Capital Markets

The Great Controls Divide: Small v. Big

The number of companies with less than $75 million in market cap that reported material internal-controls weaknesses surged from 573 in 2005 to 677...
Stephen TaubMarch 1, 2007

Fewer big U.S companies disclosed material internal controls flaws in 2006 than they did in 2005, according to a new report by Glass Lewis. But soaring numbers of domestic microcaps revealed big controls weaknesses.

In all, the number of U.S. public companies reporting material controls weaknesses dropped to 1,118 in 2006 from 1,285 in 2005, according to proprietary research and company filings culled by the shareholder advisory firm.

That works out to 8.8 percent of all U.S. companies reporting a material weakness in 2006 after the second year of 404 audits, down from 10 percent the prior year. Overall, the number of material-weakness disclosures by U.S. companies dipped to 1,249 last year from 1,552 in 2005.

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The story differed sharply among the smallest and largest companies studied, however. The number of companies with less than $75 million in market cap that reported material internal-controls weaknesses surged from 573 in 2005 to 677 in 2006. In contrast, the number of companies with over $750 million in market cap that reported such weaknesses dropped from 280 to 193. And the number of such companies with market caps of $75 million to $749 million recorded the steepest descent between the two years: 699 to 379.

Companies with market caps of $75 million are not yet required to comply with the internal-controls assessment rules. “This raises an unsettling question: If these companies already have disclosed this many material weaknesses before they were required to comply with SOX 404, how many more material-weakness disclosures would there have been if independent accounting firms had audited these companies’ internal controls?” Glass, Lewis asks in its report. “Twice as many? More? We can only speculate.”

The most common types of material weaknesses were equity-related and tax accounting, GL notes. “Lack of competent accounting staff, or other personnel issues, were behind one of every five material weaknesses,” the firm added.