Several months ago, I raised the question of why the large-scale accounting fraud cases of the type that had been so prevalent in the early 2000s were no longer a staple for either federal prosecutors or the SEC. In so doing, I was not the only one to have noted a dramatic shift away from such cases towards investigations involving Ponzi schemes, allegations of insider trading, violations of the Foreign Corrupt Practices Act, or other types of financial improprieties. Accounting commentators have noted the decline of such cases – as well as the financial restatements that often precede them – for some time now. Moreover, because the marquee financial statement fraud cases of the early 2000s were a significant driver of growth in white collar defense and forensic accounting practices, the decline of those kinds of cases has been duly noted in professional circles.
As luck would have it, shortly thereafter, Hewlett-Packard loudly accused UK software firm Autonomy of engaging in a willful effort to mislead HP and investors in connection with HP’s 2011 acquisition of that firm, triggering several investigations and extensive media coverage of the same types of revenue recognition issues that had been central to many earlier accounting fraud investigations. Moreover, in the wake of President Obama’s nomination of Mary Jo White as SEC chairman, the question of regulatory enforcement priorities has received significant scrutiny. Included among the questions raised by commentators and the news media is whether the SEC will be focusing more attention on financial statement fraud. In mid-March, for example, the Wall Street Journal reported that one likely area of increased focus under the SEC’s new leadership will be accounting fraud, in part because claims of financial statement misconduct were the biggest single category of tips under the SEC’s whistleblower scheme for the year prior to October 2012. The SEC also recently announced the launch of a highly specialized computerized tool designed to analyze public companies’ reporting data and flag potentially anomalous accounting items.
At the same time, recent press articles have suggested that restatements are on the rise at large public companies. For example, a March 12 article in the Wall Street Journal’s CFO Report highlighted an “uptick” in restatements at largeU.S. companies, relying in part on an analysis performed by data tracking and analysis firm Audit Analytics.
Taken together, one potential inference is that increased financial statement misconduct is resulting in increased restatements, thereby stoking greater interest on the part of the SEC – and perhaps other law enforcement personnel – in what was once a key driver of SEC enforcement activity. However, it is not clear that this conclusion really is borne out by the statistics. To this end, it is worth looking more carefully at the empirical evidence.
To be sure, Audit Analytics’ analysis of financial restatements does suggest that restatements from U.S. “accelerated filers” – typically the largest public companies – have increased over the past three years. However, the overall number of restatements has remained relatively constant since 2009 after experiencing a dramatic drop following their 2006 peak. Moreover, other data reviewed by Audit Analytics suggests that the severity of 2012 restatements, as measured by both the impact on net income and by the average number of issues per restatement, was generally less than in the period prior to 2008. Likewise, the percentage of so-called “revision restatements” – restatements not deemed serious enough to require a disclosure in Item 4.02 of an 8K filing – were markedly higher in 2012 than at any point over the past 8 years.
Thus, while gross restatements may be up for a segment of public companies, the underlying quality of those restatements is suggestive of a further reduction in acknowledged accounting-related errors or transgressions. Moreover, in terms of total numbers, overall restatements are still well below the 1771 restatements issued in 2006 – a high water mark that is more than double the figure reported for 2012.
All of this of course begs the question whether the number and type of restatements are really reflective of the incidence of fraud, as opposed to other variables. Regardless, the data alone does not really support the conclusion that accounting fraud is on the rise. This may not ultimately affect enforcement priorities, given that perception matters and a greater enforcement focus on financial statement fraud does not necessarily depend on an increase in fraud. But it gives reason to question whether the cases of the next few years will be driven by a genuine increase in the incidence of fraud.