Why Companies Don't Fix Their Numbers
Financial restatements say a lot about a company, some of it unintended. One of my favorite examples occurred last week, when CannaVest Corp., a Las Vegas-based company that makes hemp oil, said it would have to restate its numbers for most of last year.
Tellingly, CannaVest in its news release said it had determined its results were "not in accordance with Generally Accepted Accounts Principals." You see, the accounting was so bad, CannaVest's executives misstated what GAAP stands for: generally accepted accounting principles. (Principal is what you owe on a loan.)
Give CannaVest credit for getting straight, though. (I couldn't resist, though the company's products won't get you high.) Companies aren't correcting their numbers as often as they used to. Last year 759 companies filed restatements with the SEC, according to Audit Analytics Inc., a Sutton, Massachusetts-based research firm. That isn't much different from the results for the previous few years. But it's less than half the record 1,621 in 2006.
There have been many theories offered for why restatements have plunged in recent years. A common explanation: Restatements began to surge about a decade ago because of new rules requiring companies to have their internal controls audited by outside accounting firms. The auditors discovered lots of buried errors, which led to more restatements. After the companies improved their financial-reporting controls, errors declined.
That probably explains some of the drop. But I also have long suspected that the Securities and Exchange Commission isn't forcing companies to correct known errors with the same zeal that it once did. There's no way to know how many examples there may be of this. But we got another one this week when the SEC settled an accounting-fraud case with CVS Caremark Corp., the drug-store chain and health-benefits manager.
One of the SEC's allegations was that CVS fraudulently overstated its earnings in the third quarter of 2009. To this day CVS hasn't acknowledged that its accounting was wrong. The SEC didn't require the company to issue a restatement for that quarter. You could argue that an error in a single quarter more than four years ago is immaterial today and not worth correcting. But the SEC in its complaint said it was material at the time.
The moral of the story here is that if you drag out an SEC investigation long enough, you won't ever have to admit your accounting was wrong. In its news release about the $20 million accord, CVS noted that the settlement was done on a "no admit or deny basis" and "will not require CVS Caremark to restate its earnings for any reporting period." It might as well have issued a blanket denial of the SEC's allegations: Officially speaking, CVS's position remains that its financial statements were right.
The SEC pulled a similar feat of kindness in December, when it accused Fifth Third Bancorp of committing accounting fraud during the height of the 2008 financial crisis. The company agreed to pay a $6.5 million penalty to settle the agency's claims, without admitting or denying the allegations -- and without having to restate any of its numbers.
Since taking the helm at the SEC, Mary Jo White and her lieutenants repeatedly have stressed that they intend to make accounting-fraud cases a priority again. Under her two immediate predecessors as chairman, Mary Schapiro and Christopher Cox, the agency at times seemed to do everything it could to avoid challenging companies' numbers, especially at banks. White also has said she wants more defendants to admit wrongdoing when they enter settlements.
The CVS settlement sends exactly the wrong message: Even if the SEC says a company's earnings are fraudulent, that doesn't mean the company will have to correct them. That isn't enforcement. It's a joke.
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