RESTATEMENTS & LAWSUITS ARE ON THE RISE
RESTATEMENTS & LAWSUITS ARE ON THE RISE
2005-01-20 at 10:13:00 am #11379
Restatements, and Lawsuits, Are on the Rise
years after ENRON made financial reports look less reliable than a preschooler’s math, public companies are still having trouble getting their numbers right.
The number of restatements by publicly held companies surged to a high in 2004, according to results of a study of regulatory filings by the Huron Consulting Group.
The firm, which is expected to release its findings today, found that 253 companies restated their annual audited financial reports last year, a 23 percent increase from 206 in 2003. Another 161 companies restated quarterly financial statements, as against 117 in 2003.
That is the highest number of restatements of any of the last five years and is something of a surprise, said Joseph J. Floyd, managing director and national practice leader of Huron’s disputes and investigations practice. He added, “One would hope that what we’re experiencing is a period of time that is at the top of the curve.”
The study also found that the number of companies restating results from more than one year increased. About 40 percent – 101 – of the companies restating annual results were revising financial reports for three years, Mr. Floyd said.
“Of the problems being identified in 2004, a large number of those are multiyear problems,” he said. He added that more than 60 companies that filed restatements last year reported errors in filings in previous years, too.
There are various possible explanations for the overall increase in restatements, none of them entirely satisfactory. Most likely a combination of factors led corporate executives to restate results last year.
Some of the surge was a result of companies’ efforts to comply with Section 404 of the Sarbanes-Oxley Act, the corporate governance legislation passed in the wake of revelations of corporate fraud in 2002, Mr. Floyd said. That provision requires that companies have their outside auditors review their internal controls – the processes the companies use to record financial transactions and report their results.
“The 404 effort that was under way was an unprecedented period of scrutiny for accounting controls,” Mr. Floyd said. Nearly a third of the restatements involved improper reporting of revenue or faulty accounting for stock options or other equity instruments, according to Huron.
But Section 404 would not lead directly to a restatement, said John T. Bostelman, a partner at the law firm of Sullivan & Cromwell and author of a reference work on the law. A company could receive a clean audit even if its internal controls were found wanting, he said. “I actually would be surprised if restatements were being driven by the internal control requirements.”
Some of the restatements may simply reflect the fact that auditors are much more conservative and more apt to instruct a client to restate earnings after finding an error that several years ago might have been overlooked or ignored. The criminal prosecution of Enron’s auditor, Arthur Andersen, put accounting firms on notice that times had changed.
“Auditors in the wake of the demise of Andersen are less likely to turn the other cheek in the face of financial fraud,” said Paul Geller, a partner at Lerach Coughlin Stoia Geller Rudman & Robbins, a law firm specializing in securities litigation that is based in San Diego.
The number of restatements does not necessarily mean that the level of shareholder litigation activity will increase because not all restatements are evidence of fraud, said Joseph Grundfest, a professor at Stanford Law School.
“There’s a popular perception that a restatement inevitably leads to litigation,” he said. “That statement is wrong. Restatements can happen for entirely non-fraudulent reasons, and restatements do not always lead to significant stock price declines.”
Nonetheless, the overall number of shareholder lawsuits filed in 2004 rose to 212, from 181 the preceding year, according to the Securities Class Action Clearinghouse at Stanford Law School. It is not clear how many of those lawsuits followed restatements.
Although every restatement may not be evidence of fraud, “the fact remains that there’s a strong correlation between the issuing of financial restatements and the filing of securities class actions on behalf of investors,” Mr. Geller said. He said his firm was busy in 2004 and added, “This report doesn’t give any indication that things are going to slow down.”