a

GAO

United States Government Accountability Office

On March 5, 2007, this report was reissued to 

amend our economic analysis and selected 

company shares outstanding (see next page for 

more details). It also incorporates our August 

2006 correspondence (GAO-06-1053R) as 

appendix V.

Report to the Ranking Minority Member, 

Committee on Banking, Housing, and 

Urban Affairs, U.S. Senate

July 2006 FINANCIAL 

RESTATEMENTS

Update of Public 

Company Trends, 

Market Impacts, and 

Regulatory 

Enforcement 

Activities

GAO-06-678
United States Government Accountability Office

Washington, DC 20548 

March 5, 2007 

The Honorable Christopher J. Dodd 

Chairman 

Committee on Banking, Housing, and Urban Affairs 

U.S. Senate 

Dear Mr. Chairman: 

We are reissuing Financial Restatements: Update of Public Company Trends, 

Market Impacts, and Regulatory Enforcement Activities (GAO-06-678), July 25, 

2006, to reflect revisions in our market impact calculations. In addition, we are 

incorporating our August 2006 supplemental report, Financial Restatement Database

(GAO-06-1053R), which updated the restatement database through June 2006, into 

this reissued report as Appendix V. The associated electronic database (GAO-06-

1079SP) has also been reissued. We have recalculated the dollar impact calculations 

in this study, which has resulted in a lower calculation of cumulative market impact 

for 2002–2005; however, these revisions do not change the report’s findings, 

conclusions, or recommendations. That is, the impact on stock prices in the days 

surrounding a restatement announcement continues to be much lower than we found 

in our 2002 report (GAO-03-138). 

The revisions to this report are generally concentrated in the second objective of the 

report, which discusses the impact of restatement announcements on the restating 

company’s stock price in the immediate-, intermediate-, and longer-term. The 

revisions were prompted because the shares outstanding for several foreign 

companies reflected American Depositary Receipts (ADR) that had not been 

converted to equivalent ordinary shares outstanding.1

 As a result, the market 

capitalization calculations for these companies used in our impact analysis for a few 

companies resulted in the market capitalization calculations being higher than they 

should have been. 

 

1

An American Depositary Receipt is a negotiable certificate issued by a U.S. bank representing a 

specified number of shares (or one share) in a foreign stock that is traded on a U.S. exchange. ADRs 

are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution 

overseas. 
This reissued report reflects the appropriate conversions for foreign companies and 

amends our market capitalization calculations and impact analysis. We also 

conducted an additional comprehensive review of our database and calculations in 

the report and are making a number of other technical revisions. 

Sincerely yours, 

Orice M. Williams 

Director, Financial Markets and Community 

 Investment 

Enclosure 

Page 2 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

July 2006 

FINANCIAL RESTATEMENTS 

Update of Public Company Trends, 

Market Impacts, and Regulatory 

Enforcement Activities 

Highlights of GAO-06-678, a report to the 

Ranking Minority Member, Committee on 

Banking, Housing, and Urban Affairs, U.S. 

Senate 

In 2002, GAO reported that the 

number of restatement 

announcements due to financial 

reporting fraud and/or accounting 

errors grew significantly between 

January 1997 and June 2002, 

negatively impacting the restating

companies’ market capitalization 

by billions of dollars. GAO was 

asked to update key aspects of its 

2002 report (GAO-03-138). This

report discusses (1) the number of, 

reasons for, and other trends in 

restatements; (2) the impact of

restatement announcements on the 

restating companies’ stock prices

and what is known about investors’ 

confidence in U.S. capital markets; 

and (3) regulatory enforcement

actions involving accounting- and 

audit-related issues. To address

these issues, GAO collected 

restatement announcements 

meeting GAO’s criteria, calculated 

and analyzed the impact on

company stock prices, obtained

input from researchers, and 

analyzed selected regulatory

enforcement actions. 

What GAO Recommends

GAO recommends that SEC 

investigate potential 

noncompliance with current Form 

8-K filing requirements and make

consistent the guidance to 

registrants concerning required 

disclosures regarding certain 

restatements. SEC stated that it

would examine the instances of

potential non-compliance and 

carefully consider harmonizing 

guidance concerning Form 8-Ks. 

While the number of public companies announcing financial restatements 

from 2002 through September 2005 rose from 3.7 percent to 6.8 percent, 

restatement announcements identified grew about 67 percent over this 

period. Industry observers noted that increased restatements were an 

expected byproduct of the greater focus on the quality of financial reporting 

by company management, audit committees, external auditors, and 

regulators. GAO also observed the following trends: (1) cost- or expenserelated reasons accounted for 35 percent of the restatements, including lease 

accounting issues, followed in frequency by revenue recognition issues; and 

(2) most restatements (58 percent) were prompted by an internal party such 

as management or internal auditors. In the wake of increased restatements, 

SEC standardized disclosure requirements by requiring companies to file a

specific item on the Form 8-K when a company’s previously reported 

financials should no longer be relied upon. However, between August 2004-

September 2005, about 17 percent of the companies GAO identified as 

restating did not appear to file the proper disclosure when they announced 

their intention to restate. These companies continued to announce 

intentions to restate previous financial statements results in a variety of 

other formats. 

Although representing about 0.2 percent of the market capitalization of the 

major exchanges, which was $17 trillion in 2005, the market capitalization of 

companies announcing restatements between July 2002 and September 2005 

decreased over $36 billion when adjusted for market movements (nearly $18

billion unadjusted) in the days around the initial restatement announcement. 

Researchers generally agree that restatements can negatively affect overall

investor confidence, but it is unclear what effects restatements had on 

confidence in 2002–2005. Some researchers noted that investors might have 

grown less sensitive to the announcements. Others postulated that investors 

had more difficulty discerning whether restatements represented a response 

to aggressive or abusive accounting practices, complex accounting 

standards, remediation of past accounting deficiencies, or technical 

adjustments. Although researchers generally agree that restatements can 

have a negative effect on investor confidence, the surveys, indexes, and 

other proxies for investor confidence that GAO reviewed did not indicate 

definitively whether investor confidence increased or decrease since 2002. 

As was the case in the 2002 report, a significant portion of SEC’s 

enforcement activities involved accounting- and auditing-related issues. 

Enforcement cases involving financial fraud- and issuer-reporting issues 

ranged from about 23 percent of total actions taken to almost 30 percent in 

2005. Of the actions resolved between March 1, 2002, and September 30, 

2005, about 90 percent were brought against public companies or their 

directors, officers, and employees, or related parties; the other 10 percent 

involved accounting firms and individuals involved in the external audits of 

these companies. 

www.gao.gov/cgi-bin/getrpt?GAO-06-678. .

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Orice M. 

Williams at (202) 512-5837 or 

williamso@gao.gov. 
Page i GAO-06-678 Financial Restatements

Contents

Letter 1

Results in Brief 4

Background 7

The Number of Restatements Has Continued to Grow and New 

Trends Have Emerged 11

Market Capitalization of Restating Companies Decreased by Billions 

in the Days Surrounding Restatement Announcements, but Was 

Less Severe Than in Our Prior Report 23

Certain Restatements Appear to Affect Investor Confidence but 

Trends in Restatements Complicate Analysis 33

Accounting- and Auditing-Related Enforcement Actions Have 

Continued to Grow 42

Conclusions 48

Recommendations 49

Agency Comments and Our Evaluation 50

Appendixes

Appendix I: Objectives, Scope, and Methodology 52

Appendix II: Comments from the Securities and Exchange Commission 64

Appendix III: Comments from the Public Company Accounting Oversight 

Board 65

Appendix IV: Summary of Selected Sarbanes-Oxley Act Provisions 

Affecting Public Companies and Registered Accounting 

Firms 66

Appendix V: GAO-06-1053R 69

Appendix VI: Comparison of Our Restatement Database to Those of Glass, 

Lewis & Co. LLC and the Huron Consulting Group 156

Appendix VII: SEC Enforcement Process 162

Appendix VIII: Case Study Overview 164

Business Overview 165

Restatement Data 165

Accounting/Audit Firm 165

Stock Prices 165

Securities Analysts’ Recommendations 165

Credit Rating Agency Actions 166

Legal and Regulatory Actions Taken 166

Appendix IX: American International Group, Inc. Case Study 167
Contents

Page ii GAO-06-678 Financial Restatements

Business Overview 167

Restatement Data 167

Accounting/Audit Firm 169

Stock Prices 170

Securities Analysts’ Recommendations 171

Credit Rating Agency Actions 171

Legal and Regulatory Actions Taken 172

Appendix X: Dynacq Healthcare, Inc. Case Study 176

Business Overview 176

Restatement Data 176

Accounting/Audit Firm 177

Stock Prices 178

Securities Analysts’ Recommendations 179

Credit Rating Agency Actions 179

Legal and Regulatory Actions Taken 179

Appendix XI: Federal National Mortgage Association (Fannie Mae) Case 

Study 181

Business Overview 181

Restatement Data 181

Accounting/Audit Firm 183

Stock Prices 183

Security Analysts’ Recommendations 184

Credit Rating Agency Actions 185

Legal and Regulatory Actions Taken 185

Appendix XII: Qwest Communications International, Inc. Case Study 188

Business Overview 188

Restatement Data 188

Accounting/Audit Firm 189

Stock Prices 189

Securities Analysts’ Recommendations 190

Credit Rating Agency Actions 191

Legal and Regulatory Actions Taken 191

Appendix XIII: Starbucks Corporation Case Study 196

Business Overview 196

Restatement Data 196

Accounting/Audit Firm 198

Stock Prices 198

Securities Analysts’ Recommendations 199

Credit Rating Agency Actions 199

Legal and Regulatory Actions Taken 200
Contents

Page iii GAO-06-678 Financial Restatements

Appendix XIV: Sterling Bancshares, Inc. Case Study 201

Business Overview 201

Restatement Data 201

Independent Auditor 203

Stock Prices 203

Securities Analysts’ Recommendations 204

Credit Rating Agency Actions 204

Legal and Regulatory Actions Taken

 204

Appendix XV: GAO Contact and Staff Acknowledgments 205

Glossary 206

Tables Table 1: Number of Listed Restating Companies as a Percentage of 

Average Listed Companies, 2002–September 2005 13

Table 2: Financial Restatement Category Descriptions 19

Table 3: Summary of Immediate Impact of Restatement 

Announcements on Restating Companies’ Market 

Capitalization, July 2002–September 2005 24

Table 4: Summary of Immediate Impact on Restating Company 

Market Capitalization as a Percentage of Total Market 

Capitalization, July 2002–September 2005 26

Table 5: Summary of Intermediate Impact of Restatement 

Announcements on Restating Companies’ Market 

Capitalization, July 2002–September 2005 31

Table 6: Summary of Longer-Term Impact of Restatement 

Announcements on Restating Companies’ Market 

Capitalization, July 2002–September 2005 32

Table 7: Summary of Selected Sarbanes-Oxley Act Provisions 

Affecting Public Companies and Registered Accounting 

Firms 66

Table 8: Six Case Studies of Public Companies That Announced 

Restatements from July 2002 through September 2005 164

Table 9: Selected Financial Data for AIG, 2000–2004 169

Table 10: Selected Financial Data for Dynacq, Fiscal Years 1999–

2002 177

Table 11: Selected Financial Data for Qwest, 2000 and 2001 189

Table 12: Selected Reported Financial Data for Starbucks, 2002–

2004 197

Table 13: Selected Financial Data for Sterling Bancshares (Fiscal 

Year 2002, the First Two Quarters of Fiscal Year 2003) 203
Contents

Page iv GAO-06-678 Financial Restatements

Figures Figure 1: Existing System of Corporate Governance and 

Accounting Oversight Structures 10

Figure 2: Total Number of Restatement Announcements Identified, 

January 1997–September 2005 12

Figure 3: Percentage of Listed Companies Restating, 2002–

September 2005 16

Figure 4: Restatements by Reason, January 1997–June 2002 and 

July 2002– September 2005 17

Figure 5: Who Prompted Restatements, January 1997–June 2002 

versus July 2002–September 2005 20

Figure 6: Immediate Market-Adjusted Impact on Market 

Capitalization of Restating Companies by Restatement 

Reason, July 2002–September 2005 28

Figure 7: UBS/Gallup Investor Optimism Index, October 1996–May 

2006 37

Figure 8: Effect of Accounting Concerns on Investor Confidence in 

the Stock Market, March 2002–May 2006 39

Figure 9: Number of SEC Enforcement Actions and Financial 

Reporting and Issuer Disclosure Issues Initiated, Fiscal 

Years 1998–2005 43

Figure 10: Total Market Capitalization by Trading Market, 2005 157

Figure 11: Number of Restatements, by Research Study 159

Figure 12: Number of Companies Restating, 2003–2004, GAO versus 

Glass Lewis 161

Figure 13: Flowchart of SEC’s Enforcement Process 163

Figure 14: Daily Stock Prices for AIG, July 1, 2004–February 28, 

2006 170

Figure 15: Daily Stock Prices for Dynacq, January 2, 2002–May 31, 

2005 179

Figure 16: Daily Stock Prices for Fannie Mae, October 1, 2002–

February 28, 2006 184

Figure 17: Daily Stock Prices for Qwest, January 2, 2001February 28, 

2004 190

Figure 18: Daily Stock Prices for Starbucks, June 1, 2004–April 28, 

2006 199

Figure 19: Daily Stock Prices for Sterling Bancshares, April 1, 2003–

April 30, 2004 204
Contents

Page v GAO-06-678 Financial Restatements

Abbreviations

AAER Accounting and Auditing Enforcement Release

AIG American International Group, Inc.

AIGFP American International Group Financial Product

Amex American Stock Exchange

AOL AOL Time Warner Inc.

CAO chief accounting officer

CEO chief executive officer

CFO chief financial officer

CPA certified public accountant

DOJ Department of Justice

E&Y Ernst & Young, LLP

EDGAR Electronic Data Gathering, Analysis, and Retrieval system

EITF Emerging Issues Task Force

ERISA Employment Retirement Income Security Act of 1974

FAF Financial Accounting Foundation 

FASB Financial Accounting Standards Board 

GAAP generally accepted accounting principles

HCG Huron Consulting Group

IPR&D in-process research and development

NYSE New York Stock Exchange

NYSOAG Office of the Attorney General for the State of New York

OFHEO Office of Federal Housing Enterprise Oversight

OTC over-the-counter

PCAOB Public Company Accounting Oversight Board

SAS Statement on Auditing Standards

SEC Securities and Exchange Commission

SFAS Statement of Financial Accounting Standards

SIA Securities Industry Association

TAQ Trade and Quote

This is a work of the U.S. government and is not subject to copyright protection in the 

United States. It may be reproduced and distributed in its entirety without further 

permission from GAO. However, because this work may contain copyrighted images or 

other material, permission from the copyright holder may be necessary if you wish to 

reproduce this material separately.
Page 1 GAO-06-678 Financial Restatements

United States Government Accountability Office

Washington, D.C. 20548

A

July 24, 2006 Letr

The Honorable Paul S. Sarbanes

Ranking Minority Member 

Committee on Banking, Housing, and Urban Affairs

United States Senate

Dear Senator Sarbanes:

Public confidence in financial reporting is critical to the effective 

functioning of the securities markets. However, restatements have resulted 

in billions of dollars of lost market capitalization, as markets react to news 

that companies plan to restate their prior financial statements or earnings 

reports. For example, in a 2002 report, we estimated that restatements of 

financial statements or other financial information resulted in 

approximately $100 billion decline in market capitalization in the days 

surrounding the restatement announcement.1

 Moreover, we found that 

from January 1997 through June 2002, 845 public companies announced the 

need to restate their financial information because of financial reporting 

fraud and/or accounting errors.2

 

Responding to corporate failures and the financial reporting fraud that 

resulted in substantial losses to institutional and individual investors, 

Congress passed the Sarbanes-Oxley Act in 2002 (Sarbanes-Oxley Act).3

 

The act contains provisions affecting the financial reporting of public 

companies, including management assessment and auditor attestation 

1

GAO, Financial Statement Restatements: Trends, Market Impacts, Regulatory Responses, 

and Remaining Challenges, GAO-03-138 (Washington, D.C.: Oct. 4, 2002). For the purposes 

of our 2002 report and this report (1) a restatement occurs when a company, either 

voluntarily or prompted by auditors or regulators, revises public financial information that 

was previously reported; and (2) the restatement announcement is considered the market 

event whose effect is to be measured. Market capitalization is the value of a company as 

determined by the market price of its issued and outstanding common stock (the number of 

shares outstanding multiplied by the current market price of a share).

2

Financial reporting fraud generally is defined as an instance in which a company 

intentionally misstates its financial statements or intentionally misapplies an accounting 

pronouncement. Accounting errors generally are unintentional mistakes in a transaction or 

application of an accounting principle that results in the financial statements not being fairly 

presented in conformity with generally accepted accounting principles. Our analysis 

includes both financial reporting fraud and accounting errors. In our 2002 report, we 

referred to financial reporting fraud and accounting errors as accounting irregularities.

3

Pub. L. No. 107-204, 116 Stat. 745 (July 30, 2002).
Page 2 GAO-06-678 Financial Restatements

about the effectiveness of internal controls. Industry observers expected 

that the number of public companies restating their financial statements 

would increase for some period of time because of increased scrutiny of 

internal controls over financial reporting, and then eventually level off as 

companies improved their controls. 

You asked that we update our 2002 report on restatements. In this report, 

we (1) determine the number of, reasons for, and other trends in 

restatements of previously reported financial information; (2) analyze the 

impact of restatement announcements on the restating companies’ stock 

market capitalization; (3) research available data to determine the impact 

of restatements on investors’ confidence in the existing U.S. system of 

financial reporting and capital markets; and (4) analyze Securities and 

Exchange Commission (SEC) enforcement actions involving accountingand audit-related issues.

To identify restatements, we used Lexis-Nexis, an online information 

service, to systematically search for restatement announcements using 

variations of “restate” and other relevant words. We then identified and 

collected information on 1,390 restatements announced by 1,121 public 

companies—984 of which were listed companies on the New York Stock 

Exchange (NYSE), Nasdaq, and American Stock Exchange (Amex)—from 

July 1, 2002, to September 30, 2005, that involved corrections of previously 

reported financial results.4

 Throughout the report, we refer to the subset of 

companies with stock listed on NYSE, Nasdaq, and Amex as “listed.” Our 

database generally excludes announcements involving stock splits, 

changes in accounting principles, and other announced restatements that 

were not made to correct errors in the application of accounting 

principles.5

 We classified each of the 1,390 announced restatements we 

identified into one of nine categories: revenue recognition; cost- or 

expense; acquisitions and mergers; in-process research and development 

(IPR&D); reclassification; related-party transactions; restructuring, assets, 

or inventory; securities related; and “other” restatements. This 

classification process involved some degree of judgment and other 

4

The number of announcements exceeds the number of public companies because some 

companies announced restatements more than once.

5

Because numerous revisions to the Financial Accounting Standards Board’s Financial 

Interpretation No. 46, Consolidation of Variable Interest Entities, were issued over a short 

span, we generally excluded restatements made to comply with such guidance, unless the 

compliance was not timely. 
Page 3 GAO-06-678 Financial Restatements

researchers could interpret certain restatements differently. While several 

other studies have used a similar methodology, we know of no publicly 

available restatement list against which to compare the completeness of 

our list. However, we did review companies’ SEC filings and Web sites to 

verify the accuracy of particular restatement announcement dates and 

reasons. We also compared some qualitative features of our database with 

proprietary information provided by financial consulting firms. We also 

compared companies in our database with a list of companies that had filed 

Form 8-K, Item 4.02, disclosures with SEC between August 2004 and 

September 2005 to identify companies that warranted further review 

concerning how they disclosed their restatement announcements. 

To determine the immediate impact on stock prices, as in our prior report, 

we used the standard event study methodology, which is widely accepted 

in the academic literature. We were able to analyze 1,061 of the 1,390 

restatements that were announced from July 1, 2002, through September 

30, 2005; we also collected information on other characteristics of 

restatement trends. We were unable to include 329 in our primary analysis 

because (1) they involved stocks not listed on NYSE, Nasdaq, or Amex; or 

(2) they were missing data for the relevant period for causes including 

trading suspensions, bankruptcies, and mergers. For the 1,061 cases, we 

analyzed the company’s stock price from the trading day before through the 

trading day after the announcement date to assess the immediate impact 

and calculate the change in market capitalization. We analyzed the 

intermediate impact (20 trading days before and after the restatement 

announcement date) for 991 of the 1,390 restatements to capture any 

potential information leakage concerning potential restatements.6

 We also 

analyzed the longer-term impact (60 trading days before and after the 

restatement announcement date) for 928 of the 1,390 restatements to gauge 

whether the company’s stock prices rebounded over time.7

 In the 

immediate-, intermediate-, and longer-term calculations, we adjusted for 

overall market movements. Additionally, we performed a separate 

immediate impact analysis of the 329 announcements that we were unable 

to analyze in the primary event study, which was limited to a simple 

assessment of any changes in unadjusted market capitalization. To analyze 

6

There were fewer restatements analyzed over the intermediate period than restatements 

analyzed in the immediate impact analysis because of missing longer-term data.

7

There were even fewer restatements analyzed over the longer-term period than 

restatements analyzed in the intermediate and immediate impact analysis due to missing 

longer-term data.
Page 4 GAO-06-678 Financial Restatements

the impact of restatements on investor confidence, we identified a number 

of indexes, reviewed quantitative research on the issue, conducted 

structured interviews with (and collected information) from experts in 

accounting and financial markets, and collected data on a variety of proxy 

measures. 

