Financial restatements among U.S public companies hit their lowest level in years in 2017, according to the latest annual report from Audit Analytics. The total number of restatements declined in 2017 to a 17-year low and the number of reissuance restatements (those requiring withdrawal and reissuance of previously released financial reports) declined for the eleventh consecutive year. The number of companies restating their financials is at its lowest level since at least 2002. The findings are summarized in a June 7, 2018 Audit Analytics blog post (here). The full report can be found here (subscription or purchase required).
Audit Analytics has been tracking and analyzing financial restatements by U.S. reporting companies now for 17 years. As a general matter, the number of financial restatements peaked in the years immediately following the passage of the Sarbanes-Oxley Act, and then declined since that time. Thus, in 2017, there were 553 financial restatements, representing a 17-year low. The relatively lower 2017 figures stand in sharp contrast to the 1,859 restatements in 2006. According to an article about the report in Compliance Week (here), the percentage of decline has reached double digit figures in each of the last three years, dropping by 12 percent in 2015, 10 percent in 2016, and nearly 19 percent in 2017.
The report divides the annual number of financial restatements into two categories, reissuance restatements (those requiring reissuance of prior financial statements) and revision restatements (in which the companies made corrections without withdrawing prior financials). The number of reissuance restatements fell to 109 in 2017, down from 128 in 2016. As recently as 2006, there were as many as 943 reissuance restatements. The number of reissuance restatements has declined every year for the last ten years.
Approximately 77% of the 2017 restatements were revision restatements. The numbers of revision restatements are also declining. There were 370 revision restatements in 2017, down from 467 in 2016 and 522 in 2015. The number of revision restatements has declined every year for the last three years (after increasing slightly during the period 2009 to 2014).
The average number of days restated also decreased in 2017. The 2017 average was 509, compared to 541 in 2016, and much lower than the 737 days experienced in 2005.
There were more restatements in 2017 among non-accelerated filers (that is, those companies with a public float below $75 million). There were 236 restatements reported by non-accelerated filers during the year, while there were 184 restatements among accelerated filers in 2017. The 2017 figures for accelerated filers represent a significant improvement over prior years; for example, in 2014, accelerated filers disclosed 351 restatements.
The most significant problem area for reporting companies resulting in restatements is the accounting for debt and quasi-debt instruments, which was the subject of about 15% of the restatements. The Compliance Week article explains that “companies are getting used to new rules on how to reflect financial instruments in financial statements, with a new model for reporting losses taking effect in 2020.”
As reflected in a June 25, 2018 post on the Cooley law firm’s PubCo blog about the restatement report (here), 54% if 2017 restatements had no effect on net income, compared with 59% in 2016.
In commenting on the results reported in the Audit Analytics report, the Compliance Weekly article stated that the decline in the number of restatements during suggests “another year of incremental improvement in the quality of financial reporting.”
As reflected in the final comment of the Compliance Weekly article, the declining numbers of financial restatements could be interpreted to suggest that the quality of companies’ financial reporting is improving and has been improving for years. This might be interpreted to suggest not only fewer reporting errors but also possibly less financial reporting fraud. Under these circumstances, one might expect that the number of securities class action lawsuits would be declining, along with the declining numbers of financial restatements.
Paradoxically, and despite the fact that fewer public companies are disclosing prior financial reporting errors, the number of securities class action lawsuits is at its highest level in years and the percentage of public companies getting hit with securities suits is at all-time high levels (as discussed here). The fact is that the frequency of securities class action litigation is increasingly detached from the level of financial reporting errors.
Among other things, as I have noted elsewhere, securities class action lawsuit filings are increasingly about operational and business process setbacks, rather than about financial reporting. According to NERA Economic Consulting’s 2017 securities class action litigation report (here) only about 25% of the securities class action litigation lawsuit filings in 2017 included accounting allegations, the lowest level in at least five years. (The two categories of allegations that have increased correspondingly are missed earnings guidance and regulatory issues.)
In trying to figure out why the numbers of securities class action lawsuits is increasing, the one possibility that can be rejected is that there are more lawsuits now because there is more financial fraud. The Audit Analytics report arguably can be interpreted to suggest that in fact there is less financial fraud than in the past, at least as a relative matter. The number of securities class action lawsuits is rising for reasons unrelated to the overall quality of financial reporting.