Financial Restatements:

Update of Public Company Trends, Market Impacts, and Regulatory Enforcement Activities

GAO-06-678: Published: Jul 24, 2006. Publicly Released: Aug 1, 2006.

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In 2002, GAO reported that the number of restatement announcements due to financial reporting fraud and/or accounting errors grew significantly between January 1997 and June 2002, negatively impacting the restating companies' market capitalization by billions of dollars. GAO was asked to update key aspects of its 2002 report (GAO-03-138). This report discusses (1) the number of, reasons for, and other trends in restatements; (2) the impact of restatement announcements on the restating companies' stock prices and what is known about investors' confidence in U.S. capital markets; and (3) regulatory enforcement actions involving accounting- and audit-related issues. To address these issues, GAO collected restatement announcements meeting GAO's criteria, calculated and analyzed the impact on company stock prices, obtained input from researchers, and analyzed selected regulatory enforcement actions.

While the number of public companies announcing financial restatements from 2002 through September 2005 rose from 3.7 percent to 6.8 percent, restatement announcements identified grew about 67 percent over this period. Industry observers noted that increased restatements were an expected byproduct of the greater focus on the quality of financial reporting by company management, audit committees, external auditors, and regulators. GAO also observed the following trends: (1) cost- or expense-related reasons accounted for 38 percent of the restatements, including lease accounting issues, followed in frequency by revenue recognition issues; and (2) most restatements (58 percent) were prompted by an internal party such as management or internal auditors. In the wake of increased restatements, SEC standardized disclosure requirements by requiring companies to file a specific item on the Form 8-K when a company's previously reported financials should no longer be relied upon. However, between August 2004-September 2005, about 21 percent of the companies GAO identified as restating did not appear to file the proper disclosure when they announced their intention to restate. These companies continued to announce intentions to restate previous financial statements results in a variety of other formats. Although representing about 0.4 percent of the market capitalization of the major exchanges, which was $17 trillion in 2005, the market capitalization of companies announcing restatements between July 2002 and September 2005 decreased $63 billion when adjusted for market movements ($43 billion unadjusted) in the days around the initial restatement announcement. Researchers generally agree that restatements can negatively affect overall investor confidence, but it is unclear what effects restatements had on confidence in 2002-2005. Some researchers noted that investors might have grown less sensitive to the announcements. Others postulated that investors had more difficulty discerning whether restatements represented a response to aggressive or abusive accounting practices, complex accounting standards, remediation of past accounting deficiencies, or technical adjustments. Although researchers generally agree that restatements can have a negative effect on investor confidence, the surveys, indexes, and other proxies for investor confidence that GAO reviewed did not indicate definitively whether investor confidence increased or decrease since 2002. As was the case in the 2002 report, a significant portion of SEC's enforcement activities involved accounting- and auditing-related issues. Enforcement cases involving financial fraud- and issuer-reporting issues ranged from about 23 percent of total actions taken to almost 30 percent in 2005. Of the actions resolved between March 1, 2002, and September 30, 2005, about 90 percent were brought against public companies or their directors, officers, and employees, or related parties; the other 10 percent involved accounting firms and individuals involved in the external audits of these companies.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: SEC agreed entirely with this recommendation. The agency said that while it is the Commission's policy to conduct its investigations on a confidential basis, and therefore the agency cannot confirm or deny the existence of an investigation, the Division of Corporation of Finance has been made aware of our findings and have taken appropriate actions, including making referrals to the Commission's Division of Enforcement where that is merited. The Division of Corporation Finance completed its review of potential noncompliance cases in 2007.

    Recommendation: To better enable SEC to enforce its regulations and improve the consistency and transparency of information provided to investors about financial restatements, SEC should take specific actions to improve oversight and compliance of disclosures of certain restatements. SEC should direct the head of the Division of Corporation Finance to investigate the instances of potential noncompliance we, and Glass Lewis, identified, and take appropriate corrective action against any companies determined to have filed a deficient filing.

    Agency Affected: United States Securities and Exchange Commission

  2. Status: Closed - Implemented

    Comments: In a January 2008 speech, an SEC official said that SEC is likely to propose rulemaking this year that would require the filing of a Form 8-K any time a company has determined to restate its financial statements. Subsequently, on 8/1/08, the Advisory Committee on Improvements to Financial Reporting issued its final report with recommendations to increase the usefulness of financial information to investors. Recommendation 3.2 reflects GAO's recommendation on Item 4.02 of the Form 8K. Chairman Cox has asked SEC staff to immediately begin analyzing these recommendations and to prepare regulatory actions based on them wherever appropriate. As of 6/25/10 this matter remains current in that the Commission has identified it as a pending matter in the spring 2010 (most recently published) Unified Agenda of Federal Regulatory and Deregulatory Actions. An SEC official said that this project has been overtaken by other events and the timing of further work is subject to resources available and to Congressional priorities - such as those that will require immediate rulemaking work in response to Dodd-Frank Wall Street Reform and Consumer Protection Act. Since the Commission has included this recommendation in the Unified Agenda of Federal Regulatory and Deregulatory Actions as a pending matter, it is concluded that SEC has implemented the recommendation.

    Recommendation: To better enable SEC to enforce its regulations and improve the consistency and transparency of information provided to investors about financial restatements, SEC should take specific actions to improve oversight and compliance of disclosures of certain restatements. SEC should harmonize existing instructions and guidance concerning Item 4.02 by amending the instructions to Form 8-K and other relevant periodic filings to clearly state that an Item 4.02 disclosure on Form 8-K is required for all determinations of non-reliance on previously issued financial statements (Item 4.02), irrespective of whether such information has been disclosed on a periodic report or elsewhere.

    Agency Affected: United States Securities and Exchange Commission


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