In a working paper recently released, the Public Company Accounting Oversight Board (PCAOB), a non-profit entity created by the Sarbanes-Oxley Act (SOX) to oversee the auditors of public companies, found that the loss in market value following announcements of financial restatements has diminished since the July 30, 2002 implementation of SOX. Specifically, on average, a post-SOX restatement announcement resulted in $207 million less market value loss than a pre-SOX restatement. This study was limited to restatements filed by companies that traded on the NYSE and NASDAQ stock exchanges during the period from 1998 to 2005. The authors speculate that these shifts are due to increased investor confidence in the timeliness and quality of post-SOX financial disclosures.
Shareholder class action plaintiffs' lawyers and D&O insurers historically have viewed financial restatements (and pre-SOX) significant stock price drops as significant indicators of shareholder class action activity. The PCAOB study suggests this may no longer be the case.
Separately, to the extent that financial restatements do not result in a material adverse market reaction, shareholder class action plaintiffs may be unable to adequately plead “loss causation” to survive a motion to dismiss. Following the significant Dura Pharmaceuticals decision, shareholder class action plaintiffs must demonstrate that alleged misrepresentations and omissions “proximately caused” their economic loss. Where the market fails to react to a restatement announcement, plaintiffs may face difficulty showing that the alleged misrepresentations and omissions giving rise to a restatement proximately caused economic loss.