To obtain information about the recent enforcement actions SEC has taken 

involving accounting- and auditing-related issues, which may or may not 

involve a restatement, we collected information on SEC’s enforcement 

process, reviewed available SEC information, and collected enforcement 

case data from over 800 Accounting- and Auditing-Related Enforcement 

Releases (AAER) issued from March 1, 2002, through September 30, 2005 

posted on SEC’s Web site as of July 1, 2006. We also interviewed officials 

from SEC and the Public Company Accounting Oversight Board (PCAOB), 

which was established by the Sarbanes-Oxley Act to oversee the audits of 

public companies subject to the securities laws.

We conducted our work between June 2005 and August 2006 in accordance 

with generally accepted government auditing standards. For additional 

information on our scope and methodology, see appendix I. 

Results in Brief While the number of companies announcing financial restatements from 

2002 through September 2005 rose from 3.7 percent to 6.8 percent, 

restatement announcements identified grew about 67 percent over this 

period. Of the restatements identified, cost- or expense-related issues were 

the primary reason for restatements during this period and most were 

prompted by internal parties, such as management or internal auditors. 

Some industry observers commented that increased restatements were the 

expected byproduct of the greater focus—by company management, audit 

committees, external auditors, and regulators—on the quality of financial 

reporting. The cumulative totals were 919 restatements over a 66-month 

period that ended June 30, 2002, and 1,390 restatements over the 39-month 

period that ended September 30, 2005. Over the period of January 1, 2002, 

through September 30, 2005, the total number of restating companies 

(1,084) represents 16 percent of the average number of listed companies 

from 2002 to 2005, as compared to almost 8 percent during the 1997-2001 

period. The median size (by market capitalization) of restating companies 

increased from $277 million in 2002 to $682 million in 2005. For the July 

2002 through September 2005 period, the 1,121 restating companies we 

identified (accounting for 1,390 restatement announcements) announced 

that they would restate their financial information for many reasons—for 
Page 5 GAO-06-678 Financial Restatements

example, to adjust revenue, costs or expense, or address securities-related 

issues. Cost- or expense-related issues were the primary reason for 

restatements, which included numerous lease accounting issues in early 

2005; overall cost- or expense related issues accounted for 35 percent of 

the 1,390 announced restatements during this period. Internal parties (e.g., 

management or internal auditors) prompted a majority (58 percent) of the 

announced restatements, while external parties (e.g., external auditors or 

regulators) prompted nearly one-quarter (24 percent) of them; we were 

unable to identify the prompter in the remaining 18 percent. 

The market capitalization of the companies—those we were able to analyze 

from among the listed companies that we identified as announcing 

restatements of previously reported information between July 2002 and 

September 2005—decreased an estimated $36 billion when adjusted for 

overall market movements (nearly $18 billion unadjusted) in the days 

around the initial restatement announcement.8

 For the restating companies 

we analyzed, stock prices fell almost 2 percent on average (market 

adjusted) from the trading day before through the trading day after an 

initial restatement announcement. This short-term impact ($36 billion), if 

realized, may have been significant for the companies and shareholders 

involved, but represents about 0.2 percent of the combined total market 

capitalization of NYSE, Nasdaq, and Amex, which was $17 trillion in 2005. 

Although capturing the impact of a restatement announcement over 

intermediate and longer periods (20 and 60 trading days before and after 

the event, respectively) is more difficult, our analyses suggest that 

restatement announcements have had a somewhat negative effect on stock 

prices beyond their immediate impact. The announced reasons for 

restatements also were a factor in how great an impact a restatement 

announcement had on stock prices. In a change from our previous report, 

cost- or expense-related issues were the most frequently cited reasons for 

restating and had the greatest impact on market capitalization in dollar 

terms, but as was the case in our previous report, restatements involving 

revenue issues and financial reporting fraud and/or accounting errors 

generally led to greater market losses than restatements for other reasons.

8

These results are based on our event study and include only those stocks listed on NYSE, 

Nasdaq, and Amex at the time the companies announced restatements. Adjusting for market 

movements is important in general because the impact of negative (or positive) companyspecific news can be dampened (or bolstered) on a day when the overall market is moving 

higher, and vice versa. Failing to control for market movements can result in attributing a 

greater or smaller impact to an event than is warranted.
Page 6 GAO-06-678 Financial Restatements

Although researchers generally agree that restatements can have a negative 

effect on investor confidence, the surveys, indexes, and other proxies for 

investor confidence that we reviewed did not indicate definitively whether 

investor confidence increased or decreased since 2002. To illustrate, some 

researchers noted that, since 2002, investors may have had more difficulty 

discerning whether a restatement represented a response to: aggressive or 

abusive accounting practices, the complexity of accounting standards, the 

remediation of past accounting deficiencies, or technical adjustments. 

However, several survey-based indexes and other proxies for investor 

sentiment did not indicate a consensus on the direction of investor 

confidence since 2002. For example, a periodic UBS/Gallup survey, aimed 

at measuring investor confidence indicated that while concerns over 

corporate accounting practices still existed, overall investor confidence 

remained low primarily because of concerns such as high energy prices and 

the federal budget deficit. In contrast, the Yale confidence indexes, which 

found investor confidence levels were largely unaffected by the accounting 

scandals prior to 2003, more recently showed that institutional investors 

have slightly more confidence in the stock market—but results for 

individual investors were unclear.9

 Finally, other measures and proxies for 

investor confidence indicated that increased financial restatements may 

not have had a negative impact on overall confidence or, if they had, any 

negative impact had been counterbalanced by other, more positive forces.

The number of SEC enforcement cases involving financial fraud and issuer 

reporting issues increased from 79 in fiscal year 1998 to 185 in fiscal year 

2005—a more than a 130 percent increase. Moreover, in fiscal year 2005, 

cases involving financial fraud and issuer reporting issues constituted the 

largest category of enforcement actions. The resources SEC devoted to 

enforcement grew as well. The financial debacles of the late 1990s and 

early 2000s spurred Congress to increase SEC’s resources to help SEC 

better manage its increased workload. This resulted in a 22 percent 

increase in SEC’s enforcement resources between fiscal years 2002 and 

2003. Of the enforcement actions SEC resolved between March 1, 2002, and 

September 30, 2005, SEC brought about 90 percent against public 

companies or their directors, officers, and employees; the other 10 percent 

of the cases involved accounting firms and individuals affiliated with 

accounting firms. To address such violations, SEC sought a variety of 

penalties against these companies and individuals, including monetary 

9

The four Yale indexes are (1) the One-Year Confidence Index, (2) the Buy on Dip 

Confidence Index, (3) the Crash Confidence Index, and (4) the Valuation Confidence Index.
Page 7 GAO-06-678 Financial Restatements

sanctions, cease-and-desist orders, and bars on individuals appearing 

before SEC or serving as officers or directors in public companies. In 

addition, the newly created PCAOB also has broad investigative and 

disciplinary authority over public accounting firms that have registered 

with it and persons associated with such firms; PCAOB has initiated 

several enforcement actions since its inception. 

This report includes recommendations to SEC to help ensure compliance 

with its Form 8-K reporting requirements and make consistent existing SEC 

guidance on public company disclosures of restatements that result in nonreliance on previously issued financial statements. This would include 

investigating the instances of potential noncompliance that we identified 

and take any necessary actions to correct them. Moreover, to improve the 

consistency and transparency of information provided to markets about 

restatements, we recommend that SEC harmonize existing instructions and 

guidance concerning Item 4.02 by amending the instructions to Form 8-K 

and other relevant periodic filings to clearly state that an Item 4.02 

disclosure on Form 8-K is required for all determinations of non-reliance on 

previously issued financial statements (Item 4.02), irrespective of whether 

such information has been disclosed on a periodic report or elsewhere.

We requested comments on a draft of this report from the Chairmen of SEC 

and PCAOB. SEC and PCAOB provided written comments. In response to 

our recommendations, SEC noted that it would (1) continue its practice of 

examining instances of potential noncompliance and take appropriate 

actions, and (2) carefully consider our recommendation that it harmonize 

certain instructions and guidance related to restatements. PCAOB noted 

that as the overseer of the audit of public companies, it is very interested in 

the trends in financial restatements identified in the report and the impact 

on public companies and investors and thinks that the report will advance 

an understanding of this important issue. We reprinted SEC’s and PCAOB’s 

written comments in appendixes II and III, respectively, and discuss them 

in greater detail near the end of this report. Both SEC and PCAOB provided 

technical comments that were incorporated into the report as appropriate. 

We also obtained comments from officials at several of the companies 

selected as case studies in this report and have incorporated their 

comments as appropriate.

Background Public confidence in the reliability of financial reporting is critical to the 

effective functioning of the securities markets, and various federal laws 

and entities help ensure that the information provided meets such 
Page 8 GAO-06-678 Financial Restatements

standards. Federal securities laws help to protect the investing public by 

requiring public companies to disclose financial and other information. 

SEC was established by the Securities Exchange Act of 1934 (the Exchange 

Act) to operationalize and enforce securities laws and oversee the integrity 

and stability of the market for publicly traded securities. SEC is the primary 

federal agency involved in accounting requirements for publicly traded 

companies. Under Section 108 of the Sarbanes-Oxley Act, SEC has 

recognized the accounting standards set by the Financial Accounting 

Standards Board (FASB)—generally accepted accounting principles 

(GAAP)—as ”generally accepted” for the purposes of the federal securities 

laws. SEC reviews and comments on registrant filings and issues 

interpretive guidance and staff accounting bulletins on accounting matters.

To issue securities for trading on an exchange, a public company must 

register the securities offering with SEC, and to register, the company must 

meet requirements set by the Exchange Act, as amended, including the 

periodic disclosure of financial and other information important to 

investors. The regulatory structure of U.S. markets is premised on a 

concept of corporate governance that makes officers and directors of a 

public company responsible for ensuring that the company’s financial 

statements fully and accurately describe its financial condition and the 

results of its activities. Company financial information is publicly disclosed 

in financial statements that are to be prepared in accordance with 

standards set by FASB and guidance issued by SEC. The integrity of these 

financial statements is essential if they are to be useful to investors and 

other stakeholders. 

In addition to the requirements and standards previously discussed, the 

securities acts and subsequent law set requirements for annual audits of 

the financial statements by registered public accounting firms to help 

ensure the integrity of financial statements. The applicable standards under 

these laws require that auditors plan and perform the audit to obtain 

reasonable assurance about whether the financial statements are free of 

material misstatement. An audit includes an examination, on a test basis, of 

evidence supporting the amounts and disclosures in the financial 

statements; an assessment of the accounting principles used and 

significant estimates made by management; and an evaluation of the 

overall financial statement presentation. The purpose of the auditor’s 

report is to provide reasonable assurance about whether the financial 

statements present fairly, in all material respects, the financial position of 

the company, the results of its operations, and its cash flows, in conformity 

with U.S. GAAP. 
Page 9 GAO-06-678 Financial Restatements

The Sarbanes-Oxley Act reinforces principles and strengthens 

requirements (established in previous law), including measures for 

improving the accuracy, reliability, and transparency of corporate financial 

reporting. Specifically, Section 302 requires that the chief executive officer 

(CEO) and chief financial officer (CFO) must certify for each annual and 

quarterly report filed with SEC that they have reviewed the report; the 

report does not contain untrue statements or omissions of a material fact; 

and the financial information in the report is fairly presented. In addition, 

Section 404 requires company management to annually (1) assess its 

internal control over financial reporting and report the results to SEC and 

(2) have a registered public accounting firm attest to and report on 

management’s assessment of effectiveness of internal control over 

financial reporting. While larger public companies have implemented 

Section 404, most companies with less than $75 million in public float—

about 60 percent of all public companies—have yet to complete this 

process.10 (See app. IV for further discussion of the act.)

To oversee the auditing of publicly traded companies, the Sarbanes-Oxley 

Act established PCAOB, a private-sector nonprofit organization. Subject to 

SEC oversight, PCAOB sets standards for, registers, and inspects the 

independent public accounting firms that audit public companies and has 

the authority to conduct investigations and disciplinary proceedings and 

impose sanctions for violations of law or PCAOB rules and standards. 

Specifically, Section 105 of the Sarbanes-Oxley Act granted PCAOB broad 

investigative and disciplinary authority over registered public accounting 

firms and persons associated with such firms. In May 2004, SEC approved 

PCAOB’s rules implementing this authority. According to the rules, PCAOB 

staff may conduct investigations concerning any acts or practices, or 

omissions to act, by registered public accounting firms and persons 

associated with such firms, or both, that may violate any provision of the 

act, PCAOB rules, the provisions of the securities laws relating to the 

preparation and issuance of audit reports and the obligations and liabilities 

of accountants with respect thereto, including SEC rules issued under the 

act, or professional standards. Furthermore, PCAOB’s rules require 

registered public accounting firms and their associated persons to 

cooperate with PCAOB investigations, including producing documents and 

providing testimony. The rules also permit PCAOB to seek information 

from other persons, including clients of registered firms. See figure 1 for 

10SEC defines public float as the aggregate market value of voting and non-voting common 

equity held by non-affiliates of the issuer.
Page 10 GAO-06-678 Financial Restatements

the existing system of corporate governance and accounting oversight 

structures.

Figure 1: Existing System of Corporate Governance and Accounting Oversight Structures

a

SEC has delegated front-line regulation of broker-dealers to the self-regulatory organizations. NASD 

was previously known as the National Association of Securities Dealers.

b

FAF refers to the Financial Accounting Foundation.

Public sector

Private sector

(established by

government) Private sector

SEC

State boards

of accountancy

PCAOB

Self-regulatory

organizationsa

(e.g., NASD,

stock exchanges)

Broker-dealers

(buyers and sellers

of securities)

Auditors of

publicly traded

companies

Publicly traded

companies

Corporate

governance

Other

(transfer agents and

securities advisers)

FAFb

FASBc EITFd

• Boards of 

 directors

• Audit committees

• Management

 - Financial

 reporting

 - Internal controls

 - Compliance

 with laws and

 regulations

 - Code of ethics

Standard-setting/regulation only

Oversight/audit only

Enforcement, standard-setting/regulation, and oversight/audit

Source: GAO.

Public interest

Effective financial

and capital markets

Individual investors

Institutional investors

Banks and lenders

 (creditors)

Rating agencies

Securities analysts
Page 11 GAO-06-678 Financial Restatements

c

SEC has recognized the accounting standards set by the Financial Accounting Standards Board 

(FASB) to be “generally accepted” for the purposes of the securities laws.

d

EITF refers to FASB’s Emerging Issues Task Force.

The Number of 

Restatements Has 

Continued to Grow and 

New Trends Have 

Emerged

Although the number of public companies restating their publicly reported 

financial information due to financial reporting fraud and/or accounting 

errors remained a relatively small percentage of all publicly listed 

companies, the number of restatements has grown since 2002. For 

example, 314 companies announced restatements in 2002 and 523 

announced restatements in 2005 (through September). In addition, of the 

1,390 announced restatements we identified, the percentage of large 

companies announcing restatements has continued to grow since 2002.11

While large and small companies restate their financial results for varying 

reasons, change in cost- or expense-related items, which includes lease 

accounting issues, was the most frequently cited reason for restating. While 

both internal and external parties could prompt restatements, internal 

parties such as company management or internal auditors prompted the 

majority of restatement announcements. Finally, we found that, despite 

SEC’s efforts to create a more transparent mechanism for disclosing 

restatements through revisions to Form 8-K, some companies had not 

properly filed such disclosures and continued to announce intentions to 

restate previous financial statements results in a variety of other formats. 

The Number of Restatement 

Announcements Grew since 

2002, as Did the Number of 

Listed Companies Restating

The number of annual announcements of financial restatements generally 

increased, from 314 in 2002 to 523 in 2005 (through September)—an 

increase of approximately 67 percent (see fig. 2). This constituted a nearly 

five-fold increase from 92 in 1997 to 523 in 2005. Furthermore, from July 

2002 through September 2005, a total of 1,121 public companies made 1,390 

restatement announcements.12 Some industry observers noted that several 

factors may have prompted more U.S. publicly traded companies to restate 

11See appendix V, Financial Restatement Database, GAO-06-1053R (Washington, D.C.: 

Aug. 31, 2006), for a detailed listing of restatement announcements we identified July 2002 

through September 2005, and additional information. This correspondence also includes a 

listing of restatement announcements we identified from October 2005 through June 2006. 

The database is available electronically at http://www.gao.gov/cgi-bin/getrpt?GAO-06-

1079sp. For the purpose of this report, we define a large company as having over $1 billion 

in total assets.

12The number of announcements exceeds the number of public companies because some 

companies announced more than one restatement.
Page 12 GAO-06-678 Financial Restatements

previously reported financial results, including (1) the financial reporting 

requirements of the Sarbanes-Oxley Act, especially the certification of 

financial reports required by Section 302 and the internal controls 

provisions of Section 404; (2) increased scrutiny from the newly formed 

PCAOB through its inspections of registered public accounting firms; and 

(3) increased staffing and review by SEC. 

Figure 2: Total Number of Restatement Announcements Identified, January 1997–

September 2005

Notes: Includes restatement announcements by larger public companies traded on the Over-theCounter (OTC) Bulletin Board and on the National Quotation Service Bureau’s Pink Sheets (Pink 

Sheets). 

As the number of restatement announcements rose, the numbers of listed 

companies making the announcements increased as well. While the 

average number of companies listed on NYSE, Nasdaq, and Amex 

decreased about 10 percent from 7,144 in 2002 to 6,473 in 2005, the number 

of listed companies restating their financial results increased from 265 in 

2002 to 439 in 2005 (through September), representing about a 67 percent 

increase (see table 1). On a yearly basis, the proportion of listed companies 

restating grew from 3.7 percent in 2002 to 6.8 percent in 2005. Over the 

period of January 1, 2002, through September 30, 2005, the total number of 

0

100

200

300

400

500

600

2005

(through

Sept.)

1997 1998 1999 2000 2001 2002 2003 2004

Restatements

Source: GAO analysis of relevant press releases and SEC filings.

Year

92 102

174

201

225

314 308

370

523
Page 13 GAO-06-678 Financial Restatements

restating companies (1,084) represents 16 percent of the average number of 

listed companies from 2002 to 2005, as compared to almost 8 percent 

during the 1997-2001 period.

Table 1: Number of Listed Restating Companies as a Percentage of Average Listed 

Companies, 2002–September 2005

Sources: GAO analysis of restatement announcements; NYSE, Nasdaq and SEC. 

a

The numbers of listed companies (NYSE-, Nasdaq-, and Amex-listed companies) for each year from 

2002 to 2004 are based on year-end totals. The number of NYSE- and Amex-listed companies for 

2005 is through March. The number of Nasdaq- listed companies for 2005 is through June.

b

Companies that restated more than one time are counted only once in the yearly total. Also, note that 

the number of listed companies restating differs from the total number of restatements because not all 

companies that restated were listed on NYSE, Nasdaq, or Amex, and some companies restated 

multiple times. For example, in 2004, there were 370 restatements; however, 46 were attributed to 

companies not listed on a major exchange. There were 294 listed companies that were responsible for 

324 of the restatement announcements in 2004, with some companies announcing more than once.

A number of other researchers also found that restatements had increased 

since calendar year 2002. The researchers used somewhat different search 

methodologies to identify companies that restate previously reported 

financial information and included slightly different criteria for inclusion 

but arrived at similar conclusions. The Huron Consulting Group (HCG) 

identified 1,067 financial statement restatements from 2002 to 2004 and 

noted that the increase was significant from 2003 to 2004.13 Also, Glass, 

Lewis & Co. LLC (Glass Lewis) identified 2,319 restatements of previously 

issued financial information by U.S. public companies from 2003 to 2005 

and also found an increase in the number of restatements over that 

period.14 Unlike our work, which included a limited number of companies 

traded OTC Bulletin Board or on Pink Sheets, the Glass Lewis study also

Year

Number of

companies listeda

Number of listed 

companies restatingb

Percent of listed 

companies restating

2002 7,144 265 3.7

2003 6,780 237 3.5

2004 6,729 294 4.4

2005 6,473 439 6.8

13Huron Consulting Group, “A Study of Restatement Matters,” (Chicago: Huron Consulting 

Group, 2005).

14Glass, Lewis & Co. LLC, “Getting It Wrong the First Time,” (Denver: Glass, Lewis & Co. 

LLC, 2006).
Page 14 GAO-06-678 Financial Restatements

included hundreds of smaller companies quoted on the OTC Bulletin Board 

or on Pink Sheets that generally lacked analyst coverage. See appendix VI 

for a comparison of various restatements studies. 

The Percentage of Large 

Companies Restating Has 

Continued to Grow

For the restatements we identified, the number of large companies 

announcing restatements of their previously reported financial information 

due to financial reporting fraud and/or accounting errors has increased. 

More specifically, large companies (i.e., companies having over $1 billion in 

total assets), as a percentage of the total restating companies have 

increased from about 30 percent in 2001 to over 37 percent in 2005. 

Likewise, the average market capitalization of a company announcing a 

restatement (for which we had data) has grown from under $3 billion (with 

a median of $277 million) in the latter half of 2002 to over $10 billion (with a 

median of $682 million) through September 2005. While the average size of 

listed companies increased about 68 percent from 2002 to 2005, the average 

size of companies restating their financials grew almost 300 percent.

Another indication that large public companies announcing restatements 

has continued to increase, is the number of companies identified as 

announcing restatements that are listed on the NYSE, which has more large 

companies than the other U.S. stock exchanges.15 For example, between 

2002 and September 2005, the number of NYSE-listed companies 

announcing restatements had increased 64 percent from 114 to 187.16

During the same time, the number of Nasdaq-listed companies announcing 

restatements increased 55 percent from 137 to 212, and the number of 

Amex-listed restating companies increased more than 175 percent from 14 

to 40.17 

15The average market capitalization of companies restating their financial statements for 

which we had data was $924 million for those listed on Nasdaq, and $7.2 billion for those 

listed on NYSE. The Nasdaq totals include National Market System and Small Cap Venuelisted companies. 

