The SEC, Financial Fraud and Restatements

Financial fraud actions have long been a staple of SEC Enforcement. Following Arthur Levitt’s famous “Numbers Game” speech in 1997 for example, the Commission brought a series of blockbuster financial fraud actions that spurred the passage of The Sarbanes-Oxley Act in 2002. Since that time, and particularly following the market crisis, the agency has tried to rekindle its earlier successes, formed a task force to focus on financial fraud a few years back while making efforts to create what many called “RoboCop” – a computer to fret out financial fraud. Cases have been brought. But not a series of actions like those that spawned SOX.

One explanation is that following SOX the number of restatements has dwindled. To be sure that is true. There are, however, still restatements with a significant number issuers restating and revising their financial statements, according to a report prepared by Audit Analytics titled “2015 Financial Statements: A Fifteen Year Comparison” (here).

Restatements come in two types. One is where the issuer has to disclose in a Form 8-K that the past financial statements can no longer be relied on but will be reissued at some point in the future, according to the Report. A second does not require disclosure in a Form 8-K or the reissuance of the firm’s historical financial statements because it is a revision.

The high water mark for restatements in recent years was 2006 when there were 1851. Since that date the number of restatements has declined to 737 in 2015. That is more than in the year prior to the passage of SOX when there were 625 restatements and the 700 in the year the Act was passed but below the 788 in 2003. From that year forward the number increased until the high point in 2006 after which there has generally been a decline.

The numbers and the trends differ, however, if they are broken out to show the trend in reissuances vs. revisions. For the former the numbers generally decline over the period 2008 to 2015. In 2008 there were 433 reissuances – that is, situations where disclosure that the historical financial statements could no longer be relied on was required. By 2015 that number had dropped to 161. The trend for revisions is the opposite. In 2008 there were 448 revisions (just over half of the total number of restatements). By 2015 the number had increased to 516 (over three quarters of the restatements). The numbers between 2008 and 2015 generally increases overall but not each year while the percentage of revisions as a function of the total number of restatements increased every year, according to tables in the Report.

While restatements can involve a variety of issues, the average income adjustment for companies listed on the three U.S. exchanges has ranged from a low of about $3.1 million in 2014 to a high of just under $13 million in 2011 and about $5.2 million in 2015. At the same time a significant number of restatements do not have an impact on the income statement. In 2007, for example, over 39.4% of the restatements had no impact on the income statement. In 2014 that percentage reached a high for the period of 60% before dropping to just over 55% the next year.

Other restatements have involved significant dollar amounts for particular issuers. For example, in 2002 the restatement for Tyco International, Ltd, had a negative impact on net income of $4,512,700,000. Two years later the restatement for Federal National Mortgage Association Fannie Mae had a negative impact of $6,335,000,000. In 2005 the restatement for AIG had a negative impact of $5,193,000,00, in 2011 for China Unicom Ltd. it was $1,556,743, in 2013 for Quicksilver Reserves, Inc., it was $1,419,888,000 and in 2015 for Alphabet (parent of Google) it was $711,000,000.

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