Financial restatements force companies to throw a lot of assumptions and supposedly reliable numbers out the window. Now an increasing number of executives at restating companies are going out that way, too.
A Compliance Week analysis of executive and auditor turnover for 2005 and 2006—the first two years companies have had to disclose such departures in formal filings—shows that the number of companies experiencing executive or auditor turnover in the wake of a restatement is rising markedly. More chief executives and chief financial officers are getting fired, resigning, or otherwise leaving their jobs after a restatement, and more auditors are getting dismissed.
DeGraff
“The issue is on people’s radar,” says Harold DeGraff, a partner at the law firm of Perkins Coie. “There’s no question that there’s more sensitivity at the board level to restoring credibility among investors and maintaining good relations with large investors.”
Still, the vast majority of companies that have a restatement see no turnover, largely because boards understand that most restatements arise from unintended errors rather than fraud, experts say.
“The overwhelming majority of restatements are caused by honest mistakes or nothing more than negligence, not by people who acted recklessly and knowingly,” says Ralph Ferrara, a former general counsel at the Securities and Exchange Commission, now at the law firm LeBoeuf, Lamb, Greene & MacRae.
Carcello
“Restatements are far more common today than they were pre-SOX,” adds Joseph Carcello, an accounting professor and director of research of the corporate governance center at the University of Tennessee. Carcello says in part, “that reflects heightened sensitivity by boards, management and auditors … What might’ve been handled in way that didn’t involve a restatement five or 10 years ago now gets restated,” he notes.
A complete breakdown of CEO, CFO, and auditor departures at restating companies can be seen in the “Related Resources” box at upper right. Among the main findings:
The portion of CEOs at restating companies who resigned rose from 8.8 percent in 2005 to 11.3 percent in 2006; the percentage who were dismissed jumped from 0.9 percent to 1.2 percent;
CFOs resigned in greater numbers (12.9 percent in 2005, 14.9 percent in 2006), but fewer were dismissed (0.8 percent and 1 percent, respectively);
The percentage of restating companies that saw both the CEO and CFO depart rose sharply, from 5.5 percent to 8.1 percent;
Auditor dismissals after a restatement rose from 12.3 percent to 14.8 percent, but auditor resignations actually fell, from 8.2 percent to 7.4 percent.
The number of registrants making restatements is rising as well, from 1,529 in 2005 to 1,607 in 2006—or roughly 20 percent of all registrants last year.
Ferrara
How many departures were due specifically to restatements, versus some other reason? That is difficult to determine, since companies only need to disclose that an executive’s exit has occurred, not the exact reason why. But industry observers say boards are taking restatements more seriously than ever. “Unquestionably, there’s more board involvement upon the announcement of a restatement than pre-Sarbanes-Oxley,” Ferrara says.
Richard Koppes of the law firm Jones Day and a member of two boards himself, says, “Boards are treating the issue very seriously, particularly in an age of Sarbanes-Oxley and the law’s requirement that the CEO and CFO certify the financials.”
Acting Responsibly
OUSTERS
Below is a summary of CEO and CFO departures at companies that filed restatements in 2005 and 2006.
2005
2006
Registrants who restated
1,529
1,607
Total restatements
1,690
1,845
CEOs dismissed
14
19
CEOs resigned
135
182
Total CEOs departed
202
266
As % of restating cos.
13.2%
16.6%
CFOs dismissed
12
16
CFOs resigned
197
239
Total CFOs departed
262
312
As % of restating cos.
17.1%
22.2%
Source
Compliance Week Research Dept. (Sept. 5, 2007)
Accounting and governance experts stress that every restatement is different and does not automatically mean somebody should be fired. The prudent course of action, they say, is for the board to determine why the restatement was necessary at all.
“As a governance issue, it’s important to look at the description of the reason for the restatement and the proposed remedies to keep it from happening again,” says Annalisa Barrett, senior research associate at The Corporate Library.
“If you’re on a board, particularly an audit committee, [a restatement] has got to make you uncomfortable,” Carcello says. The board’s reaction should depend on the nature, magnitude and cause of the restatement. “All of those things matter,” he says.
DeGraff says the reason for the restatement usually has far more importance than the actual size of it. “The actions the board takes are those they view as most likely to restore confidence in the company,” he says. “In many cases, management is going to pay the price, particularly the CFO.”
Ferrara says boards are far more inclined than in the past to “to take separating action aimed at those in the executive suite.”
“When the restatement ball starts rolling down hill, directors act in an almost reflexive way,” he says. “They have to hold someone responsible. It’s about as endemic as the knee jerk.”
Beyond directors’ increased oversight responsibilities under SOX, Ferrara says boards also want to demonstrate to the SEC and Justice Department that they are acting responsibly, to curry good favor if the regulators are mulling any action against the company.
“They’re trying to demonstrate … that they can be good, cooperative community servants, so when it’s time to determine whether the company, the audit committee or the outside directors should be indicted or sued, they can say, ‘We took prophylactic action,’” he says.
Barrett
Regardless, ousting top leadership isn’t always the answer when a restatement hits. “Making leadership changes might not solve the underlying problem,” Barrett says. For example, she says, if a restatement is due to aggressive accounting, “that isn’t automatically a reason to get rid of somebody … The board should identify the underlying reason why the aggressive accounting was accepted as a policy approach.”
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