16Companies restating multiple times in one year are counted only once in this analysis. For 

example, in 2003 there were 110 restatements attributable to NYSE-listed companies; 

however there were only 103 companies restating—some more than once.

17Because our methodology reflects a focus on the impact of restatement announcements on 

market capitalization, we do not capture a large number of small public companies, many of 

which are not traded on the listed markets. See appendix I.
Page 15 GAO-06-678 Financial Restatements

While more Nasdaq-listed companies announced restatements than NYSElisted companies, the proportion of NYSE-listed companies restating 

(relative to the total number of companies listed on the NYSE) surpassed 

Nasdaq-listed companies over the period 2002–2005.18 As figure 3 

illustrates, for the announced restatements we identified, in 2002, about 4 

percent of NYSE-listed companies announced restatements for financial 

reporting fraud and/or accounting errors, whereas this percentage rose to 

more than 7 percent by September 2005. During the same period, the 

percentage of Nasdaq-listed restating companies rose from less than 4 

percent to almost 7 percent. From 2002 to 2005, the percentage of NYSEand Nasdaq-listed companies restating essentially mirrored each other in 

movement throughout the period by declining and then increasing. 

However, the percentage of Amex-listed restating companies rose each 

year during the 2002 to September 2005 period from about 2.0 percent to 

almost 5.5 percent. 

18In 2005, Nasdaq had almost 900 more companies listed than NYSE. 
Page 16 GAO-06-678 Financial Restatements

Figure 3: Percentage of Listed Companies Restating, 2002–September 2005

Note: The 2005 figures are based on restatement announcements collected through September 2005.

Restatement 

Announcements Most 

Frequently Were Made for 

Cost- or Expense-Related 

Reasons

Although public companies restate their financial results for a variety of 

reasons, cost- or expense-related issues accounted for more than one-third 

of the 1,390 restatement announcements identified from July 2002 through 

September 2005 (see fig. 4). We classified cost- or expense-related 

restatements generally to include a company understating or overstating 

costs or expenses, improperly classifying expenses, or any other mistakes 

or improprieties that led to misreported costs. Lease accounting issues that 

surfaced in early 2005 were also included in this category. 

Percentage

Source: GAO analysis of NASDAQ and SEC data on listed companies.

Year

AMEX

Nasdaq

NYSE

0

1

2

3

4

5

6

7

8

9

2002 2003 2004 2005
Page 17 GAO-06-678 Financial Restatements

Figure 4: Restatements by Reason, January 1997–June 2002 and July 2002– 

September 2005

Note: Our database includes announced restatements that were being made to correct material 

misstatements of previously reported financial information. Therefore, our database excludes 

announcements involving stock splits, changes in accounting principles, and other restatements that 

were not made to correct mistakes in the application of accounting standards. For this report, we found 

only one restatement announcement resulting from IPR&D. 

40 35 30 25 20 15 10 5 0 0 5 10 15 20 25 30 35 40

IPR&D

Related-party

transactions

Acquisition

and merger

Other

Reclassification

Restructuring,

assets, and

inventory

Securities

related

Revenue

Cost or expense

January 1997-June 2002 July 2002-September 2005

Percentage Percentage

Source: GAO analysis of initial restatement announcements.

35.2

20.1

14.1

11.8

6.8

6.5

3.6

1.8

15.7

37.9

5.4

8.9

5.1

14.1

5.9

3

3.6
Page 18 GAO-06-678 Financial Restatements

Our analysis also shows a significant drop in restatements announced for 

revenue recognition reasons, which had accounted for almost 38 percent of 

the restatements in our 2002 report. Cost- or expense-related issues 

surpassed revenue recognition issues as the most frequently identified 

cause of restatements primarily because of a large number of 

announcements made in early 2005 to correct accounting for leases by the 

retail/restaurant industry and tax-related issues. For example, 135 public 

companies announced restatements involving issues solely related to 

accounting for leases in 2005 after SEC chief accountant’s February 7, 2005, 

letter regarding the treatment of certain leases and leasehold 

improvements.19 However, revenue recognition remained the second most 

frequently identified reason for restatements from July 2002 through 

September 2005, accounting for 20 percent of all the restatements. Actions 

that we classified under “revenue recognition” included a company 

recognizing revenue sooner or later than would have been allowed under 

GAAP, or recognizing questionable or invalid revenue. (See table 2 for a 

description of each reason.) 

19A lease is a document granting possession of a property for a given period without 

conferring ownership. The lease document specifies the terms and conditions of occupancy 

by the tenant, including a period of occupancy, rent payable, etc. A leasehold improvement 

is an expense incurred for the permanent improvements to rented facilities. Leasehold 

improvements are considered fixed assets and depreciate over the leased period.
Page 19 GAO-06-678 Financial Restatements

Table 2: Financial Restatement Category Descriptions

Source: GAO. 

Note: We excluded announcements involving stock splits, changes in accounting principles, and other 

financial statement restatements that were made for reasons other than correcting for financial 

reporting fraud and/or accounting errors.

Category Description

Cost or expense Restatements due to improper accounting for costs or expenses. This category 

generally includes a company understating or overstating costs or expenses, 

improperly classifying expenses, or any other number of mistakes or improprieties 

that led to misreported costs. It also includes improper treatment of expenses related 

to tax liabilities and tax reserves. In addition, it includes improper treatment of 

financing arrangements, such as leases, when a related asset was improperly 

capitalized or expensed as part of the financing arrangement. Improperly reserved 

litigation restatements are also included in this category.

Revenue recognition Restatements due to improper revenue accounting. This category includes instances 

in which: revenue was improperly recognized, questionable revenues were 

recognized, or any number of other mistakes or improprieties that led to misreported 

revenue. Also included in this category are transactions with non-related parties that 

artificially inflate volume and revenues, through the simultaneous purchase and sale 

of products between colluding companies. These are known as round-trip 

transactions.

Securities-related Restatements due to improper accounting for derivatives, warrants, stock options and 

other convertible securities.

Restructuring, assets, or inventory Restatements due to asset impairment, errors relating to accounting treatment of 

investments, timing and amount of asset write-downs, goodwill and other intangibles, 

restructuring activity and inventory valuation, and inventory quantity issues.

Reclassification Restatements due to improperly classified financial statement items, i.e., current 

liabilities classified as long-term debt on the balance sheet, or cash flows from 

operating activities classified as cash flows from financing activities on the statement 

of cash flows.

Other Any restatement not covered by the listed categories. Includes restatements due to 

inadequate loan-loss reserves, delinquent loans, loan write-offs, or other allowances 

for doubtful accounts or accounting estimates; and restatements due to fraud or 

accounting errors that were left unspecified.

Acquisition and merger Restatements due to improper accounting for—or a complete lack of accounting for—

acquisitions or mergers. These include instances in which the wrong accounting 

method was used, or losses or gains related to the acquisition were understated or 

overstated. 

Related-party transaction Restatements due to inadequate disclosure or improper accounting of revenues, 

expenses, debts, or assets involving transactions or relationships with related parties.

In-process research and development Restatements resulting from instances in which improper accounting methodologies 

were used to value in-process research and development at the time of an acquisition.
Page 20 GAO-06-678 Financial Restatements

Internal Parties Prompted 

the Majority of 

Restatements Announced 

from 2002 through 2005

While both internal and external parties—such as the restating company’s 

management or internal auditor, an external auditor, SEC, or others—can 

prompt restatements, about 58 percent of the 1,390 announced 

restatements were prompted by internal parties. This was an increase from 

about 49 percent in our 2002 report. However, in both our prior report and 

this report, external parties may have been involved in discovering some of 

these misstatements, even if the companies may not have made that 

information clear in their restatement announcements or SEC filings. The 

external auditor, SEC, or some other external party such as the media (as in 

the case of an August 2002 restatement announcement by AOL Time 

Warner Inc. (AOL)), was identified as prompting the restatement in 24 

percent of the announcements (compared to 16 percent in our 2002 report). 

In the remaining 18 percent of the announcements (compared with 35 

percent in our 2002 report), we were not able to determine who prompted 

the restatement because the announcement or SEC filing did not clearly 

state who discovered the misstatement of the company’s prior financial 

results.

Figure 5: Who Prompted Restatements, January 1997–June 2002 versus July 2002–September 2005

18%

58% 24%

35%

16%

49%

Unknown

External

Internal

Unknown

External

Internal

January 1997-June 2002

Source: GAO analysis of GAO-identified initial restatement announcements.

July 2002-September 2005
Page 21 GAO-06-678 Financial Restatements

While SEC Revised Its 

Forms to Make Disclosures 

of Certain Restatements 

More Uniform, Many 

Companies Continue to File 

in Other Formats 

SEC has revised Form 8-K, in part, to make information on financial 

restatements more uniform and apparent to investors, but many companies 

appeared to have filed potentially deficient filings. In addition, conflicting 

instructions and guidance resulted in some companies disclosing similar 

financial information in varying degrees and formats. In a 2003 report 

required by the Sarbanes-Oxley Act, SEC proposed to address the lack of 

uniformity by amending several of its periodic disclosure forms—

essentially to make issuers’ public notification of financial information 

uniform.20 Specifically, in its report, SEC proposed to amend Form 8-K to 

add a specific line item for public companies to disclose what was restated 

and why. 

In March 2004, consistent with its proposal in the 2003 report, SEC 

amended Form 8-K to, among other things, add a new line item (Item 4.02), 

which requires public companies to file the Form 8-K (Item 4.02) within 4 

business days if management or the company’s independent auditors 

determine that previously issued financial statements should not be relied 

upon.21 This alerts investors to potentially important company events that 

may impact their investment decision. This change became effective 

August 23, 2004. This change to Form 8-K included a limited safe harbor for 

failure to timely file an 8-K in certain situations, including in a situation in 

which the company makes the determination the financial statements may 

not be relied upon, but not in a situation when the independent auditor 

makes such a determination.

In November 2004, SEC issued additional guidance to address questions 

concerning the revised disclosures. This “Frequently Asked Questions” 

guidance states that a Form 8-K is required for Item 4.01 (Change in 

Accountant) and Item 4.02 events, even if a periodic report such as a Form 

10-K or 10-Q disclosing such information is filed during the 4 business days 

20Section 704 of the Sarbanes-Oxley Act directed SEC to study its enforcement actions over 

the 5 years preceding the enactment of the act in order to identify areas of issuer financial 

reporting that are more susceptible to fraud, inappropriate manipulation, or inappropriate 

earnings-management. Section 704 also directed SEC to report its findings to Congress, 

including potential recommendations to address any identified issues. SEC reported the 

results of its study in 2003.

21Such a determination is based upon Statement on Auditing Standards (SAS) No. 1, Section 

561.06, which requires the appropriate disclosure of newly discovered facts and their impact 

on the financial statements to persons who are known to be currently relying, or who are 

likely to rely on, the financial statements when the newly discovered information meets the 

criteria set forth in SAS No. 1, Section 561.05. 
Page 22 GAO-06-678 Financial Restatements

following the event. The amended forms and the amended rules do not 

make this Form 8-K filing requirement clear, and instead indicate that the 

filing of a Form 8-K may not be required if previously reported. Specifically, 

the instructions for Form 8-K state that a public company is not required to 

file a Form 8-K when, substantially the same information has been 

previously disclosed on a periodic report. 

Between August 23, 2004, and September 30, 2005, about 17 percent of 

restating companies (111 companies) did not appear to file a Form 8-K for 

restatements as required by SEC guidance.22 According to our analysis, 

about 30 percent of restating companies (34 companies), during this same 

time period, failed to file a Form 8-K disclosing their restatements. It 

appears that these companies either failed to disclose the announced 

restatement at all or disclosed it in a Form 10-K or 10-Q or an amended 

form. The remaining 77 companies filed a Form 8-K disclosing their 

restatement, but under items other than the required 4.02—such as 2.02 

(Results of Operations and Financial Condition) or 8.01 (Other Events). 

Furthermore, we found that the companies filing these potentially deficient 

filings included a mix of large and small companies. For example, over onethird of the 111 companies we identified were large companies (as 

measured by market capitalization, asset size, or revenue). Moreover, a 

study by Glass Lewis found that about one-third of companies restating in 

calendar year 2005 did not file a Form 8-K (Item 4.02) to notify investors, or 

the public in general, about such a corporate event.

22We excluded foreign issuers. 
Page 23 GAO-06-678 Financial Restatements

Market Capitalization 

of Restating 

Companies Decreased 

by Billions in the Days 

Surrounding 

Restatement 

Announcements, but 

Was Less Severe Than 

in Our Prior Report

We estimated that—from the trading day before through the trading day 

after an initial restatement announcement—stock prices of the restating 

companies decreased by an average of almost 2 percent, compared with an 

average decline of nearly 10 percent in our 2002 report.23 In addition, we 

estimated that the market capitalization of restating companies decreased 

by over $36 billion when adjusted for overall market movements (nearly 

$18 billion unadjusted) compared to adjusted and unadjusted declines of 

around $100 billion reported in 2002. These declines, while potentially 

significant for the investors involved, if realized, represented about 0.2 

percent of the total market capitalization of the three securities exchanges, 

which was about $17 trillion in 2005. The reasons for restatements also 

appear to have affected the severity of the impact on market capitalization, 

with restatements for reasons that could involve financial reporting fraud 

or other unspecified causes resulting in the most severe size-adjusted 

market reaction on average. However, revenue issues continued to have a 

sizeable impact and, in a change from our previous report, cost- or 

expense-related restatements had the greatest impact in dollar terms 

because there are more of them. We also found that the market impact of 

restatement announcements on restating companies over longer periods 

was mixed, in contrast to our prior report, in which we found larger, more 

persistent stock price and market capitalization declines for restating 

companies.

On Average, Stock Prices 

Fell over the Days 

Surrounding the Initial 

Restatement Announcement

We estimated that, for the 1,061 cases we were able to analyze from July 1, 

2002, to September 30, 2005, the stock prices of companies making an 

initial restatement announcement fell by almost 2 percent (marketadjusted), on average, from the trading day before through the day after the 

announcement (the immediate impact). Unadjusted losses in the market 

capitalization of restating companies totaled nearly $18 billion, ranging 

23To assess the impact of the restatement announcement on a company’s stock price, we 

calculated the abnormal return of the stock over the event window (one trading day before 

through one trading day after the announcement for the immediate impact, 20 trading days 

before through 20 trading days after for the intermediate impact, and 60 trading days before 

through 60 trading days after for the longer-term impact). The abnormal return for a given 

stock is the actual rate of return for that stock over the event window minus the expected 

rate of return of that stock (the rate of return predicted by a statistical model incorporating 

the price behavior of a market index) over the same period. This measure attempts to 

isolate the impact of the announcement by controlling for general market movements. We 

reported the average holding period abnormal return for all stocks that we were able to 

analyze for a given event window for a given time period. See appendix I for more details.
Page 24 GAO-06-678 Financial Restatements

from a net gain of almost $9 billion from July through December 2002 to a 

loss of about $16 billion for 2004 (see table 3). But, when the losses were 

adjusted for general movements in the overall market, the market 

capitalization of the restating companies decreased an estimated $36 

billion.

Table 3: Summary of Immediate Impact of Restatement Announcements on Restating Companies’ Market Capitalization, July 

2002–September 2005 

Sources: GAO, NYSE’s TAQ, and SEC.

Notes: The changes in stock prices (measured by average holding period abnormal returns) were 

statistically different from zero at the 5 percent level of significance for all periods except 2003. We 

excluded 329 restatement announcements because they involved companies that were not listed on 

NYSE, Nasdaq, or Amex, or had missing data because of trading suspensions, delistings, 

bankruptcies, mergers, or other reasons noted in appendix I. Numbers may not sum due to rounding.

In our prior report, we found that the immediate impact was an average 

decline in stock price of nearly 10 percent and a decline, both adjusted and 

unadjusted, in market capitalization of around $100 billion. Thus, in total, 

the immediate impact for July 2002–2005 appeared to be less severe. The 

smaller average decline in stock price (a 2 percent decline compared with a 

nearly 10 percent decline) suggested that the market’s reaction for each 

company, on average, was not as severe. On an annual basis, and when not 

adjusted for market movements, in the current report the average annual 

decline was $5.4 billion, compared with $18.2 billion, in our 2002 report. 

However, when market-adjusted, the average decline was $11.2 billion over 

the analysis period for this report, compared with an average $17.4 billion 

decline for the period covered in our prior report. The increased severity of 

the market-adjusted immediate impact on market capitalization likely 

reflected the more negative reaction to a restatement announcement given 

the generally positive overall market movement during the 2003–2005

Period

Percent of market–

adjusted increase 

(decrease) in

stock price

Total unadjusted 

increase (decrease) in 

market capitalization

(dollars in billions)

Total market-adjusted 

increase (decrease) in 

market capitalization

(dollars in billions)

Number of restatement 

announcements analyzed

July–December 2002 (4.1 %) $8.7 $2.1 121 of 189

2003 (1.6) (13.6) (20.1) 242 of 308

2004 (2.5) (16.4) (16.6) 297 of 370

January–September 

2005 (1.0) 3.7 (1.9) 401 of 523

Total (July 2002–

September 2005) (1.9) ($17.7) ($36.5) 1,061 of 1,390
Page 25 GAO-06-678 Financial Restatements

period, and could also reflect the fact that more, larger companies 

announced restatements in the July 2002–2005 period.

The immediate impact on the market capitalization of restating companies, 

while potentially large for the investors involved, if realized, generally was 

less than 0.2 percent of the total market capitalization of companies listed 

on NYSE, Nasdaq, and Amex for a given year during 2002–2005, ranging in 

magnitude from 0.01 percent to 0.14 percent (see table 4). That the 

immediate impact—as a percentage of total market capitalization—would 

appear relatively small is not surprising, considering the short trading day 

interval that we analyzed. We chose the 3-trading-day window to focus as 

much as possible on the restatement announcement, to the exclusion of 

other factors.24 Later in this report, we examine losses over longer periods, 

as well as the effects of restatements on overall market confidence. 

24Although we attempted to control for general market movements over each 3-trading-day 

window to isolate the impact of the announcement, other factors may have influenced the 

stock prices of the restating companies during this period. For example, a company might 

have issued its third quarter 2005 earnings while also announcing that it was going to restate 

its earnings for the first two quarters of 2005. If the company’s third-quarter earnings fell 

short of the market’s expectations, the news likely would exacerbate the negative reaction 

to the restatement announcement; if, however, the company’s third-quarter earnings 

exceeded the market’s expectations, the news likely would temper the negative reaction to 

the restatement announcement. Our analysis did not attempt to disaggregate these 

reactions.
Page 26 GAO-06-678 Financial Restatements

Table 4: Summary of Immediate Impact on Restating Company Market Capitalization as a Percentage of Total Market 

Capitalization, July 2002–September 2005

Sources: GAO, NYSE’s TAQ, SEC, and World Federation of Exchanges.

Notes: Data on the total market capitalization of listed companies are as of year-end. We excluded 

329 restatement announcements for a variety of reasons, including cases that involved companies that 

were not listed on NYSE, Nasdaq, or Amex; and announcements that involved missing data because 

of trading suspensions, delistings, bankruptcies, and mergers. Numbers may not sum due to rounding. 

While our analysis generally showed declines in market capitalization, the 

results for the second half of 2002 were positive and can be explained in 

large part by the influence of two large companies—Tyco International Ltd. 

(Tyco) and AOL. The market reactions to the restatement announcements 

of the two companies resulted in adjusted market capitalization gains of 

$4.5 billion. In the cases of Tyco and AOL, both of which involved revenue 

recognition issues, the restatement announcements came weeks or months 

after initial news of potential accounting fraud and errors surfaced, and so 

the market had likely already anticipated these announcements and 

factored the information into the companies’ stock prices well before the 

restatement announcement. Over the 3 trading days surrounding the 

announcement dates that we identified, Tyco’s market capitalization 

increased by around $2.8 billion and AOL’s market capitalization increased 

by around $1.6 billion.

Period

Total market capitalization of 

listed companies

(dollars in billions)

Total adjusted increase 

(decrease) in market 

capitalization of restating 

companies 

(dollars in billions)

Total adjusted increase 

(decrease) in market 

capitalization as a percentage 

of total market-capitalization

July–December 2002 $11,055 $2.1 0.02%

2003 14,266 (20.1) (0.14)

2004 16,324 (16.6) (0.10)

January–September 2005 17,001 (1.9) (0.01)

Total (July 2002–September 

2005) $14,662 ($36.5) (0.25)
Page 27 GAO-06-678 Financial Restatements

We also conducted a separate analysis of the immediate impact of 

restatement announcements for the 329 announcements that we were 

unable to analyze in the primary event study. This group included 159 

announcements that were attributed to companies with stock not listed on 

the exchanges. We limited this additional analysis to a simple assessment 

of the unadjusted change in market capitalization over the three trading 

days surrounding the restatement announcement, generally relying on data 

we obtained from SEC’s and Nasdaq’s Web sites. We were able to gather 

sufficient data to analyze 242 of the 329 announcements (114 

announcements made by listed companies and 128 announcements made 

by unlisted companies).25 We estimated that, on average, these restatement 

announcements resulted in an average decline in market capitalization of 

1.5 percent from the trading day before the announcement through the 

trading day after the announcement, reflecting an unadjusted decline of 

about $3.7 billion in addition to the nearly $18 billion decline estimated in 

the primary event study.

