An auditor’s issuance of a “disclaimed opinion” on Section 404 of The Sarbanes-Oxley Act of 2002—in which the accounting firm reports that it is unable to express an opinion regarding a company's internal control over financial reporting—may have an impact on market analysts, but it probably won’t get much attention from the Securities and Exchange Commission right now. That’s according to experts, who spoke with Compliance Week regarding a list of such opinions extracted from regulatory filings.

DISCLAIMED:

Deloitte And Touche's Disclaimed Opinion At Cray

"Because of the limitation on the scope of our audit described in the second paragraph of this report, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion on management’s assessment referred to above."

PwC's Disclaimed Opinion At Southern Union Company

"The Company has not reported on its assessment of the effectiveness of internal control over financial reporting. Accordingly, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion on the effectiveness of the Company's internal control over financial reporting."

BDO Seidman's Disclaimed Opinion At RAE Systems

"Since management did not complete its documentation, testing and remediation of a significant portion of its internal control processes on a timely basis and we were unable to apply other procedures to satisfy ourselves as to the effectiveness of the Company’s internal control over financial reporting, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion either on management’s assessment or on the effectiveness of the Company’s internal control over financial reporting."

PwC's Disclaimed Opinion At Shurgard Storage Centers

"The Company has not reported on its assessment of the effectiveness of internal control over financial reporting. Accordingly, the scope of our work was not sufficient to enable us to express, and we do not express, an opinion on the effectiveness of the Company’s internal control over financial reporting."

Grant Thornton's Disclaimed Opinion At Pre Paid Legal Services

"Since management was unable to complete its assessment on internal control over

financial reporting as of December 31, 2004, and therefore we were unable to

apply other procedures to satisfy ourselves as to the effectiveness of the

Company's internal control over financial reporting, the scope of our work was

not sufficient to enable us to express, and we do not express, an opinion either

on management's assessment or on the effectiveness of the Company's internal

control over financial reporting."

More Opinions

Click Here For More Examples Of Disclaimed Opinions

Related Coverage

Nasdaq Threatens Delisting For ‘Disclaimed Opinion’ (May 17, 2005)

Related Document

Nasdaq Confirms Cray in Compliance with Listing Requirements

PCAOB Standard

"If the auditor concludes that management has not fulfilled the responsibilities

enumerated in the preceding paragraph, the auditor should communicate, in writing, to

management and the audit committee that the audit of internal control over financial

reporting cannot be satisfactorily completed and that he or she is required to disclaim an

opinion."

Details In The PCAOB's Audit Standard No. 2

Halpern

Joseph Halpern, of Halpern Capital in New York, says an auditor’s issuance of a disclaimed opinion definitely impacts the assessment of a company. And he should know: Halpern follows Cray, a Seattle-based high-performance computing company that filed an amended Form 10-K on March 31 that included a disclaimed opinion from auditor Deloitte & Touche (see box at right). “Simply stated, it calls into question the quality of earnings which is a fundamental of equity analysis,” he says.

But the SEC is another matter.

Jeffrey Grill, a partner with Pillsbury Winthrop Shaw Pittman in Washington, agrees with Halpern that a disclaimed opinion will be tracked rigorously by analysts, but he also adds that the opinion “more sends a message to the market” than to the SEC. Grill notes that companies are in compliance with Commission rules under Section 404 of Sarbanes-Oxley if they file a disclaimed opinion from an auditor (see excerpt from the Public Company Accounting Oversight Board's relevant audit standard below, right).

However, that doesn’t mean the SEC ignores disclaimed opinions. “I wouldn’t be surprised if you go on to a watch list at the SEC, so they can monitor you,” says Grill. “[But] it’s technically not a violation, so it shouldn’t affect your SEC compliance issues.”

Stewart Landefeld, a partner with Perkins Coie in Seattle, says the SEC’s primary concern is disclosure. “The severity of the problem depends 100 percent on the severity of the underlying issue that led to a ‘no opinion,’ and the ability of the company to clearly explain this issue so that both the SEC and the market understand exactly how severe—or non-severe—it is.”

