Ten steps to avoiding a restatement.

• Author: LERNER, JONATHAN J.

The shockwaves resulting from a restatement reach right into the boardroom. Here is how you may lessen the likelihood that such a disaster will occur.

AS THE 21ST CENTURY DAWNS, there are few words that have come to be as dreaded throughout Corporate America as "restatement?" The number of high-visibility companies announcing restatements has recently burgeoned. It is, therefore, not surprising that eradicating fraudulent accounting has become a cause celebre of the chairman of the Securities and Exchange Commission.

The disclosure that a company's financial statements were materially misstated and need to be "restated" is often a cataclysmic event comparable to a corporate earthquake, although this kind of corporate disaster is surely of human creation. Its impact leaves few, if any, corporate constituencies unaffected and the aftershocks continue to radiate for a long time to come.

The aftermath of an announced restatement can be dramatic. The company's investors are often at ground zero as the company's stock price plunges precipitously -- frequently falling a multiple of the earnings lost on the downward revision to the financial statement. The shockwaves also will be felt acutely in the executive suite, where many members of senior management ordinarily have a sizeable portion of their personal wealth tied to the company's stock price from stock options and other forms of incentive compensation linked directly to the corporation's equity value.

Apart from a steep decline in their personal net worth, senior management also may face the specter of being investigated by regulators, criminal authorities, as well as the company itself, and the daunting possibility of being held personally accountable for the problems facing the company. In this area, senior management can expect to share scrutiny with the outside auditors, who will be asked to explain why the books were wrong and, if the restatement involves audited year-end financials or quarterly financials that the outside auditors reviewed, why the misstatements were not detected sooner.

Not surprisingly, the shockwaves resulting from a restatement will reach right into the boardroom. Faced with the publication of materially false financial statements, a drop in the price of the company's stock, the possibility that the accounting errors may have been the product of fraud that could involve senior managers of the company, and investigations by civil regulators and criminal prosecutors, it is important that a responsible board of directors spring into action at the first hint of problems with financial statement disclosures.

Unlike an earthquake which cannot be controlled or prevented, however, a restatement may be avoidable. At a minimum, steps can be taken to decrease the chances of such a disaster. We outline 10 salutary steps that may lessen the likelihood that a restatement will occur.

1. Strengthen the company's audit controls

   Certainly, having a strong independent audit committee is one of the most salutary ways to attempt to avoid a restatement. At every meeting of the audit committee, the committee should meet privately with the auditors to obtain their views on the company's compliance efforts and how they can be strengthened. The auditors should be specifically asked if they have any criticism of management, whether there are any practices that the auditors believe should be improved or changed, and whether the internal accounting staff is adequate.

   These private discussions between the auditors and the audit committee should be carefully recorded in the minutes of the audit committee. Although auditors are statutorily required to be on guard to detect any fraud, this kind...