Reasons That Could Involve 

Reporting Fraud or Other 

Unspecified Issues, and 

Revenue Recognition Issues 

Continued to Significantly 

Impact Market 

Capitalization; but Cost or 

Expense Issues Produced 

Greater Dollar Losses

Announcements made for reasons that could involve financial reporting 

fraud or other unspecified causes, which we classified in the Other 

category, as well as restructuring and revenue recognition-related issues, 

had the largest negative impact on market capitalization when adjusted for 

the size of a restating company (see fig. 6); however, when measured in 

dollars, cost- or expense-related restatement announcements accounted 

for more of the immediate decline in market capitalization than each of the 

other reasons, over our analysis period.26 These results are different from 

the findings in our earlier report, suggesting that the nature of the market 

response to restatements may have changed in some respects. (We discuss 

how different types of restatements may have affected investor confidence 

in another section of this report.) To assess the immediate market impact 

of a given type of restatement on a restating company’s market 

capitalization, we computed the ratio of the estimated change in the 

company’s market capitalization to the company’s total market 

25We were unable to analyze 87 announcements due to companies merging with or being 

acquired by other companies, companies filing for Chapter 11 bankruptcy protection, 

companies deregistering their stock, and companies for which we were unable to find any 

additional information.

26In this section we focus on market-adjusted results; the unadjusted results were 

qualitatively similar.
Page 28 GAO-06-678 Financial Restatements

capitalization over the 3 trading days surrounding the announcement of a 

restatement. We then averaged these impacts for each reason.

Figure 6: Immediate Market-Adjusted Impact on Market Capitalization of Restating 

Companies by Restatement Reason, July 2002–September 2005

Notes: Company size is measured by market capitalization. This figure illustrates the average change 

in market capitalization (the immediate impact) as a percentage of restating company market 

capitalization. The single observation categorized as IPR&D was omitted from this figure.

While restatement announcements involving related-party transactions, 

which can revolve around revenue issues, appeared to have the largest 

negative impact, this result was not statistically different from zero. This 

category accounted for a relatively small number of restatements, and the 

results were heavily influenced by three announcements that had sizeable 

market reactions.27

27For example, the three restatements attributable to related-party transactions with the 

largest negative responses (in excess of 18 percent of market capitalization) involved 

misreported sales between affiliates (at Digital Video Systems, Inc. in April 2003), 

unspecified intercompany transactions (at Ionics, Inc. in Nov. 2002), and failure to disclose 

and account for a compensation arrangement with a former CEO (at Nara Bancorp, Inc. in 

March 2005).

Reclassification

Acquisitions

and mergers

Securities

related

Cost or

expense

Revenue

recognition 

Restructuring,

assets, or inventory

Other

Related-party

transactions

Reason Change in market capitalization 

as a percentage of company size Frequency of reason (percent)

+.04

-.49

-.77

-1.25

-2.05

-2.13

-2.87

-3.76

6.9

3.7

12.8

37.6

19.4

11.6

6.1

1.8

Sources: GAO analysis of initial restatement announcements; NYSE TAQ, and SEC data.

Not statistically significantly different from zero at the 5 percent level
Page 29 GAO-06-678 Financial Restatements

In contrast to our previous report, in which positive responses to two large 

restatements attributed to restructuring, asset impairment, and inventory 

issues led to market gains in that category, restatements made for these 

reasons in 2002–2005 represented about 29 percent of the market-adjusted 

market capitalization losses. These reasons accounted for about 11 percent 

of the cases we analyzed, and the median size of a company restating for 

these reasons was $504 million.

The effect of restatements announced for revenue recognition issues on 

market capitalization initially appeared weaker than in our previous report. 

Restatements involving revenue recognition accounted for almost 20 

percent of the cases, but only around 10 percent of the market-adjusted 

market capitalization losses. The median size of a company restating for 

this reason was $321 million; thus it appears that companies announcing 

restatements for revenue recognition reasons tended to be smaller. 

However, when adjusted by the size of the restating company, restatement 

announcements involving revenue recognition issues (more than many 

other reasons) resulted in an average loss that represented a larger 

percentage of a restating company’s market capitalization.

Cost- or expense-related restatements had a greater effect on market 

capitalization than in our previous report, and were distinguished from 

restatements for other reasons in three ways. First by dollars, cost- or 

expense-related restatement announcements accounted for more of the 

immediate declines in market capitalization than other reasons over our 

analysis period. More specifically, cost- or expense-related restatement 

announcements accounted for $15.2 billion, or about 42 percent, of the 

$36.5 billion in total losses (market-adjusted) over our analysis period. This 

decline was driven in large part by the January 9, 2004, restatement 

announcements by Shell Transport and Trading Company, plc, and Royal 

Dutch Petroleum Company, which represented a decline in estimated 

market capitalization attributed to the cost- or expense category of over $4 

billion. Second, when measured by median market capitalization, 

companies announcing restatements involving cost or expense issues were 

the largest. The median size of a company restating for cost or expense
Page 30 GAO-06-678 Financial Restatements

reasons was $632 million. Furthermore, of the 1,061 cases analyzed, cost or 

expense was the most frequently cited reason for restating (38 percent).28 

Finally, the market did not perceive all restatements negatively. We found 

that announcements involving the acquisition and merger category—with a 

median company size of $318 million—resulted in an overall increase of 

over $1.5 billion in market capitalization. The positive results are in 

significant contrast to our previous report, in which we attributed more 

than $19 billion in market capitalization decline to this category.

Restatement 

Announcements Continued 

to Have Some Longer-Term 

Impact on the Market 

Capitalization of Restating 

Companies

Our analysis of restatement announcements showed mixed results over 

intermediate and longer periods, but these announcements overall tended 

to have some longer-term impacts. On a market-adjusted basis, from 20 

trading days before through 20 trading days after a restatement 

announcement (the intermediate impact), we estimated that the stock 

prices of restating companies declined by nearly 2 percent on average, and 

their market capitalization declined by over $78 billion in aggregate; 

whereas, on an unadjusted basis, the market capitalization of restating 

companies decreased around $5 billion (see table 5).29 This suggests that 

the reaction was more negative than expected given the movement in the 

overall market.

28As noted earlier, a large number of public companies announced restatements involving 

accounting for leases recently. We found that of the 1,390 restatement announcements that 

we captured, 151 were due solely to the lease accounting issue. We were able to analyze 131 

of these 151 announcements and found that, on a market-adjusted basis, the stock prices of 

these companies declined by around 0.5 percent on average and their market capitalization 

decreased by $2.1 billion from the trading day before through the trading day after the 

announcement. We found that the average (median) immediate market-adjusted impact on 

market capitalization for these announcements was -$15.8 million (-$0.3 million). This is in 

comparison to the average (median) immediate market-adjusted impact on market 

capitalization of -$34.4 million (-$1.4 million) for all of the 1,061 announcements that we 

analyzed in the primary event study. 

29In our 2002 report, we specified the intermediate impact as 60 trading days before through 

60 trading days after the announcement. For purposes of this report, we have specified 20 

trading days before through 20 trading days after the announcement as the intermediate 

impact and the longer-term impact as 60 trading days before through 60 trading days after 

the announcement.
Page 31 GAO-06-678 Financial Restatements

Table 5: Summary of Intermediate Impact of Restatement Announcements on Restating Companies’ Market Capitalization, July 

2002–September 2005 

Sources: GAO, NYSE’s TAQ, and SEC.

Notes: We excluded 399 restatement announcements for a variety of reasons, including those cases 

that involved companies not listed on NYSE, Nasdaq, or Amex; and announcements that involved 

missing data resulting from trading suspensions, delistings, bankruptcies, and mergers.

On a market-adjusted basis, from 60 trading days before through 60 trading 

days after the announcement (the longer-term impact), we estimated that 

the stock prices of restating companies decreased by less than 2 percent on 

average and their market capitalization decreased by over $126 billion in 

aggregate (see table 6). Unadjusted, the longer-term impact was an increase 

of about $34 billion in the market capitalization of restating companies.30 In 

our 2002 report, we estimated that the unadjusted market capitalization of 

restating companies that we analyzed decreased by close to $240 billion 

from 60 trading days before through 60 trading days after the 

announcement. This large difference may be the result of the generally 

positive overall market movement during 2003–2005, an increased number 

of restatements that the market did not view negatively, or the possibility 

that the financial markets have grown increasingly less sensitive to 

restatement announcements since 2002.

Period 

Percent of marketadjusted increase 

(decrease) in stock 

price 

Total unadjusted 

increase (decrease) in 

market capitalization

(dollars in billions)

Total market-adjusted 

increase (decrease) in 

market capitalization

(dollars in billions)

Number of restatement 

announcements analyzed

July–December 2002 (4.7%) ($8.7) ($13.7) 116 of 189

2003 0.5 (25.7) (49.4) 225 of 308

2004 (3.8) (2.6) (34.6) 273 of 370

January–September 

2005 (0.6) 31.7 19.1 377 of 523

Total (July 2002–

September 2005) (1.7) ($5.2) ($78.6) 991 of 1,390

30As we considered longer event time frames, we increased the possibility that other factors 

and events may have impacted a restating company’s stock price.
Page 32 GAO-06-678 Financial Restatements

Table 6: Summary of Longer-Term Impact of Restatement Announcements on Restating Companies’ Market Capitalization, July 

2002–September 2005

Sources: GAO, NYSE’s TAQ, and SEC.

Notes: We excluded 462 restatement announcements for a variety of reasons, including 

announcements that involved companies that were not listed on NYSE, Nasdaq, or Amex; and 

announcements that involved missing data resulting from trading suspensions, delistings, 

bankruptcies, and mergers.

As we considered longer event time frames, this increased the possibility 

that other factors and events may have affected a restating company’s 

stock price. Nevertheless, expanding the event window beyond the 

immediate trading days around the restatement announcement date 

allowed us to assess the longer-term impact of restatement 

announcements. The longer time frame also allowed us to capture any 

impact from earlier company announcements, which may have signaled 

restatements (for example, a company’s CFO departing a company 

suddenly, its outside audit firm resigning, or the notice of an internal or 

SEC investigation at the company). With such events, investors may sense 

that more negative news is forthcoming and drive the company’s stock 

price lower. For example, speculation about potential accounting problems 

at AOL first appeared publicly in mid-July 2002 in The Washington Post; 

however, it was not until mid-August that the company announced that it 

would restate. Our immediate impact analysis around the August 14, 2002, 

announcement date revealed a sizeable positive impact. However, our 

intermediate impact analysis showed that the market reacted negatively to 

the release of the news over this event window.

Finally, our analysis only attempts to control for overall market 

movements, and so for these longer periods we cannot adjust for other 

factors such as company-specific news unrelated to the restatement. For 

example, several weeks after announcing a restatement a company could 

Period

Percent of marketadjusted increase 

(decrease) in

stock price

Total unadjusted 

increase (decrease) in 

market capitalization 

(dollars in billions)

Total market-adjusted 

increase (decrease) in 

market capitalization 

(dollars in billions)

Number of restatement 

announcements analyzed

July–December 2002 (12.6%) ($70.7) ($14.2 ) 113 of 189

2003 5.3 82.4 (14.1) 199 of 308

2004 (4.7) 39.7 (32.4) 258 of 370

January–September 

2005 (0.1) (17.3) (65.5) 358 of 523

Total (July 2002–

September 2005) (1.7) $34.1 ($126.3) 928 of 1,390
Page 33 GAO-06-678 Financial Restatements

win a lucrative contract or be the target of an acquisition, both of which 

would likely have a positive impact on its stock price. We subsumed the 

impacts of any additional, unrelated events that occurred during this time 

period, which would attribute them to the restatement announcement. 

Appendix I provides additional details about these measures, along with 

information about their limitations.

Certain Restatements 

Appear to Affect 

Investor Confidence 

but Trends in 

Restatements 

Complicate Analysis

Although researchers generally agree that restatements can have a negative 

effect on investor confidence, the surveys and indexes of investor 

confidence that we reviewed did not indicate definitively whether investor 

confidence increased or decreased since 2002. Researchers noted several 

reasons for the inconclusive results about the effects of restatements on 

investor confidence. For example, some researchers have noted that, since 

2002, investors may have had more difficulty discerning whether a 

restatement represented a response to aggressive or abusive accounting 

practices, constituted remediation of past accounting deficiencies, or 

merely represented technical adjustments. Furthermore, investor 

confidence remains difficult to quantify because it cannot be measured 

directly and because investors consider a variety of factors when making 

investment decisions. However, we identified several survey-based indexes 

that use a variety of methods to measure investor confidence; we also 

identified empirical work by academics and financial industry experts. A 

periodic UBS/Gallup survey-based index aimed at gauging investor 

confidence found that, although investor confidence remains low, 

accounting issues appear to be of less concern. In contrast, according to 

the Yale index, which asks a different set of questions, institutional 

investors have had slightly more confidence in the stock market since 2002; 

the index produced uncertain results for individual investors. 
Page 34 GAO-06-678 Financial Restatements

Researchers Have 

Suggested Numerous 

Reasons for Why Investors 

May Have Reacted Both 

Positively and Negatively to 

Restatements since 2002 

Although researchers generally have agreed that restatement 

announcements could send unfavorable messages about restating 

companies to the capital markets, an analyst with whom we spoke 

expressed less agreement about the causes and effects of restatement 

announcements on investors (and investor confidence) since 2002.31 While 

we found some evidence in our 2002 report that suggested that restatement 

announcements prior to July 2002 may have led to widespread concerns 

about the perceived unreliability of financial reports, the impact of 

restatements since July 2002 on investor confidence has been more 

uncertain because the driving forces behind the increase in restatements 

have been less clear. For example, some analysts have suggested that 

investors may not have been able to discern whether restatements since 

2002 represented a response to: aggressive or abusive accounting practices, 

the complexity of accounting standards, the remediation of past 

accounting deficiencies, or just technical adjustments.32 

Some analysts indicated that the increase in the restatements is a serious 

problem with negative consequences on investor confidence. Other 

analysts have said that restatements might have minimal (or positive) 

31For example of some empirical studies see Z. Palmrose et al., “Determinants of Market 

Reactions to Restatement Announcements,” Journal of Accounting and Economics, 37 

(February): 2004, K. Anderson and T. Yohn, “The Effect of 10-K Restatements on Firm Value, 

Information Asymmetries, and Investors’ Reliance on Earnings”, Working Paper, 

Georgetown University, 2002, P. Hribar and N. Jenkins, “The Effect of Accounting 

Restatements on Earnings Revisions and the Estimated Cost of Capital”, Review of 

Accounting Studies, 9: 2004. and C. Gleason et al., “Financial Statement Credibility: The 

Contagion Effects of Accounting Restatements,” AAA FARS Meeting Paper (2004); and 

those studies reviewed in GAO-03-138, among others. These studies, which examine 

measures that may proxy for investor confidence—such as long-term cumulative abnormal 

returns, earnings response coefficients, bid-ask spreads, and cost-of-capital measures—

suggest negative impacts, but may not extend to all types of restatements or generalize to 

restatements since the passage of the Sarbanes-Oxley Act. However, we found no published 

studies that attempted to measure how long this impact may last on restating companies, or 

whether the decline in confidence spreads to non-restating companies (thereby impacting 

the overall investment climate).

32Several studies have suggested there is a greater investor concern over errors involving 

revenue recognition, more than one account, financial reporting fraud, or accounting errors 

than over technical accounting issues and unintentional accounting defects that involve 

relatively smaller amounts and fewer accounting periods—or that suggest corrective action 

taken by the company. For example, see Palmrose et al. (2004); D. Farber, “Restoring Trust 

After Fraud: Does Corporate Governance Matter?”, The Accounting Review, 80 (April): 

2005, Anderson and Yohn (2002); A. Akhigbe et al., “Why Are Some Corporate Earnings 

Restatements More Damaging?” Applied Financial Economics, 15: 2005 and Hribar and 

Jenkins (2004).
Page 35 GAO-06-678 Financial Restatements

effects on confidence if investors saw them as a remediation of accounting 

problems existing prior to the passage of the Sarbanes-Oxley Act, 

recognizing some restatements as the expected byproduct of a greater 

focus on the quality of financial reporting by management, audit 

committees, external auditors, and regulators since 2002. Although 

accounting issues discovered at one company could cause capital market 

participants to reassess the credibility of financial statements issued by 

other companies, researchers also noted the absence, so far, of large 

numbers of restatements that represent deliberate violations of GAAP—the 

same kind of restatements many believed produced widespread effects on 

investor confidence in 2001 and 2002 (e.g., Enron, WorldCom, and 

Adelphia). In that vein, others noted that the Sarbanes-Oxley Act, the 

collapse of Arthur Andersen, and perceived litigation risks have 

encouraged more conservative approaches that resulted in restatements to 

correct small errors or technical adjustments that likely were irrelevant to 

investors. Some believed that at least a portion of the restatements since 

2002 have resulted from excessive complexity in accounting principles or 

the second-guessing of legitimate judgment calls that did not appear 

relevant to the valuations of the companies involved. One expert expressed 

concern that restatements may have lost their salience to market 

participants because they now occur so frequently, while others noted that 

investor confidence would be negatively affected if the number of 

restatements did not decline in the near future. 

UBS/Gallup Index of 

Investor Confidence 

Reveals Investor 

Confidence Remains Low 

but Accounting Issues 

Appear to Be of Less 

Concern

Directly measuring the effect of restatements on investor confidence 

remains difficult because so many factors go into any investment decision 

and the reasons for restatements, which can affect investor response, often 

are unclear. However, we have highlighted results from two respected 

survey-based indexes of investor confidence, obtained from UBS Americas, 

Inc. and the International Center for Finance at the Yale School of 

Management. The UBS Index has been acknowledged for its accuracy and 

timeliness, and the Yale School of Management Indexes are considered to 

be the longest-running effort to measure investor confidence.
Page 36 GAO-06-678 Financial Restatements

The UBS/Gallup Index of Investor Optimism suggests that investor 

confidence remains well below the March 2002 level, when investor 

optimism had started to rebound following the Enron scandal.33 As shown 

in figure 7, according to the survey, concerns about accounting practices 

and corporate governance started to affect investor optimism, which were 

heightened following the WorldCom restatement announcement in June 

2002. The index continued to decline until March 2003 when it reached an 

all-time low of 5—mirroring a similar decline in stock markets. However, in 

April, the survey indicates that investors where becoming more confident 

in the U.S. economic recovery throughout most of 2003. By January 2004, 

the index was back up to 108 before experiencing another steep decline by 

September 2005 as markets reacted, in part, to a sharp increase in energy 

prices. While the Index increased over the reminder of 2005, it remained 

below the March 2002 level through the second quarter of 2006.34

33The UBS/Gallup Poll of Investor Attitudes determines a monthly Index of Investor 

Optimism. The index, composed of “personal” and “economic” dimensions, yields an overall 

estimate of investor confidence. The personal element asks investors (defined as any 

private household with at least $10,000 in investable assets, or nearly 40 percent of all U.S. 

households) how confident they are about increasing their income and achieving 

investment goals. The economic dimension poses questions about macroeconomic 

influences such as unemployment and overall stock market performance. A positive result 

indicates optimism, while a negative result denotes pessimism. In a statistical study of the 

poll’s accuracy, Lawrence Klein, a Nobel Laureate in Economics and Professor at the 

University of Pennsylvania, endorsed the indicator as “at least as good as and probably 

better, in terms of accuracy, than the competing [indexes].” 

34One critique of survey sentiment indexes is that they may unduly measure the optimism of 

small investors, which may not be as important to the stock market. However, Lawrence 

Klein’s research using the Index of Investor Optimism shows that it has good correlations 

with key economic indicators, such as consumer spending, personal income, industrial 

production, employment, and stock market averages. Moreover, the U.S. Trust’s Affluent 

Investor Index, which is based on individuals with adjusted gross incomes of more than 

$325,000 annually (or a net worth greater than $5.9 million), also found an increase in 

confidence in 2003 and 2004, and a decline in confidence in 2005. 
Page 37 GAO-06-678 Financial Restatements

Figure 7: UBS/Gallup Investor Optimism Index, October 1996–May 2006

These trends are consistent with various proxies for investor confidence. 

For example, since April 2003, net new cash flows to equity mutual funds 

have been positive. And, according to “Barron’s Confidence Index,” 

investor confidence returned to its historical average by mid-2004 and—

despite a decline in investor confidence in 2005—has remained above its 

lows in 2002 and 2003.35

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Feb-99

Apr-99

Jun-99

ep-98

S

Dec-97

Mar-98

Jun-98

ep-97

Oct-96

Feb-97

Jun-97

Source: UBS/Gallup.

Month and year 

Index

35According to some researchers, mutual fund flows are another indicator of investor 

sentiment because mutual funds have become an important alternative to direct purchases 

of securities. Mutual fund investors demonstrate their confidence in the stock market by 

buying or selling equity mutual fund shares. The ratio of the average yield on high-grade 

bonds to the average yield on intermediate-grade bonds—commonly referred to as “Barron’s 

Confidence Index” when employing Barron’s yields—is used by some to indicate the general 

faith in corporations and investors’ attitude toward risk. (For the purposes of this report, the 

Barron’s Confidence Index is somewhat of a misnomer since we used Moody’s yields from 

the Board of Governors of the Federal Reserve System.) A higher ratio (i.e., closer to 100 

percent) implies that investors require less compensation for taking on additional risk and 

therefore are relatively confident in the stock market. However, changes in the ratio could 

also reflect investor sentiment about the economy, inflation, political climate, or other 

phenomena.
Page 38 GAO-06-678 Financial Restatements

While the 2002 and 2003 surveys reported that the leading concern 

expressed by investors was the negative impact of questionable accounting 

practices on the market, in 2005 and 2006, investors identified a number of 

other reasons as more significant for the decline in investor optimism. The 

major reasons cited for the decline were (1) the price of energy, including 

gas and oil; (2) the outsourcing of jobs to foreign countries; (3) the federal 

budget deficit; (4) the situation in Iraq; and (5) the economic impact of 

Hurricane Katrina and other storms. While some of these reasons reflect 

current events, others consistently were viewed as less important than 

accounting issues in the 2002, 2003, and 2004 surveys. However, it should 

be noted that accounting issues continue to be viewed as more important 

than a variety of other forces affecting the investment climate such as 

expectations regarding inflation, the value of dollar, and the threat of more 

terrorist attacks.