To those ends, complicated accounting issues that impact many companies would probably be viewed differently than major company-specific problems. An example that may not raise many eyebrows, says Landefeld, is a failure that stems from difficultly in assessing foreign taxes in one non-U.S. jurisdiction, or a failure “due to a change in or very recent clarification by the SEC of an accounting issue that may be widespread” among issuers. “By contrast,” he says, “failure of an inventory-rich manufacturing or retail company to be able to accurately price its inventory may be more severe.”

Case-By-Case Assessment

Grill

According to Grill at Pillsbury Winthrop Shaw Pittman, the biggest risk in a disclaimed opinion is market reaction. “How is it going to affect your capital raising?” he poses.

Of course, that impact is difficult to predict, especially because it’s nearly impossible to track the market’s reaction to a disclaimed opinion—auditor opinions are typically disclosed alongside myriad other issues. In fact, all of the disclaimed opinions flagged by Compliance Week were made on Form 10-K (see box at right).

As a result, companies would need to research how investors might react to such a disclosure. Halpern at Halpern Capital acknowledges that it is a “case-by-case assessment” as to how much of a financial impact a disclaimed opinion will have. That assessment “is appropriately based on the facts relayed by the auditors, statements of management and possibly actions of the auditors,” he notes.

And the fact that companies are still getting their feet wet with Sarbanes-Oxley won’t necessarily mean they’ll catch a break from the market. “Given [that] SOX is rather new, and was an extremely hard regulation to follow—costing companies material resources to comply with—one would think that investors would understand a situation where a control was lax to some degree with no affect on past and future results,” says Halpern. “However, in practice I do not think this has been the case, probably stemming from [the fact that it calls into question the] quality of earnings.”

Grill says that public companies often know “well in advance” that a disclaimed opinion is coming, and should put out an explanatory Form 8-K beforehand. “You get credibility in the marketplace for doing that,” he says, by informing investors that “you’re working toward the solution, that you know the problem, that it will take a little more time than expected.” According to Grill, companies that have fully explained the situation have done better in the marketplace; he adds that larger companies have in general dealt with the situation more effectively.

Landefeld

Landefeld, of Perkins Coie, agrees that companies facing a disclaimed opinion are better off if they’re candid. “The solution depends on an ability to clearly explain the underlying cause for the ‘non opinion’,” he says. According to Landefeld, that attitude is in line with other disclosure issues related to the internal control provisions of Sarbanes-Oxley. “Those companies with 404-related problems that have been up-front about the status of efforts to comply with the rules, and the identification and explanation of any material weaknesses known, have generally found the market to have a ‘ho-hum’ response to minor control problems.”

Nasdaq Backs Off Delisting Threats

Earlier this year, Nasdaq had been threatening companies with delisting for filing disclaimed opinions. Cray, the company Halpern follows, was one of the companies that received a delisting notice from Nasdaq.

But according to Grill at Pillsbury Winthrop, the Nasdaq “has started to dismiss most of those proceedings.” Indeed, Cray is one of several companies that had been informed by Nasdaq that the filing of a disclaimed opinion did not violate exchange rules. "Upon further review, the Nasdaq Listing Qualifications Department reversed its earlier decision, and determined that Cray complied with all requirements necessary for continued listing on the Nasdaq National Market," the company disclosed June 1. "The hearing with respect to the delisting procedure has been canceled as being moot." (see box at right for complete announcement)

Again, Landefeld advises that companies get in front of the issue. “Notify your representative at Nasdaq or [the] NYSE in advance,” he says.

In addition, he notes that “the SEC enforcement division seems to prefer to find out about these kinds of problems directly from the company as well.”

Grill also acknowledges that it will likely be a while before the SEC begins reacting to adverse or disclaimed opinions. “Next year, you’ll see fewer of these [disclaimed opinion] reports; after that, even fewer,” he says. “As to the true effect on what an adverse or disclaimed opinion means—in terms of SEC review or market terms—the answer now could be very different two to three years from now.”

Landefeld agrees, although he reemphasizes the points that a disclaimed opinion “is a big-time issue,” and that full disclosure is critical. “The last five months have shown that it is an issue that thoughtful companies can address and deal with successfully—with the SEC and with the market.”