In June 2024, the Center for Audit Control (the “CAQ”) released its report entitled “Financial Restatement Trends in the United States: 2013 – 2022,” announcing the findings from its study examining trends and characteristics of public company restatement events that took place between January 1, 2013 and December 31, 2022.  For purposes of the study, “restatements” are defined as corrections of errors in public company financial statements filed with the U.S. Securities and Exchange Commission (“SEC”).  The population of restatements can be divided into two kinds: (1) “Big R” restatements, which involve restatements of previously filed financial statements that have been deemed unreliable by the company or its auditors and are subject to mandatory disclosure under Item 4.02 of Form 8-K; and (2) “little r” restatements, which involve restatements to correct immaterial errors to prior period financial statements that, if uncorrected, would cause the current period financial statements to be materially misstated.  Of the 5,793 restatements[1] identified by CAQ from 2013 to 2022, 1,352 were “Big R” restatements and 4,441 were “little r” restatements.

Key findings from the CAQ’s study:

1.      The decline in financial restatements over the study period, particularly in “Big R” restatements, suggests potential improvements in financial reporting quality.

Over the study period, there was a trend towards more “little r” restatements.  The percentage of “Big R” restatements declined from 28% to 18% of total restatements over the first seven years of the study period, after which the trend reversed and climbed to 38% in 2022.  The study noted that it is unclear if the increase in “Big R” restatements at the end of the study period is indicative of a new trend or simply a disruption in the previous downward trend, but the overall downward trend in restatements could suggest that companies are catching and correcting errors before they necessitate reissuing financial statements, possibly due to improvements in internal control systems.

The study explored the impact of regulatory and accounting standard changes over the years on restatement trends, highlighting several key updates from the Financial Accounting Standards Board (FASB) and regulatory shifts that could influence financial reporting practices.  Macroeconomic factors such as the COVID-19 pandemic could have posed greater challenges for companies and auditors, resulting in a greater reliance on accounting estimates, increases in audit and fraud risk, and diminished capability to gather audit evidence.

2.      Expense-related issues, especially around the misapplication of reporting rules for accruals, reserves, and estimates, were identified as the most frequent contributors to restatements.

The study categorized and examined the types of accounting issues that led to restatements based on investor concerns, revealing that while expense recognition issues were predominant, revenue recognition, tax reporting, and debt/equity misclassification also featured prominently.  The study noted that investor concerns are predominantly around restatements affecting core earnings, with a notable interest in those that alter revenue and expense figures.

3.      Fraud was implicated in 3% of total restatements and 7% of “Big R” restatements.

The study examined restatements exhibiting various characteristics of severity including fraud and length of the restated period.  Fraud was indicative of more severe restatements, while restatements affecting interim periods were less severe. Average length of restated periods for the aggregate population of restatements was 1.44 years, with “Big R” restatements having a higher average length of restated periods of 1.60 years.

4.      The top three industries with restatements were: Financial, Banks & Insurance; Healthcare & Pharmaceuticals; and Computer & Software.

Over the study period, the Financial, Banks & Insurance industry represented 17% of the total restatements, while Healthcare & Pharmaceuticals and Computer & Software industries each represented 14% of the total restatements.

5.      Smaller companies, often traded on Nasdaq, were more prone to restatements.

Companies that announced restatements were relatively smaller in terms of average assets and often listed on Nasdaq.

6.      There was an observed link between restatements and ineffective internal control over financial reporting (“ICFR”).

Each year, approximately 70% of companies that announced restatements also reported ineffective ICFR based on managements’ assessments, compared to 80% of companies that did not announce restatements.  This percentage was even lower for companies announcing “Big R” restatements, at 55%. However, ICFR reports were not predictive of restatements, with ineffective ICFR reports generally being issued after a restatement was announced.

7.      Early evidence suggests critical audit matters (“CAMs”) disclosed by auditors do not provide significant insights into restatement risks.

In 2017, the Public Company Accounting Oversight Board adopted AS 3101, “The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Audit Opinion.”  One of the significant changes under AS 3101 was the introduction of CAMs, defined as matters that are communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex auditor judgment.  The study assessed the early implementation and potential effects of disclosing CAMs in audits, noting that while these disclosures were becoming a common part of audit reports, their direct correlation to unveiling or mitigating restatement risk was still indeterminate.

The report concluded that while overall restatement numbers have declined, indicating possibly better financial reporting or perhaps changes in regulatory or market behaviors, issues persisted particularly around expense recognition and internal controls. The study urges stakeholders to continue focusing on improving audit quality and financial reporting standards to enhance the reliability of financial statements and investor trust.

[1] The CAQ did not include 1,155 restatements that were made by special purpose acquisition companies (“SPACs”) as a result of the SEC’s Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies, dated April 21, 2021, which caused a notable spike in the number of restatements by SPACs. The CAQ considers these restatements out-of-scope for purposes of understanding trends in public company restatements generally.