Sarbanes-Oxley Yet Again

The threat of an adverse opinion on a public company’s internal controls was not an idle one. According to Compliance Week, nearly 10% of the 10-K (annual report to the SEC) filings in January included an adverse opinion because of material weaknesses in their internal controls. There may be more coming, since companies with a December year-end have until March 16 to file.

I noticed a pattern to the adverse opinions: they are nearly coterminous with companies having restated their earnings for earlier quarters. This begins to make sense: if a company’s internal controls were well-designed and operating as intended, no restatement would have been necessary. Earnings restatements and accounting problems are often punished more severely than earnings or performance disappointments, and are easy targets for class-action lawsuits. When more data is available, it will be an interesting exercise to separate the effect on share prices of the adverse opinion from that of the restatement. Maybe someone with better math skills will attempt it.

Here is a partial list of companies that have had an adverse Sarbanes-Oxley opinion, but a clean opinion on their financial statements, from their auditors:

BearingPoint Inc. (ticker: BE; formerly KPMG Consulting)
Auditor: PricewaterhouseCoopers
Material weakness: Revenue recognition (preliminary only; filing due March 16,2005)

Calpine Corporation (ticker: CPN)
Material weakness: Provision for income taxes.

Eastman Kodak Company (ticker: EK)
Auditor: PricewaterhouseCoopers
Material weakness: Provision for income taxes.

Flowserve Corp. (ticker: FLS)
Auditor: KPMG
Material weakness: Provision for income taxes, intercompany accounts, consolidation, others.

Netbank Inc. (ticker: NTBK)
Auditor: Ernst & Young
Material weakness: Estimated fair market value for rate locks and hedges.

Sapient Corporation (ticker: SAPE)
Auditor: PricewaterhouseCoopers
Material weakness: Controls over health insurance accruals and lease accounting.

SunTrust Banks, Inc. (ticker: STI)
Auditor: PricewaterhouseCoopers
Material weakness: Internal controls at a recently-acquired subsidiary; loss provision errors.

I also checked MCI, formerly WorldCom, since it was one of the companies whose accounting problems led to the adoption of Sarbanes-Oxley, and since it may hold the world record for earnings restatements in prior years. MCI is getting a clean opinion. An interesting pattern, dont you think?

5 thoughts on “Sarbanes-Oxley Yet Again”

  1. Here are a few possible reasons: first, they are by far the largest of the Final Four, and size is a function of client base. Second, they have a reputation for being sticklers for Sarbanes Oxley work, although I can’t see how any auditor could confidently give a clean opinion on controls after an earnings boo-boo. Third, I just looked at large-cap companies, and PwC is too expensive for many of the smaller ones. The smaller ones are likeliest to fail, with small staffs leading to segregation of duties issues.

    Also, the 10-K season isn’t over yet; see the earlier article on the same subject, suggesting there would be more failures. Let’s see how it shakes out.

  2. How many people actually read annual reports? (Except for Warren Buffett’s. His do entertain.)

    All the others? Quick tip. Flip and start at the back pages. Look only for lawsuits. Be informed.

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