Do restatements mean Sarbanes-Oxley is working?

• Author: Orenstein, Edith
• Position: WashingtonINSIGHTS

Restatements Should Be Eyed Suspiciously," read the headline of an item by Bruce Meyerson, national business writer for The Associated Press, earlier this year. Noting the oft-cited Glass, Lewis & Co. restatements study, "Getting it Wrong the First Time" Meyerson warned it is "best to view restatements with the suspicious eye of an exterminator: where there's one, there may be more."

The Glass, Lewis study was also cited in Glenn Cheney's article, "Making Sense of Revenue Recognition," on page 32 in this issue. Cheney writes that shareholders "can't help but wonder whether the restatement is a case of accounting confusion or shenanigans." Meyerson took a darker view, grouping restatements into three categories: "honest error," "aggressive corporate mentality" or "intentional deception."

The data raise a number of questions. For instance, how many of the 1,295 restatements indicate fraud or intentional deception, vs. "honest errors" resulting from the "complicated ... unclear mishmash" of accounting standards?

To what extent is Sarbanes-Oxley Section 404 driving restatements--or, on the flip side--to what extent are restatements driving reported "material weaknesses in internal control?" Is the reporting of such material weaknesses serving the intent of Section 404 in rooting out fraud and building investor confidence? Can investors readily discern restatements resulting from changes in reasonable, good-faith judgments under generally accepted accounting principles (GAAP)--previously signed off by company management, auditors and legal counsel, but subsequently reinterpreted due to an error or fraud?

The questions above can be summarized as: do restatements mean Sarbanes-Oxley is working? Or that Sarbanes-Oxley needs more work? A number of developments in Washington may hold keys to a possible answer.

Recent Developments

First, an "all-out war on complexity" has been called for by SEC Chairman Christopher Cox. At a March 29 Congressional hearing, FEI President and CEO Colleen Cunningham, leaders of other business and professional associations and representatives of the SEC, PCAOB and FASB concurred that it is time for all interested parties to come together in this "war on complexity."

Second, on May 17, the SEC and PCAOB announced "next steps" for Sarbanes-Oxley compliance, including an SEC concept release aimed at easing compliance and potential amendments to PCAOB Auditing Standard No. 2 (AS2). AS2 was cited by some participants at the...