According to a review of regulatory filings during the month of June, 41 companies disclosed material weaknesses or significant deficiencies in internal controls, or provided updates on the status of their control-improvement processes.
SECTION 404
That number is down from 51 similar disclosures in May. There were 39 disclosures in April, and 28 in March.
The slight dip in disclosures was a surprise to some who expected the numbers to rise consistently as the Nov. 15th deadline for Section 404 of Sarbanes-Oxley approaches. Last month, Public Company Accounting Oversight Board Deputy Chief Auditor Tom Ray told Compliance Week he expected the number of disclosures to rise due to the “lower threshold” in the definition of a significant deficiency.
But according to Rick Steinberg, a governance expert who co-authored the COSO internal control framework, the numbers will still head northward in the long term. “One month does not a trend, or trend-killer, make,” he says.
Instead, Steinberg believes that the more proactive companies had their control documentation and assessment programs in full swing during the spring. “By June they were moving into remediation mode,” he noted.
Steinberg, who led PricewaterhouseCoopers’ governance practice and now runs Steinberg Governance Advisors in Westport, Conn., believes we may see the number of disclosures increase as the summer progresses. “A large number of companies will be looking closely at their quarterly close processes for the first time at the end of the second (June) quarter,” he predicts, “and we may see an increase in deficiencies as a result.”
Smaller Companies
One trend that did continue in June was the size of companies making such disclosures. Only 16 percent of the companies disclosing internal control problems had 2003 revenue of more than $1 billion. That’s down from 20 percent in May, and 23 percent in April.
And some of the largest companies making disclosures were actually updating the status of their control-improvement processes. That was the case with $20.8 billion Bristol-Myers Squibb, which had previously disclosed a reportable condition related to its tax accounting function. In June, the company noted that it had “devoted substantial resources towards remedying the reportable condition in relation to taxes,” and outlined details on its activities.
45 percent of the companies in our June list had revenues under $100 million. That’s nearly identical to May’s number, and slightly higher than the 36 percent that we reported in April.
The large percentage of small companies disclosing reportable conditions and material weaknesses is likely due to the fact that their internal controls are less formal than at global organizations, where controls are usually more structured, documented and tested. In its release approving the PCAOB’s audit standard, SEC Chief Accountant Donald Nicolaisen acknowledged the challenge to small companies, noting, “We anticipate working with others in our continuing effort to address the concerns of smaller companies.”
Three of the companies making weakness disclosures in June had almost no revenue, including telcoBlue, a shell company that has no employees or revenue, and which recently conducted both a reverse stock split and a reverse merger.
Most Common Disclosures
As was the case with previous months, the most common reportable conditions and weaknesses were problems related to financial systems and procedures. In June, 45 percent of the disclosures fell into that category. In May, 49 percent of the disclosures were related to financial systems and procedures, and in April the number was 42 percent.
These disclosures often cited problems with the financial close process, account reconciliation, or inventory processes. That was the case at $187.4 million semiconductor maker Ixys, which noted its “inventory processes were not reviewed by a supervisor in sufficient detail,” and at $32.2 million Tut Systems, which said its controls were “inadequate to properly record our inventory quantities in an accurate and timely manner.”
One company, $104.5 million Actuate, cited the “detection of side letters.”
As in prior months, Compliance Week aggregated multiple weaknesses of the same “type” into one entry. $380.7 million ST Assembly Test Services, for example, listed two problems related to financial systems and procedures; however, they count as “one” entry in our monthly tally.
People Problems
The second most common type of disclosures was related to personnel issues, comprising 30 percent of all disclosures. In May, 33 percent were people-related, and in April the number was 26 percent.
Common disclosures cited poor segregation of duties, inadequate staffing, or related training or supervision problems. $53.8 billion bank holding company FNB, for example, cited “inadequate segregation of duties over the payroll process,” and Paris-based insurance provider AXA disclosed “insufficient personnel in the corporate accounting department with sufficient knowledge and experience of U.S. GAAP accounting principles and SEC requirements.”
$59.0 million Motient cited significant deficiencies stemming from accounting-staff layoffs and CFO turnover following the company’s emergence from bankruptcy.
Others: Fewer Documentation Problems; More Remediation
Only 5 percent of the disclosures cited weaknesses with documentation. That number is down from 9 percent in May, and 16 percent in April.
Problems with revenue recognition were cited in 10 percent of the disclosures, up from 3 percent in May, but flat with the April tally.
No companies cited specific weaknesses in IT systems.
Only a few companies disclosed a weakness without providing detail on the type of problem. Wilshire Oil was one of those companies; however, the weakness had already been disclosed in 2003, and the business to which the disclosure pertained had been sold.
Interestingly, companies seem to be providing much greater detail on their internal control improvement and remediation efforts, outlining specific steps the company has taken to improve controls. That’s a significant change from prior months, when remediation disclosures were rare or brief.
Inclusions And Exclusions
To those ends, our list of June disclosures includes those companies that provided material updates on their remediation efforts. That was the case at $57.3 million eUniverse, which originally disclosed a weakness in February, and Roanoke Electric Steel, which disclosed a material weakness back in March. Both companies provided great detail on their remediation plans and timeline for correcting problems, as did $712.9 million Ultimate Electronics, which disclosed a weakness in April.
Control-improvement disclosures were also made at $225 million aaiPharma, $3.0 billion shipping company Stolt Nielsen, and medical supply company Sola International.
Not included in June’s list are disclosures that have already been made public for which there was little additional information. $24.8 million business consultancy SYS, for example, referred to an internal control weaknesses at the company; however, the weaknesses was disclosed over a year ago, and was largely irrelevant to the current state of the company. As a result, the entry is not included in our list.
As usual, we’re including the complete list of disclosures at the link below. Please note that Compliance Week does not publish this list to point an accusatory finger; rather, our goal is to provide information to subscribers that might be helpful in understanding how their peers are making such disclosures and are approaching remediation.
Also, be aware that the excerpts at the link below are just that: excerpts. The complete SEC filings are available for those who would like to review the complete disclosures in greater detail.
Click Here For The List Of June Disclosures
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