Good news for the flood of companies that have reported internal controls weaknesses as they ready themselves to comply with Sarbanes-Oxley Section 404: Reported internal control weaknesses don't necessarily lead to increased securities class-action filings, according to a study of nearly 300 public companies.
An analysis by Deloitte & Touche and law firm Haynes and Boone LLP of nearly 600 specific internal control weakness disclosures at 290 public companies between November 2003 and August 2004 found little evidence of increased securities class actions.
"We frankly expected to see a sharp spike in class-action filings as a result of publicly disclosed internal control lapses," said Ed J. Lynch, a partner in Deloitte's financial advisory services practice. "Conversely, there appears to be virtually no immediate correlation between reported internal control weaknesses and subsequent litigation."
Added Lynch, "The recent data decidedly does not point to a class-action Armageddon from increased disclosure of internal control weaknesses."
Only 6 percent of the companies analyzed were served with a class-action securities claim related to the disclosed deficiencies. While the 290 companies collectively had been sued 120 times since 1995 for securities claims, Deloitte said that only a third of those cases were filed in 2003-2004.
The disclosures in the study ranged from simple and significant deficiencies, to reportable conditions and material weaknesses. Material weaknesses represented 52 percent of the disclosures.
Deloitte said that, while the types of weaknesses varied, they generally reflected problems related to personnel, such as inadequate hiring of qualified and experienced personnel; financial systems, such as a lack of integration of systems and inadequate quality control systems over journal entries and closing processes; and procedures, such as the inability to timely and accurately close the books, quality control over the financial reporting process, design and review of policies, and account reconciliations.
Among companies under review, computer software and services had the highest incidence of internal control weaknesses, at approximately 20 percent, followed by industrial manufacturing, health care and pharmaceutical, financial services and telecom, electronics, and aerospace.
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