Restatements dropped after initial post-SOX surge, study shows

The number of restatements announced per year by SEC-registered companies has fallen significantly since the early era of post-Sarbanes-Oxley implementation, according to research released Thursday by the Center for Audit Quality (CAQ).

Restatements, which surged in 2005 and 2006, fell to a 10-year low in 2009 and remained relatively low through 2012, according to the research report authored by Susan Scholz, a professor at the University of Kansas. The research, which was commissioned by the CAQ, examines restatements and their severity from 2003 to 2012. The research chronicles several regulatory and policy changes in the past 15 years that may have affected financial statements.

Restatements rose 66% to 1,600 in 2005 and peaked at 1,784 in 2006, soon after the implementation of internal control over financial reporting requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (SOX), P.L. 107-204.

But restatements fell steadily over the next three years, reaching a low of 711 in 2009, and remained fairly constant at 817 in 2010, 810 in 2011, and 738 in 2012, according to the research.

“As the paper capably summarizes, policy developments—such as new laws, regulations, and auditing standards—have played a role in these positive trends,” CAQ Executive Director Cindy Fornelli said in a news release. “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 CAQ is affiliated with the AICPA.

One policy development was the SEC’s introduction of Form 8-K Item 4.02 to report certain restatements. Since late 2004, the SEC has required companies to disclose a restatement on Form 8-K Item 4.02 if the restatement renders a company’s overall financial statements unreliable.

These “4.02” restatements, which are generally considered more serious than other restatements, peaked in 2005, when they accounted for 61% of all restatements. Since then, the percentage of 4.02 reports compared with overall restatements has fallen steadily to a low of 35% in 2012.

The study includes 10,479 restatements publicly disclosed by U.S. and foreign filers registered with the SEC. The report also found that:

• Restatement periods were shorter in later years, falling from an average of 2.06 years in 2005 to about 17 months each in 2008, 2009, 2010, 2011, and 2012
• The average stock price reaction to restatements was –1.5%. This reaction was measured as the percentage change in the stock price at the time of the announcement, adjusted for the overall market return.
• Average stock prices declined more for the more serious 4.02 restatements. Reactions to 4.02 restatements averaged –2.3%, compared with –0.6% for non-4.02 restatements.

The report also examined annual restatement and internal control over financial reporting reports for accelerated filers and identified several areas for more research to address whether the accounting issues underlying the restatements are related to the reported material weakness in internal control over financial reporting.

A portion of the research is summarized in the table below:

Source: Center for Audit Quality report, Financial Restatement Trends in the United States: 2003–2012.

—Ken Tysiac (ktysiac@aicpa.org) is a JofA editorial director.