Risk & Compliance

Does Sarbox Reduce Restatements?

While small companies lobby to limit their compliance with the 2002 law, a new study suggests it may provide a key benefit.
Sarah JohnsonDecember 2, 2009

A recent study could give some fodder to opponents of the movement toward exempting small publicly traded companies from the auditor-attestation requirement of the Sarbanes-Oxley Act. And it could deflate the hopes of small-company CFOs who are praying for the exemption.

The study, from research firm Audit Analytics, suggests companies that have not yet had their auditors review their internal-control reports are more likely to have a restatement than larger companies, even though they claimed to have effective controls. “The whole process of reviewing your internal controls is supposed to improve the reliability [of financial reporting] and therefore should decrease the number of restatements,” notes Don Whalen, research director at Audit Analytics.

Looking at filings made between November 2007 and November 2008, the firm found that 5.1% of companies that both reported effective internal controls and had their auditors attest to those controls later restated their financial results. In contrast, 7.4% of companies that reported effective controls but did not get their auditors’ signoff later had at least one subsequent restatement.

In effect, the Audit Analytics report suggests, the restatement rate for nonaccelerated filers is 46% higher than it is for accelerated filers. As it stands now, nonaccelerated filers — companies with market capitalizations under $75 million — have less than a year to get their auditors to weigh in on their internal controls. Only a “handful” of these companies already do, voluntarily, according to Whalen. The smaller companies will have to file these audit opinions with annual reports filed for fiscal years ending after June 15, 2010.

However, that deadline could evaporate if an amendment attached to the Investor Protection Act — a key bill included in the package of reform legislation getting heavy attention on Capitol Hill — survives. Passed narrowly by a House committee last month, the amendment would exempt nonaccelerated filers from Sarbox’s Section 404(b), which requires companies to include in their 10-K reports an independent auditor’s opinion on their internal controls. Smaller companies began complying with Section 404(a), which concerns management’s opinion on internal controls, nearly two years ago. The House is expected to vote on the bill this month.

To be sure, it’s debatable whether full compliance with Sarbanes-Oxley will reduce restatements. The number of restatements skyrocketed earlier this decade, peaking at 1,299 in 2006. Some observers argue that the 2002 law has led to overly cautious companies clogging the Securities and Exchange Commission’s filing system with immaterial restatements, and unnecessarily keeping investors in the dark while they get their financial reports in order. For example, more than a year ago, the SEC’s Advisory Committee on Improvements to Financial Reporting suggested the regulator change its guidance to reduce the number of unnecessary restatements.

The Audit Analytics study does not break down the reasons why the companies restated or reveal whether any of them were trivial. Still, a restatement could indicate a company doesn’t have proper internal controls, said Andy Burcyk, regional attest leader at accounting firm Mayer Hoffman McCann. “A restatement can come from any size company, for a variety of reasons,” he told CFO.com. “Having a better internal-control structure reduces the probability of having one.”