Confession season is upon us, but the problem so far isn't companies owing up to earnings shortfalls. Instead, they're admitting past financial results were simply wrong. Unnerved by a sterner accounting culture, companies have been increasingly reaching back years to ratchet down reported profits by tens or even hundreds of millions of dollars. Eyeing the March 15 filing deadline for calendar 2003 annual reports, Bristol-Myers Squibb ( BMY), P.F. Chang's ( PFCB), Veritas ( VRTS) and Nortel ( NT ) this week joined a fast-growing string of public companies to say prior financial reports inflated real business trends. The number of restated audited annual financial statements hit a record high of 206 last year, according to Chicago-based Huron Consulting Group. Observers say 2004 is already shaping up as a banner year for revisions. "There are certainly more high-profile restatements and you're hearing about them more" compared to past years, said Jeff Brotman, an accounting professor at the University of Pennsylvania. For Bristol-Myers Squibb, Nortel and Network Associates ( NET), recent restatements came on top of prior restatements, much to the irritation of investors. In at least two cases, the embarrassing double restatements prompted internal shifts; Nortel put two of its financial executives on leave as part of a bookkeeping probe. Network Associates fired PricewaterhouseCoopers, according to various news reports, after the auditor cited "material weakness" in its internal controls in the company's annual report. Probably the biggest reason for the wave of honesty is a host of new corporate governance and accounting rules in the wake of the corporate reform legislation known as Sarbanes-Oxley, which went into effect a year and a half ago. Also, accounting firms have grown far more cautious, cowed by the collapse of auditor Arthur Andersen in 2002 after massive fraud at its client Enron. The upshot is that both managers and auditors are now more likely to err on the side of conservative accounting.
"A lot of things in accounting are judgment calls, gray areas," said Peter Ehrenberg, chair of the corporate finance practice group at Lowenstein & Sandler, a Roseland, N.J.-based law firm. "If there are issues in any given company and we were in 2000, a person acting in good faith might easily say, 'We can pass on that.' But that same person looking at the same facts today might say, 'There's too much risk.' "Certainly regulators in general are more credible because they're much less likely to give the benefit of the doubt in this environment," he added. "The auditors know that and they're
therefore less likely to stick their necks out." Case in point: Last week Gateway ( GTW) said longtime auditor PricewaterhouseCoopers won't work for it anymore. PwC did the books back in 2000 and 2001 -- an era of aggressive accounting that still haunts Gateway, though it's now under different management.
From Executive Suite to Cell BlockTougher law enforcement against corporate offenders is also fueling more prudent behavior. The long-underfunded Securities and Exchange Commission, which is now required to review the financial statements of public companies every three years, has finally been given more dollars to hire staff. In 2003, the SEC's workforce was 11% higher than in 2001. This year, the agency's budget allocation should allow it to expand its payroll an additional 9%, to nearly 3,600 employees. On the corporate side, CEOs and CFOs have had to certify their financial reports since August 2002, also as a result of Sarbanes-Oxley. "I think Sarbanes-Oxley makes executives ask the hard questions they should have always asked," said Jeffrey Herrmann, a securities litigator and partner in the Saddle Brook, N.J.-based law firm of Cohn Lifland Pearlman Herrmann & Knopf. "Maybe today an executive says to his accounting firm: 'I'm not going to regret anything here about how we handled goodwill or reserves, am I? It isn't coming back to haunt us, is it?' "
Recent government prosecutions against high-level executives such as Tyco's Dennis Kozlowski, Worldcom's Bernie Ebbers, and Enron's Andrew Fastow and Jeffrey Skilling starkly underscore the penalties managers may face for playing fast-and-loose with accounting. Meanwhile, auditing firms are starting to rotate staff, bringing in newcomers to take a fresh look at clients' accounting. Also, new rules handed down by the Financial Accounting Standards Board have prompted reassessments of past accounting methods, which can lead to earnings revisions reaching back five years (the period for which financial data is included in annual reports). Another level of checks and balances on accounting shenanigans arrived last April when the SEC ruled that corporate audit committees must be composed entirely of members independent from the company itself. "Audit committees are getting more active and making sure that when they learn of problems, they're going to be dealt with," said Curtis Verschoor, an accounting professor at DePaul University. In this environment of heightened scrutiny, however, the notion that a restatement was tantamount to a financial kiss of death has faded, too. "We have now seen companies that issued restatements that have lived to do business another day," said Brotman. "The stock hasn't crashed; nobody's been fired or gone to jail; they haven't lost access to the capital markets; there haven't been any more shareholder lawsuits than there would have already been. If a company does a restatement early, fully and explains exactly what it is and why, it's not a lethal injection." Meanwhile, corporate reform rules are being put in place that could lead to yet more accounting cleanups down the road. One provision will make companies find a way for whistleblowers to confidentially report possible wrongdoings, noted Verschoor. Still, "the pendulum swings both ways," said Herrmann. "If the government continues to prosecute people in high-level positions, maybe that will last for a while. It probably will send a message and the fear of God will spread. But my guess is that politics being what it is, somewhere down the line the spotlight will be off and there will be fewer prosecutions."
|A Round-Up of Recent Earnings Restatements |
Some firms are no stranger to the restatement dance
|Company||Financial Scoop||Number of restatements in past year|
|Bristol-Myers Squibb (BMY:NYSE)|| ||Twice|
|P.F. Chang's China Bistro (PFCB:Nasdaq)||Will delay filing its 10K; plans to restate earnings for prior years, including for calendar year 2003||Once|
|Veritas (VRTS:Nasdaq)|| ||Once|
|Nortel (NT:NYSE)||Will restate earnings for 2003 and earlier periods; Nortel already ||Twice|
|Metris (MXT:NYSE)||Restated its financial results for 1998 through 2002 and for the first three quarters of 2003 following an SEC inquiry||Once|
|Quovadx (QVDX:Nasdaq)||Restating results for 2003||Once|
|WorldCom||Restated pretax profits from 2000 and 2001; this month former CEO Bernie Ebbers indicted on fraud charges in accounting scandal that led to 2002 corporate bankruptcy||Once|
|Service Corp. International (SRV:NYSE)||Restating results for 2000 through 2003||Once|
|Flowserve (FLS:NYSE)||Restating results for 1999 through 2003||Once|
|OM Group (OMG:NYSE)||Restating results for 1999 through 2003||Once|
|IDX Systems (IDXC:Nasdaq)||Restated results for 2003||Once|
|Network Associates (NET:NYSE)||Restated results for 2003 this month; restated earnings for periods from 1998 to 2003 after investigations by the SEC and Justice Department||Twice|
|Take-Two (TTWO:Nasdaq)||In February, restated results from 1999 to 2003 following investigation by the SEC||Once|
|Sipex (SIPX:Nasdaq)||In February, restated results from 2003, marking the second revision of third-quarter '03 results||Twice|
|Source: SEC filings, media reports.|