Study Finds Financial Restatements Declined after Sarbanes-Oxley

Financial restatements declined substantially in the decade after the passage of the Sarbanes-Oxley Act of 2002, according to a new academic study.

The study, which examined the period from 2003 to 2012, found that the severity of the restatements also declined.

The study, by Professor Susan Scholz of the University of Kansas, chronicles several regulatory and policy changes that were introduced over the past 15 years that may have affected financial restatements. The study highlights the differences between those restatements reported on Form 8-Ks under Item 4.02, meaning the previously filed financial statements and audit report could no longer be relied upon, and non-Item 4.02 restatements.

“This report takes a deeper look at restatements including the company characteristics of restating companies and analysis of market reactions to restatement announcements,” Scholz said in a statement. “The findings shed light on the impact of SOX and other regulations on financial restatements.”

The Center for Audit Quality commissioned the study to investigate restatement trends and activity from 2003-2012 that were publicly disclosed by U.S. and foreign filers registered with the Securities and Exchange Commission. Scholz conducted a similar study for the Treasury Department’s Advisory Committee on the Auditing Profession in 2008.

“As the paper capably summarizes, policy developments—such as new laws, regulations, and auditing standards—have played a role in these positive trends,” said CAQ executive director Cindy Fornelli. “This is an encouraging development for all market participants, especially the investors who play such a critical role in the effective functioning of our capital markets.”

The study includes 4,246 restatements reported in Item 4.02 from 2005 to 2012, plus 6,233 non-4.02 restatements, announced either before Item 4.02 was created or in other filings, for a total of 10,479 restatements publicly disclosed by U.S. and foreign filers registered with the SEC over the decade.

The study found that the number of restatement announcements during the period peaked in 2006 (1,784), soon after implementation of SOX Section 404 internal control reporting. In the years following the implementation of SOX, the volume of 4.02 restatements has declined significantly, with 255 reported in 2012 as compared to the 1,784 reported in the 2005 peak year-a reduction of approximately 86 percent.

Restatement periods became shorter in later years, falling from an average of two or more years in 2005 to less than 18 months in 2012.

Over the course of the decade, restatement activity was fairly consistent across industries. The computer and software industry accounted for 18 percent of the financial restatements, while the financial, banking and insurance sector made up 16 percent, and the energy, mining and chemicals sector came in at 14 percent, among the top three industries each year.

Over the decade, the average stock price reaction to restatements was -1.5%, measured as the percent change in the stock price at the time of the announcement, adjusted for the overall market return.

More serious restatements had more negative announcement reactions, however. Reactions to 4.02 restatements averaged -2.3 percent, compared to -0.7 percent for non-4.02 restatements.

This report examined annual restatements and reports on internal control over financial reporting, or ICFR, for accelerated filers, and identified several areas for further research to assess whether the accounting issues underlying the restatements are related to the reported ICFR material weaknesses.

The CAQ said it believes that an analysis of the trends in and characteristics of restatements of financial reports provides useful information for all stakeholders in the capital markets and is encouraging future research in this area.

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