While a significant portion of all investors surveyed continue to believe that 

accounting issues were negatively affecting the market, according to the 

UBS/Gallup survey the percent of investors feeling this way has decreased 

(see fig. 8). While 91 percent of all investors surveyed in 2002 felt that 

accounting issues were negatively impacting the market, about 71 percent 

felt that way in May 2006. Moreover, the percentage of investors indicating 

that accounting issues were hurting the investment climate in the United 

States “a lot” fell from 80 percent in July 2002 to 39 percent in May 2006. 
Page 39 GAO-06-678 Financial Restatements

Figure 8: Effect of Accounting Concerns on Investor Confidence in the Stock Market, March 2002–May 2006

The results of UBS surveys were consistent with the findings of the 

Securities Industry Association’s (SIA) annual investor surveys.36 SIA found 

that, although accounting at U.S. corporations was still a major concern 

among investors in 2004, concern had declined significantly from 2002. 

Moreover, in 2004, investors seemed more concerned with the political 

environment and the state of the U.S. economy than accounting fraud and 

corporate governance issues. What has happened since 2004 is unclear 

because no survey was conducted for 2005. However, a newer index, the 

State Street Investor Confidence Index, which attempts to measure 

investors’ risk appetite by measuring the percent of risky assets investors 

0

20

40

60

80

100

Hurting the investment climate “a little”

Hurting the investment climate “a lot”

Mar. May July Sept. Dec. Nov. Mar. May June Aug. Sept. Oct. Nov. Dec. Feb. May July Oct. Nov. Mar. May

2002 2003 2004 2005 2006

Percentage

Source: UBS/Gallup.

36The annual SIA Investor Survey, conducted by Harris Interactive and commissioned by the 

SIA, provides opinion research on investors’ attitudes toward the securities industry, 

brokerage services, and investing in general. The investors surveyed have financial assets 

(excluding homes) of more than $100,000. In 2002–2004, about 1,500 investors were 

interviewed each year by telephone for their views.
Page 40 GAO-06-678 Financial Restatements

hold in their portfolio, found that investor confidence remained relatively 

unchanged throughout 2005 and into 2006.37 

Yale Indexes Shows Mixed 

Results for Changes in 

Stock Market Confidence 

since 2002 

In our 2002 report, we noted the Yale Indexes suggested significantly 

different impacts of restatements on investor confidence than the 

UBS/Gallup Index of Investor Optimism; however, since the 2003, the 

differences in the indexes have become less significant. The International 

Center for Finance at the Yale School of Management calculates four 

indexes that are based on survey questions directed to both wealthy 

individual and institutional investors.38 Although the indexes do not all 

move in the same direction over time, or even approximately so, the 

indexes generally show a small improvement in institutional investor 

confidence over the value for June 2002, but a slight decline in individual 

investor confidence with one exception. Some of the Yale indexes show 

pronounced volatility in short-term confidence. In fact, there were periods 

during 2003, 2004, and 2005, where some measures of confidence declined 

significantly before rebounding in 2006. Although these confidence indexes 

did not directly measure the impact of restatements on investor 

confidence, they illustrate the difficulty in attempting to gauge general 

confidence in the market and how different classes of investors can 

interpret and respond to events in different ways.

As in 2002, we focused on the three indexes that most directly measured 

investor confidence. The first Yale index is the One-Year Confidence Index, 

37The index measures confidence quantitatively by assessing the changes in investor 

holdings of risky assets, implementing a research model developed by Harvard Professor 

Kenneth Froot and State Street Managing Director, Paul O’Connell. The index is based on 

financial theory that assigns precise meanings to changes in investor risk sentiment, or the 

willingness of investors to hold proportionally more or less of their portfolio in equities. 

While the global index dates back to 1998, the regional indexes only date back to January 

2005. Each regional index analyzes the actual and changing levels of risk contained in 

investment portfolios domiciled in each of the regions, providing a more regional 

perspective on investor confidence.

38These indexes have been released semiannually since 1989 and monthly since July 2001. 

While capturing more sophisticated investors (wealthy individuals and institutional 

investors), the sample size is little more than 100 in each 6-month interval. For individual 

investors, net worth generally exceeds $250,000. The U.S. institutional investors have been 

sampled in each survey from the investment managers section of the Money Market 

Directory of Pension Funds and Their Investment Managers. We exclude the Valuation 

Confidence Index, which is based on responses to “Are stock prices in the [United States] 

too low, too high, or about right when compared with measures of true fundamental value?” 
Page 41 GAO-06-678 Financial Restatements

which indicated that institutional investor confidence fluctuated between 

June 2002 and May 2006, but ended higher than 2002 levels.39 During the 

same periods, individual investor confidence also fluctuated, but continued 

to trend downward. This implies a divergence in opinion between 

individual and institutional investors, but it is unclear what this difference 

means for overall confidence in the stock market and how restatements 

affect confidence. These findings do appear to suggest that developments 

during 2004 and 2005 had some longer-term negative effect on individual 

investors’ confidence, but that any negative effect on institutional 

investors’ confidence was temporary.

The second Yale index is the Buy on Dip Confidence Index, which suggests 

confidence has been virtually unaffected despite fluctuations in both 

directions from 2004 to 2005.40 Since the period immediately after 

September 11, 2001, and the beginning of the Enron scandal, a few months 

later individual and institutional confidence that the stock market would 

rise the day after a sharp fall has diverged, with institutional dropping and 

individual confidence rising somewhat. However, between December 2003 

and May 2006, institutional investor confidence increased from 57 to 68 

percent, somewhat above its June 2002 value (62 percent), while individual 

investor confidence fluctuated up and down but eventually settled just 1 

percentage point below its June 2002 value. The price-to-earnings ratio 

functioned as an indicator supporting the finding of unchanged confidence; 

in January 2006, the ratio was equivalent to its June 2002 value, and has 

remained valued at more than the historical average. 

The third Yale index is the Crash Confidence Index, which suggested that 

confidence generally has been low—less than 50 percent—for both 

individual and institutional investors, providing the only evidence of a 

similar movement.41 Despite remaining low since October 2002, when the 

market reached its lowest point in 6 years, confidence has shown a distinct 

39This index is based on responses to “How much of a change in percentage terms do you 

expect to see in the Dow Jones Industrial Average [Dow] for the next year?” Some 

researchers have observed that this index displayed some peculiar features during 1999 and

2000, as it showed weak confidence in late 1999 and early 2000 when the market generally 

was characterized as very exuberant. 

40This index is based on responses to “If the Dow dropped 3 [percent] tomorrow, how would 

the Dow move the day after tomorrow?”

41This index is based on responses to “What do you think is the probability of a catastrophic 

stock market crash in the United States in the next [6] months?”
Page 42 GAO-06-678 Financial Restatements

increase for both individual and institutional investors. Specifically, by May 

2006 this index showed an improvement from June 2002 values, with a 43 

percent and a 17 percent increase for institutional and individual investors, 

respectively. However, confidence in the probability that a catastrophic 

stock market crash would not occur in the United States may provide very 

little insight into whether market participants are confident in the 

reliability of financial information transmitted to investors, because not 

even the accounting scandals of 2001 and 2002 triggered a major collapse in 

market valuations. Instead, the increase in confidence observed may 

merely be a vote of general confidence in the resiliency of U.S. capital 

markets. 

Accounting- and 

Auditing-Related 

Enforcement Actions 

Have Continued to 

Grow

The number of SEC enforcement cases involving financial fraud and issuer 

reporting issues increased more than 130 percent from fiscal year 1998 to 

2005. Moreover, in fiscal year 2005, cases involving financial fraud and 

issuer reporting issues constituted the largest category of enforcement 

actions. The resources SEC devoted to enforcement grew as well. Of the 

enforcement actions SEC resolved between March 1, 2002, and September 

30, 2005, most of the actions were taken against companies or their 

directors, officers, employees, and other related parties. Finally, the newly 

created PCAOB also has broad investigative and disciplinary authority over 

public accounting firms that have registered with it and persons associated 

with such firms; PCAOB has brought several enforcement actions since its 

inception. 

Financial Fraud and Issuer 

Reporting Issues Accounted 

for a Significant Number of 

SEC’s Actions

SEC’s Division of Enforcement investigates possible violations of securities 

laws, including those related to financial fraud and issuer reporting issues. 

Between fiscal years 2001 and 2005, these types of cases have increased as 

a percent of SEC’s total enforcement cases from 23 to almost 30 percent 

(see fig. 9). From fiscal years 2002 to 2005, SEC has initiated an average of 

about 588 enforcement actions per year, compared to an average of 497 for 

fiscal years 1998 to 2001. Of these actions, an average of about 135 per year 

involved financial fraud or issuer reporting issues compared to an average 

of 97 per year for the prior period. 
Page 43 GAO-06-678 Financial Restatements

Figure 9: Number of SEC Enforcement Actions and Financial Reporting and Issuer 

Disclosure Issues Initiated, Fiscal Years 1998–2005

In fiscal year 2005, cases involving financial fraud and issuer reporting 

issues were the largest category of enforcement actions accounting for 

almost one-third of the cases, followed by broker-dealer and investment 

company cases. For examples of some of the cases involving accountingand/or auditing-related issues see our detailed case studies on American 

International Group Inc., (app. IX), Federal National Mortgage Corporation 

( app. XI), and Qwest Communications International, Inc. (app. XII). 

SEC’s Enforcement 

Resources Have Grown

In our 2002 report, we found that SEC’s enforcement function was strained 

because of resource challenges and an increased workload; however, as a 

result of several high-profile corporate failures, and financial reporting 

fraud, among other things, the Sarbanes-Oxley Act authorized a 65 percent 

increase in SEC’s 2003 appropriations, which directed the additional 

funding to be used in certain areas. Specifically, no fewer than 200 

positions were to be used to strengthen existing program areas, including 

enforcement. In fiscal year 2003, enforcement resources increased over 20 

0

100

200

300

400

500

600

700

800

SEC enforcement actions

Financial fraud and issuer reporting issues initiated

1998 1999 2000 2001 2002 2003 2004 2005

Year

Source: SEC.

477

79

525

94

503

103

484

112

598

163

678

199

639

179

630

185
Page 44 GAO-06-678 Financial Restatements

percent, including 194 staff in Washington, D.C. and SEC’s regional and 

district offices. Moreover, between fiscal years 2003 and 2004, enforcement 

staffing increased about 29 percent. 

Accounting- and AuditingRelated Actions Included a 

Variety of Entities and 

Individuals 

SEC has taken a variety of accounting- and audit-related enforcement 

actions against various entities and individuals, ranging from public 

companies and audit firms to CEOs and CPAs. Accounting-related 

violations identified included fraud, lying to auditors, filing misleading 

information with SEC, and failing to maintain proper books and records. 

Investigations can lead to SEC-prompted administrative or federal civil 

court actions. Depending on the type of proceeding, SEC can seek 

sanctions that include injunctions, civil money penalties, disgorgement, 

cease-and-desist orders, suspensions of registration, bars from appearing 

before the Commission, and bars from participating as an officer or 

director of a public company. As previously reported, most enforcement 

actions are settled, with respondents generally consenting to the entry of 

civil, judicial, or administrative orders without admitting or denying the 

allegations against them. We found this to be true of the auditing- and 

accounting-related cases we reviewed as well. For a more detailed 

discussion of SEC’s enforcement process, see appendix VII.

About 90 percent of the more than 750 actions resolved between March 

2002 and September 2005 were brought against companies or their 

directors, officers, employees, or other parties.42 Another 10 percent 

involved audit firms and individuals associated with firms, including audit 

managers, partners, and engagement auditors. In the cases involving public 

companies and their officials and related persons, we found that SEC has 

taken a variety of actions against a wide range of officials and employees. 

Historically, SEC was reluctant to seek civil monetary penalties against 

companies in financial fraud cases because such costs would be passed 

along to shareholders who had already suffered as a result of the violations. 

In the AAERs reviewed from March 2002 to September 2005, we found that 

SEC started to take increasingly aggressive actions against public 

companies, including the levy of millions of dollars in civil money penalties 

in 2003 and 2004. However, SEC’s position on civil money penalties against 

public companies continued to evolve. In January 2006, SEC outlined its 

42Unlike SEC, which tracks cases, the number of actions were actions settled or finalized 

during this period, in some cases multiple actions were brought against the same individual 

or organization.
Page 45 GAO-06-678 Financial Restatements

position on this issue when it announced the filing of two settled actions 

against McAfee, Inc. and Applix, Inc. In one case the company paid a civil 

money penalty and in the other, the company did not. According to the 

release, SEC thought it was important to “provide the maximum possible 

degree of clarity, consistency, and predictability in explaining the way that 

its corporate penalty authority will be exercised.” The release discussed 

how the Sarbanes-Oxley Act changed the ultimate disposition of penalties, 

because SEC can now take penalties paid by individuals and entities in 

enforcement actions and add them to disgorgements for the benefit of 

victims through the Fair Funds provision.43 Under this provision, civil 

money penalties that SEC collects no longer go to the Department of 

Treasury; instead, they can be used to help compensate victims for the 

losses they experienced, which would include harmed shareholders. 

The Commission announced that it planned to more closely review actions 

involving civil money penalties against public companies and laid out the 

principles it planned to follow in making such determinations. The 

overarching principle appears to be that corporate penalties are an 

essential part of an aggressive and comprehensive enforcement program. 

In addition, SEC’s view of the appropriateness of the penalty against 

corporations versus the individuals who actually commit the violations is 

to be based on two considerations. First, SEC considers whether the 

corporation received a direct benefit as a result of the violations (e.g., the 

violation resulted in reduced expenses or higher revenues). Second, the 

degree to which the penalty will recompensate or further harm injured 

shareholders. Other factors, SEC will consider are:

• the need to deter the particular type of offense,

• the extent of the injury to innocent parties,

• whether complicity in the violation is widespread throughout the 

corporation,

• the level of intent on the part of perpetrators,

• the degree of difficulty in detecting the particular type of offense,

• the presence or lack of remedial steps by the corporation, and

43Sarbanes-Oxley Act of 2002 § 308(a), 15 U.S.C. § 7246(a).
Page 46 GAO-06-678 Financial Restatements

• the extent of cooperation with the Commission and other law 

enforcement

In our 2002 report, we also noted that Congress, market participants, and 

others, had questioned the lack of severity of many of the sanctions given 

the level of investor harm. At least one SEC official, at the time, felt that 

because monetary penalties are often paid by officer and director 

insurance policies, or are considered insignificant in relation to the 

violation, SEC should pursue more officer and director bars. However, the 

test for imposing officer and director bars was viewed as too restrictive. 

Since that time, the Sarbanes-Oxley Act changed the threshold for seeking 

officer and director bars by amending the securities acts’ requirement from 

“substantial unfitness” to “unfitness,” thereby making it easier for SEC to 

pursue officer and director bars. From March 2002 through September 

2005, SEC obtained officer and director bars against hundreds of officials. 

Specifically, SEC resolved charges against hundreds of CFOs or chief 

accounting officers and CEOs with securities fraud or issuer reporting 

violations between March 2002 and December 2005. See appendixes IX, XI, 

and XII for a summary of the actions taken by SEC in three of the six cases 

we analyzed.

SEC may also bring an enforcement action against other individuals such 

as officers and principals who are not part of top management (other 

participants and responsible parties). In the AAERs we reviewed, SEC 

charged such individuals with accounting-related violations that resulted in 

injunctions, civil monetary penalties, disgorgements, cease-and-desist 

orders; and officer and director bars. For example, SEC and in some cases 

the Department of Justice, have filed suit against several senior officers at 

public companies—including chairmen, chief operating officers, 

controllers, directors, vice presidents, and clients. These executives have 

been charged with securities law violations such as fraud, reporting 

violations, record-keeping violations, and insider trading. 

Although the Sarbanes-Oxley Act provided PCAOB enforcement authority 

over registered public accounting firms and their associated persons 

(which we discuss below), SEC continues to have the authority to bring 

actions against accounting firms. In addition to investigating violations of 

the securities laws, Enforcement investigates improper professional 

conduct by accountants and other professionals who appear before SEC, 

and the agency may pursue administrative disciplinary proceedings against 

these professionals under SEC’s Rules of Practice 102(e). If SEC finds that 

securities laws have been violated or improper professional conduct has 
Page 47 GAO-06-678 Financial Restatements

occurred, it can prohibit professionals from appearing before SEC 

temporarily or permanently. A licensed accountant engages in improper 

professional conduct if he or she intentionally or knowingly violates an 

applicable professional standard or engages in either of the two types of 

negligent conduct defined under the rule. From March 2002 to September 

2005, SEC has taken action against numerous firms and dozens of 

individuals.44 The actions included injunctions, civil monetary penalties, 

bars or suspensions from appearing before the Commission, cease- anddesist orders, officer and director bars, and censures. 

Newly Created PCAOB Also 

Took Variety of 

Enforcement Actions

As mentioned previously, the Sarbanes-Oxley Act authorized PCAOB to 

conduct investigations concerning any acts or practices, or omissions to 

act, by registered public accounting firms and persons associated with 

such firms, or both, that may violate any provision of the act, PCAOB’s 

rules, the provisions of the securities laws relating to the preparation and 

issuance of audit reports and the obligations and liabilities of accountants 

with respect thereto, including SEC rules issued under the act, or 

professional standards. In May 2004, SEC approved PCAOB’s rules 

implementing this authority. When PCAOB alleges a violation, it has the 

authority after an opportunity for a hearing, to impose appropriate 

sanctions. The sanctions can range from revoking a firm’s registration or 

barring a person from participating in audits of public companies, to 

imposing monetary penalties or requirements for remedial measures, such 

as training, new quality control procedures, or the appointment of an 

independent monitor. 

Between May 2005 and July 2006, PCAOB has instituted and settled five 

disciplinary proceedings against registered public accounting firms and 

associated persons. These proceedings dealt with cases involving 

concealing information from PCAOB and submitting false information to it, 

in connection with a PCAOB inspection; noncompliance with PCAOB rules, 

independence standards, and auditing standards in auditing the financial 

statements; and failing to take prompt and appropriate steps in response to 

indications that an issuer audit client may have committed an illegal act. 

The associated sanctions ranged from revoking the firm’s registration, 

barring the involved individual from being an associated person of a 

44The actual number of firm sanctions is actually higher, but several firms were cited more 

than once.
Page 48 GAO-06-678 Financial Restatements

registered public accounting firm, and censuring firms and associated 

persons. 

Conclusions A variety of factors appear to have contributed to the increased trend in 

restatements, including increased accountability requirements on the part 

of company executives; increased focus on ensuring internal controls for 

financial reporting; increased auditor and regulatory scrutiny (including 

clarifying guidance); and a general unwillingness on the part of public 

companies to risk failing to restate, regardless of the significance of the 

event. Given the new regulatory and oversight structure, and the current 

operating environment, it is unclear if and when the current trend toward 

increasing restatements will subside. The number of restatements may 

continue to increase in the immediate future, as new areas of scrutiny (for 

example, small public company implementation of the Sarbanes-Oxley Act 

internal control requirements and hedge accounting rules), by SEC and 

others, may trigger future restatements similar to the trends experienced 

after the focus on accounting for leases or income taxes in early 2005. 

Currently, approximately 60 percent of public companies—generally 

smaller public companies—have yet to fully implement the internal control 

requirements of the Sarbanes-Oxley Act, which could also impact the 

number of restatements. In recent years, the larger public companies’ 

implementation of Section 404 requirements resulted in many companies 

announcing financial restatements. Alternatively, the number of 

restatement announcements could subside after the regulatory and firm 

changes called for in the Sarbanes-Oxley Act have been fully implemented 

and allowed to play through.

Companies that announce restatements generally continue to experience 

decreases in market capitalization in the days around the initial 

announcement; however, the magnitude of the impact has significantly 

decreased from the period analyzed in our 2002 report. The exact reason 

for this decline is unclear, but may include a variety of factors such as 

investors’ inability to discern the reason for the restatement, varying 

reactions by investors about what the restatement means (e.g., whether the 

company is improving its disclosures), or investors’ growing insensitivity to 

financial statement restatement announcements. These views, in part, are 

supported by some investor confidence data and research including that, 

while investor confidence seems to have increased, investors often are 

unable to decipher the reason for the restatement; restatements may be 

viewed in various ways by investors, depending on whether they believe 

that the trend is part of a “cleansing process” (i.e., public companies 
Page 49 GAO-06-678 Financial Restatements

strengthening their internal controls), or whether they merely reflect 

technical adjustments for compliance. 

SEC improved disclosure of restatement announcements in 2004 by 

requiring additional information on Form 8-K. However, some public 

companies continue to announce restatements that result in non-reliance 

on prior financial statements outside of the required Form 8-K (Item 4.02) 

filing process. That is, about 17 percent of companies announcing 

restatements that resulted in non-reliance between August 2004 and 

September 2005 failed to disclose this information under the appropriate 

item or failed to file an 8-K at all. While most filed the information under an 

item other than 4.02 in the Form 8-K, some appeared to have disclosed the 

information in a Form 10-K or 10-Q, which raises questions inconsistencies 

between the Form 8-K instructions versus staff questions-and-answers 

discussion concerning filing requirements under Item 4.02. The result of the 

potential noncompliance is that some companies continue to restate 

without consistently informing investors and the general public that such 

restatements have occurred and that previously issued financial statements 

should not be relied upon—which raises concerns about compliance with 

SEC’s revised Form 8-K disclosure requirements and the ongoing 

transparency and consistency of public disclosures. 

