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corporations, and had been audited by the outside independent auditors. It seems very unlikely that
material misstatements would not be detected by either the inside professional accountants or the
outside independent auditors. A suspicion is that the material misstatements were not accidental, but
rather deliberate. In other words, one suspects fraud.
It is an acute embarrassment to a corporation, and to its outside auditors, when the financial
statements that had received approval have to be restated. Corporations and their auditors have every
incentive to avoid this embarrassment by getting the financial statements right the first time around.
Naturally everything of a material nature would be very carefully checked to ensure that it is correct
and in compliance with GAAP. One would think that restatements would very seldom be required if
audits were thorough. One would also think that restatements could be a sign that the auditors had
failed.
So restatements are a red flag, and raise a suspicion of fraud. That is why restatements are
considered an indicator of accounting and auditing failures. And that is why there are studies
published every year about restatements. In past years, restatements were rare. In recent years, they
have become more frequent. In 2006, 1,300 U.S. public companies restated their financial statements.
The Wall Street Journal of December 23, 2006, reported a study of companies that restated their
1998 and 1999 financial statements. The study found that 47% of the CEOs of these restating
companies were gone within two years of the restatements. This was twice the turnover of CEOs of
similar companies in the same industries that had no restatements. Clearly, restatements are an
embarrassing symptom of lax financial controls and/or fraud.
In 2002 the U.S. General Accounting (now Accountability) Office (GAO) made a study of
restatements by publicly listed companies and reported:
The number of financial statement restatements identified each year rose from 92 in 1997 to 225
in 2001. The proportion of listed companies on NYSE, AMEX, and NASDAQ identified as
restating their financial reports tripled from less than 0.89 percent in 1997 to about 2.5 percent in
2001 and may reach almost 3 percent by the end of 2002. From January 1997 through June 2002,
about 10 percent of all listed companies announced at least one restatement.... The 689 publicly
traded companies we identified that announced financial statement restatements between January
1997 and March 2002 lost billions of dollars in market capitalization in the days around the initial
restatement announcement. 2
There were an alarming number of restatements in the late 1990s and early 2000s, often
accompanied by accounting scandals involving huge sums. Some examples are:
• Adelphia filed Chapter 11 bankruptcy in June 2002. This cable TV operator and several
related individuals were sued in July 2002 by the Securities and Exchange Commission (SEC)
and charged with one of the most extensive financial frauds ever to take place in a public
company: fraudulently excluding from its mid-1999 to end of 2001 annual and quarterly financial
statements over $2 billion in debt, caused by systematically recording those liabilities on the
books of unconsolidated affiliates, which violated GAAP. The Rigas family, who founded
Adelphia, received $3.1 billion in off-balance-sheet loans backed by Adelphia. Three Rigas
family members were arrested on allegations of fraud. Adelphia sued its independent auditor 3 for
malpractice.