404—smaller companies.

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This is significant, given the growing chorus of business, regulatory, and political leaders who are calling for another postponement of the small-company compliance deadline for Sarbox Section 404, the internal controls provision. Those same critics are also urging regulators to scale back internal controls assessments that must be completed by audit firms.

Indeed, reported on Monday that Senators John Kerry and Olympia Snowe sent a letter to the Securities and Exchange Commission and the Public Company Accounting Oversight Board calling for a 404 deadline extension for companies with a market capitalization under $75 million. The lawmakers want to extend the compliance deadline a year from the date that the SEC and the PCAOB issue their final Sarbox 404 guidance.

If the extension is granted, smaller companies that operate on a calendar year could delay filing internal control reports until they submit their 2008 Form 10-Ks. In addition, auditors’ attestation reports would not be due until they file their 2009 10-Ks. Meanwhile, the study found that one third of larger companies, and two thirds of microcap companies, that restated still claimed to have effective internal controls over financial reporting.

Glass Lewis also pointed out in its report that for the second consecutive year, it saw a surge in what it calls “stealth restatements.” It counted 254 last year, up from 163 in 2005. It defines stealth as companies that did not file amended financial statements with the SEC to warn investors that past reports were unreliable. Among these companies was the formerly scandal-ridden Tyco. “We’ve said it before, and we’ll say it again,” Glass, Lewis opines in its report, “Auditors and regulators need to make this stop now.”

Furthermore, Glass Lewis asserted that there is a link between restatements and a company’s stock market performance. It found that the median stock return of companies that filed restatements last year was minus 6 percent. That was 20 percentage points lower than the return for the Russell 3000 stock index in 2006.