Recommendations To better enable SEC to enforce its regulations and improve the 

consistency and transparency of information provided to investors about 

financial restatements, we recommend that SEC take specific actions to 

improve oversight and compliance of disclosures of certain restatements. 

First, SEC should direct the head of the Division of Corporation Finance to 

investigate the instances of potential noncompliance we, and Glass Lewis, 

identified, and take appropriate corrective action against any companies 

determined to have filed a deficient filing. Second, SEC should harmonize 

existing instructions and guidance concerning Item 4.02 by amending the 

instructions to Form 8-K and other relevant periodic filings to clearly state 

that an Item 4.02 disclosure on Form 8-K is required for all determinations 

of non-reliance on previously issued financial statements (Item 4.02), 

irrespective of whether such information has been disclosed on a periodic 

report or elsewhere. 
Page 50 GAO-06-678 Financial Restatements

Agency Comments and 

Our Evaluation

We provided a draft of this report to the Chairmen of SEC and PCAOB, for 

their review and comment. We received written comments from SEC and 

PCAOB that are summarized below and reprinted in appendixes II and III. 

Both SEC and PCAOB provided technical comments that were 

incorporated into the report as appropriate. 

In response to our first recommendation that the Division of Corporation 

Finance investigate the instances of potential noncompliance identified 

and take appropriate corrective action, the Director of the Division of 

Corporation Finance stated that SEC appreciated the recommendation and 

that it will continue its long history of examining instances of potential 

noncompliance with federal securities laws. Finally, in response to our 

recommendation that SEC harmonize existing instructions and guidance, 

SEC stated that it will carefully consider our recommendation to 

harmonize existing instructions and guidance related to a company’s need 

to notify the public that previously issued financial statements or results 

should not be relied upon.

In commenting on the draft report, the Chairman of PCAOB stated that as 

the organization charged by the Sarbanes-Oxley Act with overseeing the 

audit of public companies, the report’s findings on the causes of, and trends 

in restatements by public companies would be useful to PCAOB’s oversight 

efforts.

As agreed with your office, we plan no further distribution of this report 

until 30 days from its issuance unless you publicly release its contents 

sooner. At that time, we will send copies of this report to the Chairman of 

the Senate Committee on Banking, Housing, and Urban Affairs; the 

Chairman and Ranking Minority Member of the Senate Subcommittee on 

Securities and Investment, Senate Committee on Banking, Housing, and 

Urban Affairs; the Chairman and Ranking Minority Member, Senate 

Committee on Governmental Affairs; the Chairman and Ranking Minority 

Member, House Committee on Financial Services; and other interested 

congressional committees. We will also send copies to the Chairman of the 

SEC and the Chairman of the PCAOB and will make copies available to 

others upon request. In addition, this report is also available on GAO Web 

site at no charge at http://www.gao.gov. 
Page 51 GAO-06-678 Financial Restatements

If you have any questions concerning this report, please contact Orice M. 

Williams at (202) 512-5837 or williamso@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on the 

last page of this report. See appendix XV for a list of other staff who 

contributed to the report.

Sincerely yours,

Orice M. Williams

Director, Financial Markets and 

Community Investment

Jeanette M. Franzel

Director, Financial Management

and Assurance 

Thomas J. McCool

Director, Center for Economics

Applied Research and Methods
Page 52 GAO-06-678 Financial Restatements

Appendix I

Objectives, Scope, and Methodology AAppenednxidexiIs

As agreed with your staff, our objectives were to (1) determine the number 

of, reasons for, and other trends in restatements since our 2002 report; (2) 

analyze the impact of restatement announcements on the restating 

companies’ stock market capitalization; (3) research available data to 

determine the impact of restatements on investors’ confidence in the 

existing U.S. system of financial reporting and capital markets; and (4) 

analyze the Securities and Exchange Commission (SEC) enforcement 

actions involving accounting- and auditing-related issues. 

Identifying the Number of 

and Reasons for 

Restatements

To determine the number of and reasons for restatements since 2002, we 

employed substantially the same methodology used in our prior report, in 

which we analyzed the period from January 1997 through June 2002.1

 We 

identified restatements of previously reported financial results announced 

from July 1, 2002, through September 30, 2005, using the Lexis-Nexis online 

information service to search for press releases and other media coverage 

on restatements. When developing our search methodology for identifying 

restatements for our prior report, we reviewed the approaches used in 

several academic and nonacademic research papers.2

 Our search 

methodology was constructed to maximize the number of potentially 

relevant articles (and minimize the potentially irrelevant articles) for our 

consideration, given the focus of our research. Using the Lexis-Nexis 

“Power Search” command and the “US Newspapers and Wires” database, 

we performed keyword searches using variations of “restate” as well as the 

terms, “adjust,” and “amend,” and “revise”—all within 50 words of 

“financial statement” or “earning.” 

As was the case in our prior report, to our knowledge, no comprehensive, 

authoritative database of financial statement restatement announcements 

exists that is publicly available. While several researchers have constructed 

and maintained their own financial statement restatement databases, these 

lists are generally proprietary and are not publicly available. Moreover, 

these researchers may have a different focus from ours and may use 

different methods and criteria for constructing their databases, as well as 

1

GAO, Financial Statement Restatements: Trends, Market Impacts, Regulatory Responses, 

and Remaining Challenges, GAO-03-138 (Washington, D.C.: Oct. 4, 2002).

2

In addition to sources cited in our 2002 report, we also relied on Huron Consulting Group 

(HCG), 2005, “2004 Annual Review of Financial Reporting Matters”; Glass, Lewis & Co., LLC 

(2005), “Restatements – Traversing Shaky Ground: and Glass, Lewis & Co., LLC (2006), 

“Getting It Wrong the First Time.”
Appendix I

Objectives, Scope, and Methodology

Page 53 GAO-06-678 Financial Restatements

different sample periods, making it difficult to directly compare the 

database of restatements that we constructed with the databases that 

others have compiled. However, we were able to compare descriptive 

statistics from our database with proprietary information provided by 

Huron Consulting Group (HCG) and Glass, Lewis & Co. LLC (Glass Lewis). 

In comparing our list to Glass Lewis’ database of actual restatement filings, 

it is clear that our database, while providing a comprehensive list of 

companies listed on the major exchanges, excludes a large number of 

small, over-the-counter companies with limited analyst and press coverage 

(see app. V). As a result, our database, which included 1,390 restatement 

announcements, should be viewed as a sample of restatements by publicly 

traded companies identified using our particular search methodology, and 

the results of our analysis should be viewed in this context. Specifically, 

users of this report should note that our figures likely do not reflect the 

number of smaller public companies that have restated over the 2002-2005 

period. Our database was constructed using a methodology that reflects 

our focus on the impact on companies’ market capitalization.3

 In many 

cases, the report discusses statistics as they pertain to publicly listed 

companies, since our database is fairly comprehensive in this regard. We 

reviewed filings in SEC’s Electronic Data Gathering, Analysis, and Retrieval 

(EDGAR) system, and companies’ Web sites, to verify the accuracy of 

particular restatement announcement dates and reasons. 

Although there are many reasons for restatements, most restatements 

involve more routine reporting issues (such as a merger or stock split) and 

are not symptomatic of financial reporting fraud. Consistent with our prior 

report, we generally specified financial reporting fraud and accounting 

errors—previously referred to as accounting irregularities in our prior 

report—to include so-called “aggressive” accounting practices, intentional 

and unintentional misuse of facts applied to financial statements, oversight 

or misinterpretation of accounting rules, and fraud. Given the general 

change in attitude toward what issues may warrant restatements in the 

post Sarbanes-Oxley Act environment, we also included restatements that 

involved computational errors—a departure from our prior report. 

Exclusion of such restatements likely had a negligible impact on our prior 

report’s results since we encountered very few such instances. Also, we 

included in our database each restatement that met our criteria, regardless 

of its impact (positive or negative) on the restating company’s financials.

3

Publicly listed companies make up over 97 percent of the total market capitalization of 

publicly traded companies. 
Appendix I

Objectives, Scope, and Methodology

Page 54 GAO-06-678 Financial Restatements

We excluded restatement announcements that resulted from normal 

corporate activity or simple presentation issues—unless we determined 

that there was some financial reporting fraud and/or accounting errors 

involved. For example, we excluded financial statement restatements 

resulting from mergers and acquisitions, discontinued operations, stock 

splits, issuance of stock dividends, currency-related issues (for example, 

converting from Japanese yen to U.S. dollars), changes in business segment 

definitions, changes due to transfers of management, changes made for 

presentation purposes, general accounting changes under generally 

accepted accounting principles (GAAP), and litigation settlements. As a 

general rule, we also excluded restatements resulting from accounting 

policy changes.4

 We excluded these financial statement restatements 

because they did not necessarily reveal previously undisclosed, 

economically meaningful data to market participants. 

Consistent with our prior report, once a relevant restatement was 

identified, we classified it into one or more of nine categories—(1) 

acquisition and merger related, (2) cost- or expense related, (3) in-process 

research and development related, (4) reclassification related, (5) relatedparty transaction related, (6) restructuring, assets, or inventory related, (7) 

revenue recognition related, (8) securities related, and (9) other.5

 Our 

classification, as developed for our prior report, closely resembles that 

employed by the Financial Executives International and Wu (2001) and 

HCG (2002). 

4

We included restatement announcements that stemmed from the issuance of SEC 

clarification about revenue recognition (SEC Staff Accounting Bulletin No. 101) and 

accounting for leases (Feb. 5, 2005, letter from SEC’s Chief Accountant to the American 

Institute of Certified Public Accountants clarifying SEC staff’s interpretation of certain 

operating lease-related accounting issues and their application under GAAP).

5

Some restatement announcements cited multiple accounting issues (for example, improper 

revenue recognition, improper recording of cost of goods sold, and improper valuation of 

inventory). In these cases, we included the restatement in all applicable categories, and in 

the analyses involving stratification by restatement reason, we assigned equal fractional 

weights to the reasons. For the above example, we would assign each reason (revenue, costor- expense, and restructuring, assets, or inventory) a weight of one-third when calculating 

the market capitalization loss.
Appendix I

Objectives, Scope, and Methodology

Page 55 GAO-06-678 Financial Restatements

Determining the Impact of 

Restatements on Market 

Values of Restating 

Companies 

To analyze the impact of restatement announcements involving financial 

reporting fraud and/or accounting errors on the stock market value of 

restating companies, we used the standard event study approach. The 

event to be measured was the initial announcement within the period from 

July 1, 2002, to September 30, 2005, of a financial statement restatement 

involving financial reporting fraud and/or accounting errors by a publicly 

traded company with common stock issued on the New York Stock 

Exchange (NYSE), Nasdaq, American Stock Exchange (Amex), or quoted 

on the Over-the-Counter (OTC) Bulletin Board or the National Quotation 

Service Bureau’s “Pink Sheets.” Throughout this report, we refer to the 

subset of companies with stock traded on NYSE, Nasdaq, and Amex as 

“listed.” We obtained historical stock price data for the relevant listed 

companies from NYSE’s Trade and Quote (TAQ) database. This database 

contains detailed records of all quotes and transactions made for all NYSE, 

Nasdaq, and Amex issues.6

Although we identified 1,390 restatement announcements from July 1, 

2002, to September 30, 2005, we excluded some restatements from our 

event study for a number of reasons. First, we excluded restatements by 

companies with common stock that was not listed (that is, with stock only 

quoted on the OTC Bulletin Board or Pink Sheets) because we did not have 

consistent access to reliable historical price data for these stocks. We 

estimated that the exclusion of these unlisted companies would have a 

negligible impact on our market capitalization results. Companies with 

stock only quoted on the OTC Bulletin Board or Pink Sheets tend to be 

smaller in terms of market capitalization, but it is not clear whether their 

exclusion will introduce positive or negative bias in our average holding 

period “abnormal returns” results (the realized rate of return of a stock 

over an event window minus the expected return of that stock over the 

same period). We also excluded from our analysis any restatement by a 

company that had extensive portions of data missing for the relevant time 

around the restatement announcement. Missing data were generally 

attributable to extended trading suspensions, stock delistings, stock

6

To ensure the reliability of the TAQ data, we randomly cross-checked TAQ data with data 

provided by a variety of publicly available stock data sources. 
Appendix I

Objectives, Scope, and Methodology

Page 56 GAO-06-678 Financial Restatements

deregistrations, bankruptcies, and mergers.7 However, TAQ was also 

missing data for several listed companies; and thus, we excluded these 

companies from our analysis. We cannot estimate the impact that these 

exclusions would have on our reported results. To the extent a company’s 

stock price declined following delisting, our analysis would be biased 

toward understating the impact of financial statement restatement 

announcements. To address these issues, we performed a separate analysis 

on a particular subset of these cases using alternative stock price data. 

To determine the impact of the restatement announcement on a company’s 

stock price, we identified the trading day that corresponded with the initial 

announcement date. We found that companies would frequently issue 

public announcements in which they suggested that they might restate 

their financial statements. Our criteria for selection required that a 

company disclosed that a restatement was, at a minimum, “likely.” We 

found that some companies announced their restatements during or before 

normal trading hours on a trading day, while others publicly announced 

their financial statement restatement after the close of trading or on a 

nontrading day. Precise measurement of the time of an announcement was 

generally not possible; however, for those cases in the latter category that 

we were able to identify, we defined the announcement day as the next 

trading day. We then identified the relevant trading days before and after 

the restatement announcement, collectively known as the event window. 

To analyze the immediate impact of restatement announcements, we 

specified the immediate event window as the period from the trading day 

before the announcement through the trading day after the announcement. 

To analyze the longer-term impact of restatement announcements, we also 

specified an intermediate event window of approximately 2 calendar 

months, which included 20 trading days (1 month) before the 

announcement through 20 trading days (1 month) after the announcement; 

and a longer event window of approximately 6 calendar months, which

7

Companies announcing financial restatements frequently were forced to delay their 

required SEC filings or were in violation of other listing standards and were subsequently 

delisted from NYSE, Nasdaq, or Amex within 60 trading days of the restatement 

announcement. In some cases, the stock of the delisted company moved to the OTC Bulletin 

Board or Pink Sheets. In several cases, these companies ultimately filed for bankruptcy or 

were acquired by other companies. 
Appendix I

Objectives, Scope, and Methodology

Page 57 GAO-06-678 Financial Restatements

included 60 trading days (3 months) before the announcement through 60 

trading days (3 months) after the announcement.8

To assess the impact of the restatement announcement on a company’s 

stock price, we calculated the “abnormal return”—the market-adjusted 

increase (or decrease) in stock price—of the stock over the event window. 

The abnormal return is the realized rate of return of a stock over the event 

window minus the expected return of that stock over the same period. The 

realized, or actual, rate of return of a stock of company i from date t–1 to 

date t is defined as 

in which is the closing price of the stock at date t, and is the 

closing price of the stock at date t–1. The expected return is defined as the 

rate of return of the stock (predicted by some valuation model) that is 

expected under the assumption that the event does not occur. In this way, 

the abnormal return is designed to capture the impact of the event on the 

stock. For any company i and date t, 

,

in which is the abnormal return of the stock of company i on date t, 

is the realized return of the stock of company i on date t, and is 

the expected return of the stock of company i on date t conditioned on 

some information set, . We used the rate of return of the Wilshire Total 

Market Index on date t as our conditioning information, .

9

 

To calculate the abnormal return, we first specified a statistical model for 

estimating the expected return of the stock of company i on date t. We used 

8

We included the trading days prior to a restatement announcement to address possible 

information leakage prior to the announcement. These longer pre-announcement date 

windows would also capture any impact of a company publicly releasing information about 

possible, unconfirmed accounting problems that later were confirmed to require a 

restatement.

9

Wilshire Associates Incorporated, an investment advisory company, provides widely quoted 

and tracked market indices. We used index data provided by Global Insight and randomly 

cross-checked them against data available on Wilshire’s Web site.

, 1

, 1

−

− − =

i t

it i t

it P

P P

R

Pit Pi t, 1−

( ) Ait Rit Rit Xt = − Ε |

Ait Rit ( ) Rit Xt Ε |

Xt

Xt
Appendix I

Objectives, Scope, and Methodology

Page 58 GAO-06-678 Financial Restatements

a standard market model, which relates the rate of return of the stock of i 

to the return of the overall market as

in which is an error term and and are the parameters of the 

market model. In this specification, and are the intercept and slope, 

respectively, of the linear relationship between the return of the stock of 

company i on date t and the return of the market on date t.

10 The 

parameter, , is a measure of the co-variation between the returns of the 

stock of i and the returns of the market. In this way, the expected return is 

risk-adjusted, taking into account the risk of stock i relative to the overall 

market. Next, we estimated the parameters of the model using a subset of 

the data. This subset, referred to as the “estimation window,”generally 

included at least 120 trading days (typically about 6 calendar months) of 

daily closing price data through the day prior to the initial restatement 

announcement.11 We estimated the market model using the ordinary leastsquares estimation procedure for each of the companies for which we had 

sufficient data. Each estimation produced parameter estimates, and , 

for the given company and estimation window. The parameter estimates 

were subsequently used to generate an estimate of the expected 

return, , for each stock i at each date t using the market model. 

This estimate of the expected return, , was determined as

.

Using this expected return, we also calculated an estimate of the expected 

stock price for each stock i at each date t, , as

.

We then calculated the abnormal return for each stock based on the results 

of our estimation. For any company i and date t, the estimated abnormal 

return, , was

10In a standard financial econometrics text, Campbell, Lo, and MacKinlay (1997) provide a 

detailed discussion of the market model. While the market model we use is very simple, 

according to these authors, it is not clear that using a more sophisticated model is 

necessary.

11The event itself is not included in the estimation window so that the event does not 

influence the estimates of the model’s parameters.

Rit i i Xt it = α + β + ε

it ε αi βi

αi βi

βi

αi ˆ βi

ˆ

( ) Rit Xt Ε |

Nit

ˆ

Nit αi β i Xt ˆ ˆ ˆ = +

ˆQit

,1 ,1 ( ) ( ) ˆ ˆ ˆ 1 1 ˆ QP N P X it i t it i t i i t = ×+ = ×+ + − − α β

Ait

ˆ
Appendix I

Objectives, Scope, and Methodology

Page 59 GAO-06-678 Financial Restatements

.

We also calculated the estimated unexpected, or market-adjusted, change 

in the stock price of i from t–1 to t, , as

.

To measure the impact of the restatement announcement on the stock of 

company i, we calculated the abnormal return over the holding period from 

day –1 to day +1 to capture the immediate impact; we calculated the 

abnormal return over the holding period from day –20 to day +20 to capture 

the intermediate impact; and we calculated the abnormal return over the 

holding period from day –60 to day +60 to capture the longer-term impact. 

We also calculated the immediate impact on the market capitalization of 

company i by multiplying the difference between the actual stock price on 

day +1 and the expected price on day +1 (the immediate market-adjusted 

change in price) by the number of shares outstanding; and we calculated 

the intermediate and longer-term impact on the market capitalization of 

company i by multiplying the difference between the actual stock price on 

days +20 and +60 and the expected price on days +20 and +60 (the 

intermediate and longer-term market-adjusted change in price) by the 

number of shares outstanding.12 To assess the overall impact of the general 

event of a restatement announcement, we averaged individual holding 

period abnormal returns over all restatement announcement events in our 

sample for each of the event windows, and we summed all of the 

unadjusted and adjusted market changes in price for each of the event 

windows.

The usual interpretation of abnormal returns over an event window is that 

they measure the impact of the event on the value of a company’s stock. 

This interpretation may be misleading due to other firm specific or market 

factors. Our simple market model attempted to account for only the overall 

market’s effect on the stock. One of the more relevant factors in this event 

12We obtained the number of shares outstanding for a company from the company’s Form 

10-Q covering the 3-month period during which the restatement announcement was made. If 

this were not available, we used either the closest Form 10-Q, appropriate Form 10-K, or 

other company sources. Specifically, we obtained the average number of diluted shares over 

this period. Diluted shares are the pools of outstanding common shares issued by a 

company, combined with the shares that would be created upon the conversion of the 

company’s options, warrants and convertible securities. Our use of diluted, rather than basic 

shares, provides a more accurate assessment of the overall impact on shareholders. 

( ) Ait Rit i i Xt Rit Nit ˆ ˆ ˆ ˆ = − α + β = −

ˆUit

,1 ,1 ( ) ( ) ˆ ˆ ˆ ˆ 1 1 ˆ U PQ PP N PP X it it it it i t it it i t i i t = − = − ×+ = − ×+ + − − α β
Appendix I

Objectives, Scope, and Methodology

Page 60 GAO-06-678 Financial Restatements

study was the simultaneous release of a restatement announcement and 

scheduled financial statements to the market. (For example, a company 

could have issued its first quarter 2005 earnings that missed, met, or 

exceeded the market’s expectations while also announcing that it was 

restating previously issued financial statements from prior periods 

including 2003 and 2004.) To the extent that this was an issue, our results 

could be biased in either direction and, hence, attributing abnormal returns 

solely to the restatement announcement could be misleading. Another 

potential factor is information leakage. Events such as the announcement 

of an SEC inquiry, internal or external accounting review, or the abrupt 

departure of a company’s chief executive officer or chief financial officer 

may be an early indication that a financial restatement is forthcoming. 

Furthermore, it is important to note that because we increased the period 

over which we attempted to assess the impact of the restatement on a 

particular stock, many other factors influencing the behavior of the stock 

price can come into play. To the extent that other influences on the price 

are significant, our intermediate results reflect not only the impact of the 

restatement announcement but these factors as well.

