One of the very few things that managed to encamp in my head during my tenure in junior high school was the ability discern the difference between exact and inexact sciences. The chasm between the two often surfaced during trigonometry tests, when despite me coming up with what I considered reasonably close to the correct answer, it would invariably end up with a red line through it. Either that or a "See me" in large print was splashed across the top of the paper. But I digress.Since trigonometry was considered an exact science, I'm pretty sure accounting was, and is, as well. And that being said, I don't think that I'm going too far out on a limb when I say that a restatement is pretty much a fairly accurate indicator of accounting errors.
I mention this because 2005 saw roughly a doubling of public company accounting restatements - 1,195 versus 613 in the year-ago period, according to a study conducted by proxy researcher Glass-Lewis. The concern attributed the spike in restatements to the mandates of Sarbanes-Oxley, which lately seems to have morphed into something of a political football - but more on that later.
According to Glass-Lewis, if something positive can be taken away from this, it's that the financial reporting and improved corporate governance procedures that resulted from SOX are working.
Glass-Lewis also highlighted the disturbing trend of what it labeled "stealth" restatements - filers who failed to amend previous financials to signal a restatement or else did not announce the restatement in a federal filing, among other egregious bouts of filing amnesia.
Stealth restatements, according to the proxy researcher, accounted for about 14 percent of all restatements filed in 2005 - compared with just 2 percent of companies that had not highlighted accounting restatements the prior year.
But here's where it gets somewhat interesting: Roughly two-thirds of these quiet restatements were attributed to filers with a market cap of less than $75 million. This is the market cap ballpark of many of the loudest opponents of SOX 404 compliance. The smaller filers are the ones who have petitioned regulators for exemption from 404, citing unfair financial and personnel costs in compliance.
In December, for example, the SEC's committee on small public filers issued a recommendation to roll back SOX 404 compliance rules for companies with less than $250 million in revenue and market capitalizations of less than $750 million. That's exclusive of the political pressure that the rollback is facing from some lawmakers, whose small public company constituency has probably reminded them of the funny and often unpredictable nature of elections.
To be fair, the complaints of small filers aren't without some justification, as the costs of 404 compliance are proportionately higher for them. But as Glass-Lewis pointed out, often these type of companies comprise the highest percentages of fraud. For every Enron and WorldCom, there are dozens of smaller frauds that often don't register on the mainstream media's radar.
As with every new process, once systems are established, the procedure gets smoother and, ultimately, less time-consuming and more cost-efficient.
The rise in restatements should leave little doubt as to whether SOX is working. That's hardly an inexact science.
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