Additionally, there are potential sources of bias in our estimation 

procedure. Some of the more important involve event-date uncertainty, 

violations of our statistical assumptions, and using daily closing stock 

prices. While our event study methodology assumes that we are able to 

precisely identify the event date, this sometimes involved a certain amount 

of judgment. The announcement of a financial statement restatement 

typically only provides the date of the announcement; whether the 

announcement was made before, during, or after trading on that date may 

not be clear. We used the 3-day event window technique to address this 

issue. Another possible source of bias stems from violation of our standard 

statistical assumptions.13 A further potential source of bias in our 

estimation involves using the daily closing prices of stocks. In the event 

study framework, we implicitly assumed that these daily closing prices 

were recorded at identical time intervals each day. However, this 

assumption is easily violated because the last transaction for a given stock, 

can and generally does, occur at a different time each day. Additionally, 

some of the stocks in our event study were “thinly” or infrequently traded, 

and several days could elapse between transactions. Referring to the last 

recorded prices as daily closing prices assumed that closing prices are 

13See Campbell, Lo, and MacKinlay (1997).
Appendix I

Objectives, Scope, and Methodology

Page 61 GAO-06-678 Financial Restatements

equally spaced at 24-hour intervals, which is not the case. To the extent that 

this assumption is violated, our results may be biased.

Overall, our analysis focused on the impact of a company’s restatement 

announcement on its market capitalization. Therefore, we did not take into 

account the effects on market participants with short positions or various 

options positions, nor did we gauge the impact on the company’s 

bondholders. To whatever extent—whether positively or negatively—these 

market participants were affected by restatements, our results are 

necessarily incomplete.

Determining the Impact of 

Restatements on Investor 

Confidence

To analyze the impact of restatements on the confidence of market 

participants, we relied principally on outside sources. Namely, we 

identified indexes of investor confidence, located quantitative research on 

the issue, conducted interviews with experts in the field, and collected data 

on mutual fund flows and other proxies for investor sentiment. The surveybased indexes of investor confidence were obtained from UBS Americas, 

Inc. and the International Center for Finance at the Yale School of 

Management. The Nobel Laureate economist, Dr. Lawrence Klein, 

acknowledged the UBS Index for its accuracy and timeliness. The Yale 

School of Management Indexes are considered to be the longest-running 

effort to measure investor confidence and the project is directed by one of 

the leading experts in the field, Dr. Robert Shiller. In addition, we obtain an 

investor confidence index from State Street Corporation. This index 

measures confidence quantitatively by assessing the changes in investor 

holdings or risky assets, implementing a research model developed by 

Harvard Professor Kenneth Froot and State Street Managing Director, Paul 

O’Connell. The index uses the principles of modern financial theory to 

model the underlying behavior of global investors. Unlike other surveybased confidence measures that focus on expectations for future prices 

and returns, the Index provides a quantitative measure of the actual and 

changing levels of risk contained in investment portfolios representing 

about 15 percent of the world's tradable assets. Unfortunately, while the 

global confidence measure dates back to 1998, the time series for 

confidence in North America only spans 2005 and 2006. We also were able 

to collect survey results about the direct impact of restatements on 

investor confidence from UBS Americas and the Securities Industry 

Association. 

Although the literature on the impact of restatements on investor 

confidence is limited, we identified a number of studies. The results of 
Appendix I

Objectives, Scope, and Methodology

Page 62 GAO-06-678 Financial Restatements

studies are consistent with the hypothesis that, while financial 

restatements elicit different responses from the market depending on the 

type, certain financial restatements can have negative effects on investor 

confidence. However, these studies were based on restatement data prior 

to the period under examination in this report and the evidence of effects 

on the broader market is limited. To gain further insight, we also 

interviewed some experts in the field and summarized their responses to a 

set of questions regarding accounting practices, restatements, and investor 

confidence. Finally, we collected data on mutual fund flows from the 

Investment Company Institute, a popular source for statistical data on the 

mutual fund industry, and data on holdings of corporate equities and bond 

yields from the Board of Governors of the Federal Reserve System. 

Analysis of SEC’s 

Accounting-Related 

Enforcement Activities

To analyze SEC enforcement actions involving accounting- and auditingrelated issues, we reviewed more than 800 SEC-identified Accounting- and 

Auditing-Enforcement Releases (AAER)14 issued from March 1, 2002, 

through September 30, 2005, posted on SEC’s Web site as of July 1, 2006. We 

collected information on all actions sought or brought but only counted 

actions against the same organization or individual once for purposes of 

analysis. We also collected other common information disclosed in the 

AAERs, such as the individuals and companies charged in the cases and the 

sanction levied. To describe the process that SEC uses to develop an 

enforcement case, including whom to include as a defendant in the case 

and penalties to assess, we used a variety of information provided by SEC. 

To obtain historical general enforcement and accounting-related 

enforcement actions, we downloaded the information from SEC’s Web site, 

and where there were gaps in the data made direct requests for information 

from SEC. To the extent possible, to determine the roles that key players, 

such as auditors and company senior management, played in fostering 

misleading financial information upon investors, we selected six financial 

restatements for in-depth case study. The cases were selected based on 

asset size, restatement period, reason for the restatement, market where 

stock traded and industry. (See app. VIII for an overview of the case 

studies; the individual studies are presented in appendixes IX–XIV.) 

14AAER is a numbering or catalogue system for SEC enforcement actions that relate to 

accounting or financial improprieties. 
Appendix I

Objectives, Scope, and Methodology

Page 63 GAO-06-678 Financial Restatements

We performed our work in Washington, D.C., between June 2005 and July 

2006, in accordance with generally accepted government auditing 

standards. 
Page 64 GAO-06-678 Financial Restatements

Appendix II

Comments from the Securities and Exchange 

Commission ApendxiI
Page 65 GAO-06-678 Financial Restatements

Appendix III

Comments from the Public Company 

Accounting Oversight Board ApendxiI
Page 66 GAO-06-678 Financial Restatements

Appendix IV

Summary of Selected Sarbanes-Oxley Act 

Provisions Affecting Public Companies and 

Registered Accounting Firms ApendxiIV

Responding to corporate failures and fraud that resulted in substantial 

financial losses to institutional and individual investors, Congress passed 

the Sarbanes-Oxley Act in 2002. As shown in table 7, the act contains 

provisions affecting the corporate governance, auditing, and financial 

reporting of public companies, including provisions intended to deter and 

punish corporate accounting fraud and corruption.1

 The Sarbanes-Oxley 

Act generally applies to those companies required to file reports with SEC 

under the Securities Exchange Act of 1934.2 

Table 7: Summary of Selected Sarbanes-Oxley Act Provisions Affecting Public Companies and Registered Accounting Firms

1

While there is no standard definition of corporate governance, it can broadly be understood 

to refer to the system by which companies are directed and controlled, including the role of 

the board of directors, management, shareholders, and other stakeholders. According to the 

Organisation for Economic Co-operation and Development, corporate governance provides 

the structure through which the objectives of the company are set and the means of 

attaining those objectives and monitoring performance are determined.

2

In addition to those companies required to file reports with SEC under the Securities 

Exchange Act of 1934, the Sarbanes-Oxley Act also applies to companies considered to be 

issuers that have filed a Securities Act of 1933 registration statement that is not yet effective.

Provision Main requirements

Section 101: Public Company Accounting 

Oversight Board (PCAOB) Establishment

Establishes PCAOB to oversee the audit of public companies that are subject to the 

securities laws.

Section 102: Registration with the Board Requires accounting firms that prepare or issue audit reports for public companies to 

register with PCAOB.

Section 103: Auditing, Quality Control, and 

Independence Standards and Rules

Requires PCAOB, by rule, to establish auditing and other professional standards to be 

used by registered public accounting firms in the preparation and issuance of audit 

reports.

Section 104: Inspections of Registered Public 

Accounting Firms

Requires PCAOB to annually inspect registered public accounting firms with more than 

100 issuer audit clients and triennially inspect registered public accounting firms with 100 

or less issuer audit clients.

Section 105: Investigations and Disciplinary 

Proceedings

Requires PCAOB to establish fair procedures for investigating and disciplining registered 

public accounting firms and associated persons and authorizes PCAOB to investigate 

and discipline such firms and persons.

Section 201: Services Outside the Scope of 

Practice of Auditors

Registered accounting firms cannot provide certain nonaudit services to a public 

company if the firm also serves as the auditor of the financial statements for the public 

company. Examples of prohibited nonaudit services include bookkeeping, appraisal or 

valuation services, internal audit outsourcing services, and management functions.

Section 301: Public Company Audit 

Committees

Listed company audit committees are responsible for the appointment, compensation, 

and oversight of the registered accounting firm, including the resolution of disagreements 

between the registered accounting firm and company management regarding financial 

reporting. Audit committee members must be independent.
Appendix IV

Summary of Selected Sarbanes-Oxley Act 

Provisions Affecting Public Companies and 

Registered Accounting Firms

Page 67 GAO-06-678 Financial Restatements

Source: GAO.

Title I of the act establishes PCAOB as a private sector non-profit 

organization to oversee the audits of public companies that are subject to 

the securities laws. PCAOB is subject to SEC oversight. The act gives 

PCAOB four primary areas of responsibility: 

• registration of accounting firms that audit public companies in the U.S. 

securities markets;

• inspections of registered accounting firms;

• establishment of auditing, quality control, and ethics standards for 

registered accounting firms; and

• investigation and discipline of registered accounting firms for violations 

of law or professional standards.

Title II of the act addresses auditor independence. It prohibits the 

registered external auditor of a public company from providing certain 

nonaudit services to that public company audit client. Title II also specifies 

communication that is required between auditors and the public company’s 

audit committee (or board of directors) and requires periodic rotation of 

the audit partners managing a public company’s audits.

Section 302: Corporate Responsibility for 

Financial Reports

For each annual and quarterly report filed with SEC, the CEO and CFO must certify that 

they have reviewed the report and, based on their knowledge, the report does not 

contain untrue statements or omissions of material facts resulting in a misleading report 

and that, based on their knowledge, the financial information in the report is fairly 

presented.

Section 304: Forfeiture of Certain Bonuses 

and Profits

The CEO and CFO of the issuer have to reimburse the issuer for any bonus or profits 

from sale of securities during the 12 month period following the filing of a financial 

document that required an issuer to prepare an accounting restatement due to 

misconduct.

Section 308: Fair Funds for Investors The civil penalties can be added to the disgorgement fund for the benefit of the victims of 

a security law violation.

Section 404: Management Assessment of 

Internal Controls

This section consists of two parts. First, in each annual report filed with SEC, company 

management must state its responsibility for establishing and maintaining an internal 

control structure and procedures for financial reporting; it must also assess the 

effectiveness of its internal control structure and procedures for financial reporting. 

Second, the registered accounting firm must attest to, and report on, management’s 

assessment of the effectiveness of its internal control over financial reporting.

Section 407: Disclosure of Audit Committee 

Financial Expert

Public companies must disclose in periodic reports to SEC whether the audit committee 

includes at least one member who is a financial expert and, if not, the reasons why.

(Continued From Previous Page)

Provision Main requirements
Appendix IV

Summary of Selected Sarbanes-Oxley Act 

Provisions Affecting Public Companies and 

Registered Accounting Firms

Page 68 GAO-06-678 Financial Restatements

Titles III and IV of the act focus on corporate responsibility and enhanced 

financial disclosures. Title III addresses listed company audit committees, 

including responsibilities and independence, and corporate responsibilities 

for financial reports, including certifications by corporate officers in 

annual and quarterly reports, among other provisions. Title IV addresses 

disclosures in financial reporting and transactions involving management 

and principal stockholders, and other provisions such as internal control 

over financial reporting. More specifically, section 404 of the act 

establishes requirements for companies to publicly report on 

management’s responsibility for establishing and maintaining an adequate 

internal control structure, including controls over financial reporting and 

the results of management’s assessment of the effectiveness of internal 

control over financial reporting. Section 404 also requires the firms that 

serve as external auditors for public companies to attest to the assessment 

made by the companies’ management, and report on the results of their 

attestation and whether they agree with management’s assessment of the 

company’s internal control over financial reporting.
Page 69 GAO-06-678 Financial Restatements

Appendix V

GAO-06-1053R ApendxiV

On March 5, 2007, this 

correspondence was 

reissued to amend selected 

company shares 

outstanding. Please select 

this link to GAO-06-678 for 

more information.
Appendix V

GAO-06-1053R

Page 70 GAO-06-678 Financial Restatements
Appendix V

GAO-06-1053R

Page 71 GAO-06-678 Financial Restatements
Appendix V

GAO-06-1053R

Page 72 GAO-06-678 Financial Restatements
Appendix V

GAO-06-1053R

Page 73 GAO-06-678 Financial Restatements
Appendix V

GAO-06-1053R

Page 74 GAO-06-678 Financial Restatements
Appendix V

GAO-06-1053R

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Appendix VI

Comparison of Our Restatement Database to 

Those of Glass, Lewis & Co. LLC and the 

Huron Consulting Group ApendxiVI

A number of other research studies have suggested that a significant 

number of companies continue to announce restatements of their financial 

statements as a result of financial reporting fraud, accounting errors, and 

the increased disclosure and internal control requirements introduced by 

the Sarbanes-Oxley Act of 2002. To provide a better understanding of 

companies announcing restatements of previous results, we analyzed 

Lexis-Nexis press releases and news articles, related SEC filings, and 

company press releases to determine the total number of restatement 

announcements, restating companies, and the reasons for announcements 

made from July 2002 through September 2005.1

 See appendix I for a 

detailed discussion of our scope and methodology. This appendix provides 

a comparison of our database with those that Glass Lewis and the Huron 

Consulting Group (HCG) produced and discusses some of the studies’ 

limitations.

Our Methodology Focused 

on Determining the Impact 

of Restatement 

Announcements on Market 

Capitalization

We identified restatements announced from July 1, 2002, through 

September 30, 2005, using the Lexis-Nexis online information service to 

search for press releases and other media coverage on restatements. 

Because the focus of our research was on the impact on market 

capitalization due to restatement announcements, we concentrated on 

publicly listed companies trading on the major securities markets—NYSE, 

Nasdaq, and Amex. As figure 10 shows, companies trading on the major 

securities markets represented approximately 98–99 percent of total 

market capitalization. 

Other securities markets accounted for the remaining 1–2 percent of 

market capitalization. For example, OTC Bulletin Board makes up a little 

more than 1 percent of the total market capitalization of all publicly traded 

companies. It should be noted that figure 12 does not include the Pink 

Sheets because we could not find reliable market capitalization data for 

companies traded on this market. However, the aggregate market 

capitalization of these companies is widely held to be very small and many 

of the companies trading on this venue are not registered with SEC, and 

therefore would not meet our criteria for inclusion. Companies that trade 

on the OTC Bulletin Board and Pink Sheets generally are very small and 

therefore have limited or no analyst coverage. As a result, our methodology 

did not capture many restatements announced by these companies, as they 

1

A follow-up GAO report will update this database from October 1, 2005, through June 30, 

2006.
Appendix VI

Comparison of Our Restatement Database to 

Those of Glass, Lewis & Co. LLC and the 

Huron Consulting Group

Page 157 GAO-06-678 Financial Restatements

may not always have been announced in the business press and therefore 

archived by Lexis-Nexis. 

Figure 10: Total Market Capitalization by Trading Market, 2005

Comparison with Outside 

Studies Suggested That Our 

Database Was a 

Comprehensive Listing of 

Publicly-Listed Companies, 

but Did Not Capture a 

Number of the Smallest 

Publicly-Traded Companies 

While several researchers have constructed and maintained their own 

databases of financial statement restatements, these lists generally are 

proprietary and not publicly available. We were able to evaluate the 

completeness of our listing by comparing descriptive statistics from our 

database with propriety information provided by HCG and Glass Lewis. 2

 

Although there were differences in the search methodologies, construction 

criteria, and types of companies included, each study found similar trends 

and reached similar conclusions (see fig. 11). 

19%

1% OTC Bulletin Board

2% Amex

78%

Nasdaq

NYSE

Source: SEC analysis of Center for Research in Security Prices data.

2

Audit Analytics, an on line market intelligence service maintained by Ives Group 

Incorporated also provides, among other things, a database of restatement filings. However, 

at the time we were completing our audit work, the database was being populated and was 

not yet comprehensive for restatements occurring prior to August 2004. 
Appendix VI

Comparison of Our Restatement Database to 

Those of Glass, Lewis & Co. LLC and the 

Huron Consulting Group

Page 158 GAO-06-678 Financial Restatements

However, the uniqueness of our announcement database rendered it 

difficult to make strict, year-to-year comparisons of companies and dates. 

For example, restating companies were tracked in both the HCG and Glass 

Lewis databases based on the filing date of the actual amended 

restatements, whereas our listing was based on when the restatement was 

announced. As a result, a company that announced the intention to restate 

in 2003, but did not file the amended return until 2004, would be captured 

differently. More importantly, HCG restatement numbers were based 

primarily on a search of amended annual (SEC Form 10-K/A) and quarterly 

(SEC Form 10-Q/A) filings, while our total restatement numbers were 

based primarily on the announcement of the restatement in business and 

financial press—when the markets are likely to receive and react to the 

information. The Glass Lewis search methodology combines elements of 

both our techniques and HCG techniques, including a search of SEC filings 

(including Forms 10-K and 10-Q) and also a search of information sources 

similar to Lexis-Nexis (e.g., Capital IQ and the Wall Street Journal) to 

capture restatements that were not included on an amended filing. As a 

result, Glass Lewis captured a larger number of restatements for the years 

in which they collected this data.
Appendix VI

Comparison of Our Restatement Database to 

Those of Glass, Lewis & Co. LLC and the 

Huron Consulting Group

Page 159 GAO-06-678 Financial Restatements

Figure 11: Number of Restatements, by Research Study 

Notes: Our numbers for 2005 include only restatements from January through September. Our 

numbers were based on restatement announcement dates, while the HCG and Glass Lewis numbers 

were based on restatement filings. Glass Lewis numbers exclude their data on foreign foreign 

companies.

Comparison of our database of restating companies for 2003 and 2004 with 

Glass Lewis’ database of actual restatement filings suggests that our 

database provides a comprehensive list of companies listed on the major 

U.S. securities markets. As figure 12 shows, both databases contain similar 

number of NYSE- and Nasdaq-listed restatements. NYSE and Nasdaq 

companies make up 97 percent of the total market capitalization of all

0

200

400

600

800

1,000

1,200

2005

(through

Sept.)

1997 1998 1999 2000 2001 2002 2003 2004

Sources: GAO, SEC filings, and selected studies.

Year

Glass Lewis

HCG

GAO

Number of restatements
Appendix VI

Comparison of Our Restatement Database to 

Those of Glass, Lewis & Co. LLC and the 

Huron Consulting Group

Page 160 GAO-06-678 Financial Restatements

publicly traded companies.3 However, a comparison of our database with 

Glass Lewis’ database also shows that we do not include a large number of 

small, OTC-traded companies with limited analyst and press coverage. To a 

smaller extent, our capture rate of Amex-listed companies also reflected 

that Amex lists a relatively higher proportion of smaller companies than 

NYSE. Although we did not capture these companies, the impact of the 

related losses in market capitalization due to restatements is likely not 

significant. Collectively, Amex and OTC Bulletin Board companies make up 

3 percent of the total market capitalization of publicly traded companies. 

Nevertheless, users of this report should note that our database was 

constructed using a methodology that reflects our focus on the impact on 

market capitalization, and that our figures did not reflect a number of 

smaller public companies that restated over the 1997–2005 period. 

3

The number of NYSE-listed companies in our database appeared to be slightly larger, but 

two methodological differences most likely accounted for the difference: (1) Glass Lewis 

numbers presented here do not include a number of companies classified by the consulting 

firm as foreign companies and (2) Glass Lewis data reflected where the company traded 

when it filed its restatement, not when it was announced. As a result, a NYSE-listed 

company that announced a restatement, was delisted, and began trading on the Pink Sheets 

or OTC Bulletin Board before it filed its amended return, would be captured as a NYSElisted company in our database, but an OTC traded company in the Glass Lewis database. In 

contrast, the number of Nasdaq-listed companies in our database appeared to be slightly 

smaller. This is likely because our methodology may miss some small companies listed on 

the Nasdaq Capital Market, which make up a very small percentage of the total market 

capitalization of Nasdaq companies.
Appendix VI

Comparison of Our Restatement Database to 

Those of Glass, Lewis & Co. LLC and the 

Huron Consulting Group

Page 161 GAO-06-678 Financial Restatements

Figure 12: Number of Companies Restating, 2003–2004, GAO versus Glass Lewis

Notes: Companies issuing multiple restatements were counted only once per year. Glass Lewis dates 

were based on restatement filings, while our dates were based on the date of restatement 

announcements. Glass Lewis numbers exclude their data on foreign companies.

OTC

AMEX

NASDAQ

NYSE

Glass

Lewis

GAO

Sources: GAO; Glass Lewis.

224

201

254

275

53

94

85

403

0 200 400 600 800 1,000
Page 162 GAO-06-678 Financial Restatements

Appendix VII

SEC Enforcement Process ApendxiVI

SEC investigates possible violations of securities laws, including those 

related to accounting issues. As figure 13 illustrates, if the evidence 

gathered merits further inquiry, SEC will prompt an informal investigation 

or request that SEC issue a formal order of investigation. Investigations can 

lead to SEC-prompted administrative or federal civil court actions. 

Depending on the type of proceedings, SEC can seek sanctions that include 

injunctions, civil money penalties, disgorgement,1

 cease-and-desist orders, 

suspensions of registration, bars from appearing before the Commission, 

and officer and director bars. After an investigation is completed, SEC may 

institute either type of proceeding against a person or entity that it believes 

has violated federal securities laws.2

 Because SEC has only civil 

enforcement authority, it may also refer appropriate cases to the 

Department of Justice (DOJ) for criminal investigation and prosecution. 

According to SEC, most enforcement actions are settled, with respondents 

generally consenting to the entry of civil judicial or administrative orders 

without admitting or denying the allegations against them. 

1

A disgorgement sanction requires the return of illegal profits. See GAO, SEC Enforcement: 

More Actions Needed to Improve Oversight of Disgorgement Collections, GAO-02-771

(Washington, D.C.: July 12, 2002) for disgorgement collection information.

2

SEC can also initiate contempt proceedings and issue reports of investigation when 

appropriate.
Appendix VII

SEC Enforcement Process 

Page 163 GAO-06-678 Financial Restatements

Figure 13: Flowchart of SEC’s Enforcement Process

Leads

Obtained through:

• Division of Enforcement 

surveillance activities or 

 other divisions of SEC

• self-regulatory organiz-

 tions and other securities 

 industry sources

• press reports

• investor complaints

• others

Inquiry

Inquiry is conducted to 

evaluate information and to 

determine whether and 

investigation is warranted

• non-public

• no subpoena authority

Commission authorizes enforcement 

staff to initiate civil action or 

administrative proceedings

• most cases are settled

Civil action

Complaint filed in U.S. District Court describing 

misconduct, identifying the laws and rules

violated, and identifying the sanction or remedial 

action sought.

Administrative proceedings

Order of proceedings instituted describing 

misconduct, identifying the laws and rules

violated, and identifying the sanction or remedial 

action sought.

Primary sanctions include

Emergency relief such as temporary restraining 

orders and asset freezes.

Injunctions, civil monetary penalties, 

disgorgement, and officer and director bars.

Primary sanctions include

Censure, cease and desist orders, suspension or 

revocation of broker-dealer or investment adviser 

registration; suspensions or bars from associating 

with broker-dealers, investment advisers, or 

investment companies; penny stock bars, civil 

monetary penalties, disgorgement, temporary or 

permanent suspension of privileges to appear or 

practice before the Commission, and stop orders.

Investigation

Enforcement staff review:

• books and records

• trading data

• witness testimony

• other relevant infromation

Investigation may be 

informal (no subpoena

authority) or formal 

(subpoena authority)

• non-public

Enforcement staff 

determine whether to 

recommend that SEC 

authorize civil and/or 

administrative enforcement action

Factors considered by SEC 

during review of staff 

recommendation:

• seriousness of the 

 wrongdoing

• message of the case

• tactical considerations

• type of sanctions or relief

 to obtain

Promising

leads may

become

matters

under

inquiry

Promising leads may also directly result in an investigation

If evidence

merits

investigation

Source: GAO.
Page 164 GAO-06-678 Financial Restatements

Appendix VIII

Case Study Overview ApendxiVI

Our objective in reviewing individual restatements was to provide detailed 

information on selected topics for six companies.1 The purpose of this 

appendix is to explain how each case study is structured and what 

information is being provided. Specifically, each of the cases discussed in 

appendixes IX–XIV provides information on (1) the company’s operations; 

(2) the chronology of the restatement, including who initiated the 

restatement; (3) its independent auditor; (4) the market’s reaction to the 

restatement; (5) the analysts’ recommendations; (6) credit ratings and 

credit rating agency actions; and (7) what legal and regulatory actions were 

taken against the company, its executives, directors, independent auditors, 

or others. The six companies are listed in table 8.

Table 8: Six Case Studies of Public Companies That Announced Restatements from 

July 2002 through September 2005

Source: GAO.

Our analysis was based on only publicly available information, including 

company press releases and filings with SEC such as Forms 10-K, 10-Q, and 

8-K; SEC press releases, complaints, and settlement agreements; public 

DOJ documents; analysts’ recommendations; credit agency ratings; 

historical company rating information maintained by research sources; 

newspaper articles; and congressional testimonies. Although we did not 

interview company officials to obtain information about the restatements, 

we requested comments on the case studies from each of the six 

companies and incorporated any technical comments they had, as 

appropriate.

1

For an explanation of how we selected the six companies, see appendix I (Objectives, 

Scope and Methodology).

Appendix Company Industry

IX American International Group Inc. Insurance

X Dynacq Healthcare, Inc. Healthcare

XI Federal National Mortgage Corporation 

(Fannie Mae)

Housing finance

XII Qwest Communications International, Inc. Telecommunications

XIII Starbucks Corporation Retail

XIV Sterling Bancshares, Inc. Banking
Appendix VIII

Case Study Overview

Page 165 GAO-06-678 Financial Restatements

Business Overview Each case begins with an overview of the business in which the company 

engages, and generally provides information on its size (total revenue and 

number of employees). 

Restatement Data Each of the companies restated their financial statements at least once 

from July 2002 through September 2005. This section discusses the nature 

of the misstated information and the resulting restatement decision by the 

companies’ management. We include previously reported or announced 

financial results, and the revised or restated financial data, for selected 

information, such as revenue and net income (or losses). We also identify 

those companies that have announced a restatement, but have not yet filed 

the restated financial statements with SEC. 

Accounting/Audit Firm This section provides information on who the independent auditor was 

during the restatement period and whether the restating company changed 

auditor before, during, or after the restatement. We also provide 

information about civil and criminal actions taken against the auditors.

Stock Prices To illustrate the impact of a restatement announcement on a company’s 

stock prices, we provide selected historical closing stock price information 

for each company. We also discuss how stock prices were affected in the 

days surrounding the restatement announcement and discuss other events 

that also positively or adversely affected the companies’ stock price. In 

many of the cases, the company had lost a significant amount of its stock 

price before the restatement announcement; often they had missed an 

earnings target or announced an internal investigation. 

Securities Analysts’ 

Recommendations

Given the criticism that many securities analysts have faced in 2002 about 

their optimistic ratings of companies in the face of adverse financial results 

and condition, we were asked once again to focus on the role played by 

analysts in recommending securities. Therefore, in this section, we provide 

historical information on securities analysts’ ratings in the months leading 

up to–and after–financial statement restatements, and other 

announcements about the financial condition of the covered (researched) 

company. We found no single authoritative source for historical analyst 
Appendix VIII

Case Study Overview

Page 166 GAO-06-678 Financial Restatements

recommendations and relied on a variety of sources for this data, such as 

Yahoo! Finance.

Analysts use different rating systems and a variety of terms, including 

strong buy, buy, near term or long-term accumulate, near term or long term 

over-perform or under-perform, neutral, hold, reduce, sell, strong sell. 

Critics often point to the large disparity between analysts’ buy 

recommendations and sell recommendations. However, the terms have 

been criticized as being misleading because “hold” may mean that investors 

should sell the stock versus holding it. Although we do not attempt to 

determine the definition of each term for each firm, we provide the 

recommendations because they illustrate the range of rating systems that 

analysts use. We generally focused on changes in ratings around certain 

key dates to provide some indication of what signals analysts were sending 

the markets.

Credit Rating Agency 

Actions

Along with analysts, credit ratings agencies have been questioned in the 

past about the quality of the information they provided, and this scrutiny 

heightened after the rapid failure of Enron Corporation. To determine the 

information credit rating agencies were providing to the market about the 

condition of these companies, we collected credit rating information on 

companies when such information was available. In this section, we again 

focus on changes in ratings around certain key dates, such as the 

restatement announcement date, the actual restatement date, 

announcements of internal investigations, and bankruptcy filings.

Legal and Regulatory 

Actions Taken

To determine the legal and regulatory actions taken, we searched for 

evidence of any shareholder actions taken and whether SEC and/or DOJ 

had taken any action in connection with the restatement of a company’s 

financial results. We found that many of the cases resulted in shareholder 

lawsuits and that SEC, and in some cases the DOJ, had taken action against 

the company, its officials, and its independent auditor. 
Page 167 GAO-06-678 Financial Restatements

Appendix IX

American International Group, Inc. Case 

Study ApendxiIX

Business Overview American International Group, Inc. (AIG), a Delaware corporation, is a 

holding company, which, through its subsidiaries, is engaged in a broad 

range of insurance and insurance-related activities in the United States and 

abroad. AIG’s primary activities include both general and life insurance 

operations. Other significant activities include financial services, 

retirement services, and asset management. For the year that ended 

December 31, 2004, AIG had total (revised) revenues of almost $98 billion 

and approximately 92,000 employees.

Restatement Data On February 14, 2005, AIG announced that it had received subpoenas from 

the Office of the Attorney General for the State of New York (NYSOAG) and 

SEC. Both entities were conducting investigations into AIG’s use of 

nontraditional insurance products, other assumed reinsurance 

transactions, and AIG’s accounting for these transactions.1

 (For more 

detailed information on legal and regulatory actions affecting AIG, please 

see the last section of this app.) 

Furthermore, on March 14, 2005, AIG’s chairman and CEO retired and on 

March 21, 2005, its vice chairman and CFO were fired. 

On March 30, 2005, AIG announced that the filing of its 2004 Form 10-K 

(annual report) would be delayed beyond the already extended due date of 

March 31, 2005, to provide AIG, its Board of Directors, and its new 

management adequate time to complete their extensive review of books 

and records. The internal review resulted from the pending NYSOAG and 

SEC investigations. At that time, AIG was not able to determine whether 

adjustments already identified through the review would require 

restatements of prior period results or adjustments to fourth quarter 2004 

published, unaudited information. 

On May 1, 2005, AIG announced in a press release that, as a result of its 

internal review of its books and records conducted in conjunction with its 

2004 annual audit, it had decided (in consultation with 

1

Reinsurance is insurance for insurers. In contrast to insurance, reinsurance is not sold as a 

standard product. Each contract is separately negotiated. Use of certain finite risk contracts 

becomes improper or illegal when there is no actual transfer of risk and there are side 

agreements that differ from the terms of the written contract. See GAO, Definitions of 

Insurance and Related Information, GAO-06-424R (Washington, D.C.: Feb. 23, 2006).
Appendix IX

American International Group, Inc. Case 

Study

Page 168 GAO-06-678 Financial Restatements

PricewaterhouseCoopers LLP (PwC), its independent auditors) to restate 

its financial statements for the years ended December 31, 2000–2003; the 

first three quarters of 2003 and 2004; and the fourth quarter of 2003. AIG 

noted that its prior financial statements for those periods—and previously 

announced unaudited financial results for the year and quarter ended 

December 31, 2004—should not be relied upon. The press release noted 

that the company planned to file its restated financials on Form 10-K for the 

year ended December 31, 2004, no later than May 31, 2005. 

As a result of the internal review, AIG concluded that consolidated 

shareholders’ equity at December 31, 2004, would be reduced by about $2.3 

billion due to the following adjustments: corrections of accounting errors 

totaling about $1.1 billion and/or fourth quarter changes in estimates 

totaling about $1.2 billion for tax accruals, deferred acquisition costs, and 

other contingencies and allowances. These adjustments would lead to a 

reduction of about 2.7 percent in AIG’s unaudited consolidated 

shareholders’ equity of $82.87 billion at year-end 2004, which was 

previously disclosed in the company’s February 9, 2005, earnings release. 

Also, AIG determined that it had incorrectly accounted for certain 

derivatives under the Financial Accounting Standards Board’s (FASB) 

Statement of Financial Accounting Standard No. 133—Accounting for 

Derivatives and Hedging Activities; this would lead to an increased 

adjustment of about $1 billion to consolidated shareholders’ equity at 

December 31, 2004. 

On May 31, 2005, AIG filed its 2004 Form 10-K with SEC. In that filing, AIG 

indicated that it had restated its financial statements for the years 2003, 

2002, 2001, and 2000. It also restated previously reported estimates of 

results for the fourth quarter of 2004. The restatements, according to the 

Form 10-K, resulted from certain accounting adjustments made after an 

internal review of AIG’s operations during 2000–2004. Table 9 shows the 

effects of the adjustments on AIG’s major balance sheet and income 

statement items.
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Table 9: Selected Financial Data for AIG, 2000–2004 

Source: SEC filing.

AIG had accounted for various reinsurance transactions and associated 

cash flows as either revenues or expenses when the transactions involved 

insufficient transfer of insurance risk to the assuming reinsurer. When 

there is insufficient risk transfer, such cash flows are accounted for as 

either deposit assets or liabilities (and not as revenues or expense). AIG’s 

internal review determined that its insurance loss reserves had been 

misstated as a result of unsupported adjustments to incurred, but not 

reported, reserves. AIG made other adjustments based on its reclassifying 

of capital gains to net investment income, conversion of underwriting 

losses to capital losses, and its accounting for derivatives. In November 

2005, AIG announced that it again would restate previously reported 

results, primarily to correct errors relating to accounting for derivatives 

and hedged items.

Accounting/Audit Firm PwC, AIG’s independent auditor, audited AIG’s financial statements for 

fiscal years 2000–2004. In AIG’s 2004 Form 10-K, which was issued in May 

2005, PwC agreed with AIG management’s assessment that the company 

did not maintain effective internal control over financial reporting as of 

December 31, 2004.

(Dollars in millions; negative values in parentheses)

Fiscal years

Affected 

financial data 2000 2001 2002 2003 2004

Total assets, as 

reported $426,671 $493,061 $561,229 $678,346 $804,607

Adjustment (2,820) (614) 327 (4,193) (5,947)

Total assets, as 

restated 423,851 492,447 561,556 674,153 798,660

Net income, as 

reported 6,639 5,363 5,519 9,274 11,048

Adjustment (498) (1,191) 347 (1,265) (1,317)

Net income, as 

restated $6,141 $4,172 $5,866 $8,009 $9,731
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Stock Prices AIG’s stock trades on the NYSE under the ticker symbol AIG. From 

February through May 2005, the price of company stock was affected more 

by the February 14, 2005, announcement of the subpoenas it received from 

NYSOAG and SEC than by the March 30, 2005, announcement of the delay 

in submitting and the possible restatement of its financial statements; or 

the May 31, 2005, filing of the restated financial statements. On February 

11, 2005, the last trading day before the date the subpoenas were 

announced, AIG’s stock closed at $73.12. On February 14, the date the 

subpoenas were announced, AIG’s stock closed at $71.49. Soon after, AIG’s 

stock price began a downward trend that lasted through the March 30, 

2005, announcement of the delay in AIG’s filing with SEC of its Form 10-K 

for 2004. The closing stock price reached a low of $50.35 on April 22, 2005, 

after which it exhibited a generally upward trend through January 2006. On 

January 11, 2006, AIG’s stock closed at $70.83. The trends in AIG’s stock 

price are shown in figure 14. 

Figure 14: Daily Stock Prices for AIG, July 1, 2004–February 28, 2006

Note: The restatement announcement actually occurred on a May 1, 2005 (a Sunday).
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Securities Analysts’ 

Recommendations

Recommendations of six securities research analysts from October 2004 

through June 2005 showed no set pattern surrounding the news, of the legal 

proceedings and restatements involving AIG. For example, in October 

2004, shortly before the legal proceedings by NYSOAG became news two 

research firms upgraded AIG while another firm downgraded AIG. In 

January 2005, before the news of the subpoenas, that same firm 

downgraded AIG. In mid-March 2005, about a month after news of the 

subpoenas, another research firm downgraded AIG. During April 1–6, 2005, 

shortly after news of the filing delay, two research firms downgraded AIG 

and two other research firms upgraded AIG. In June 2005, after AIG’s 2005 

Form 10-K was issued, one firm upgraded AIG. A February 2006 article in 

the financial press reported that AIG would pay in excess of $1.6 billion to 

settle legal claims against it; despite the news, the majority of analysts 

following AIG’s stock still rated it favorably. 

Credit Rating Agency 

Actions 

From March through early June 2005, the major rating agencies 

downgraded AIG’s ratings. Standard & Poor’s lowered AIG’s long-term 

senior debt rating and placed a negative credit watch on the ratings.2

 

Moody’s Investors Service Inc. (Moody’s) lowered AIG’s long-term senior 

debt rating and placed the ratings on review for a possible downgrade. 

Fitch Ratings downgraded the long-term senior debt ratings of AIG and 

placed the ratings on a negative watch.

According to AIG’s 2004 annual report, these rating actions have affected 

and will continue to affect AIG’s business and results of operations. For 

example, the annual report noted the following: 

• The downgrades and any future downgrades in AIG’s debt ratings, will 

increase AIG’s borrowing costs and therefore adversely affect AIG’s 

profitability.

• The downgrade in AIG’s long-term senior debt ratings will adversely 

affect the AIG Financial Products (AIGFP) unit’s ability to compete for 

certain business. Credit ratings are very important in the derivative and 

structured transaction marketplaces, where AIG’s ratings historically 

provided AIG a competitive advantage. The downgrades will reduce this 

advantage because specialized financial transactions generally are 

2

A negative watch means that the rating may be lowered.
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conducted only by triple-A rated financial institutions. Counterparties 

may be unwilling to transact business with AIGFP except on a secured 

basis. This could require AIGFP to post more collateral to 

counterparties in the future. 

Legal and Regulatory 

Actions Taken

In February 2005, AIG received subpoenas from NYSOAG and SEC relating 

to investigations into the use of nontraditional insurance products, certain 

assumed reinsurance transactions, and AIG’s accounting for such 

transactions. DOJ and the New York State insurance regulator also were 

investigating AIG on related issues. On February 9, 2006, AIG agreed to 

settle charges that it committed securities fraud and other violations of the 

law. The settlement was part of a global resolution of federal and state 

actions under which AIG would pay over $1.6 billion to resolve the claims 

related to improper insurance accounting, bid rigging, and other practices 

involving workers’ compensation funds.

Specifically, SEC’s complaint alleged that in December 2000 and March 

2001, AIG entered into two “sham” reinsurance transactions with Gen Re 

Corporation (Gen Re) that had no economic substance, but were designed 

to allow AIG to improperly add a total of $500 million in phony loss 

reserves to its balance sheet in the fourth quarter of 2000 and the first 

quarter of 2001. AIG allegedly initiated the transactions to quell analysts’ 

criticism of AIG for a prior reduction in reserves. In addition, the complaint 

alleges that in 2000, AIG structured a sham transaction with Capco 

Reinsurance Company, Ltd. (Capco) to conceal approximately $200 million 

in underwriting losses in its general insurance business by improperly 

converting them to capital (or investment) losses to make those losses less 

embarrassing to AIG. The complaint further alleges that in 1991, AIG 

established Union Excess Reinsurance Company Ltd. (Union Excess), an 

offshore reinsurer, to which it ultimately ceded approximately 50 

reinsurance contracts for its own benefit. According to the complaint, 

although AIG controlled Union Excess, it improperly failed to consolidate 

Union Excess’s financial results with its own, and in fact took steps to 

conceal its control over Union Excess from its auditors and regulators. As a 

result of these actions and other accounting improprieties, SEC alleged 

that AIG fraudulently improved its financial results. SEC’s complaint 

further alleges that AIG, directly or indirectly, singly or in concert, engaged 

in acts, practices, and courses of business that constitute violations of 

Sections 17(a)(l), l7(a)(2), and 17(a)(3) of the Securities Act of 1933 

(Securities Act); Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), and 
Appendix IX

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13(b)(5) of the Securities Exchange Act of 1934 (Exchange Act); and Rules 

10b-5(a), 10b-5(b), 10b-5(c), 12b- 20, 13a-1,13a-13, and 13b2-1.

In settling its case, AIG agreed, without admitting or denying the 

allegations of the complaint, to the entry of a court order enjoining it from 

violating the antifraud, books and records, internal controls, and periodic 

reporting provisions of the federal securities laws. The order also requires 

that AIG pay a civil penalty of $100 million and disgorge ill-gotten gains of 

$700 million, all of which the Commission will seek to distribute to injured 

investors. AIG also has agreed to certain undertakings designed to assure 

the Commission that future transactions will be properly accounted for and 

that senior AIG officers and executives receive adequate training 

concerning their obligations under the federal securities laws. AIG’s 

remedial measures include (1) appointing a new CEO and CFO; (2) putting 

forth a statement of tone and philosophy committed to achieving 

transparency and clear communication with all stakeholders through 

effective corporate governance, a strong control environment, high ethical 

standards and financial reporting integrity; (3) establishing a regulatory, 

compliance, and legal committee to provide oversight of AIG’s compliance 

with applicable laws and regulations; and (4) enhancing its “Code of 

Conduct” for employees and mandating that all employees complete 

special formal ethics training. This proposed settlement is subject to court 

approval. 

According to SEC’s press release, the settlement takes into consideration 

AIG’s cooperation during the investigation and its remediation efforts in 

response to material weaknesses identified by its internal review. From the 

outset of the investigation, AIG gave complete cooperation to the 

investigation by the Commission’s staff. Among other things, AIG (1) 

promptly provided information regarding any relevant facts and documents 

uncovered in its internal review; (2) provided the staff with regular updates 

on the status of the internal review; and (3) sent a clear message to its 

employees that they should cooperate in the staff’s investigation by 

terminating those employees, including members of AIG’s former senior 

management, who chose not to cooperate in the staff’s investigation.

In June 2005, SEC also charged a Gen Re executive with aiding and abetting 

AIG in committing securities fraud. In its complaint, SEC alleged that John 

Houldsworth, a former senior executive of Gen Re, helped AIG structure 

two sham reinsurance transactions (see above). SEC’s complaint charges 

this executive with aiding and abetting the violations by AIG and others of 

Sections 10(b), 13(a), 13(b)(2) and 13 (b)(5); and Rules 10b-5, 12b-20, 13a-1, 
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13a-13 and 13b2-1 of the Exchange Act. Mr. Houldsworth, in addition to 

undertaking to cooperate fully with SEC, consented to the entry of a partial 

final judgment permanently enjoining him from future violations of these 

provisions, barring him from serving as an officer or director of a public 

company, and deferring the determination of civil penalties and 

disgorgement to a later date. In settling the charges, he also consented to 

SEC’s order that suspends him from practicing as an accountant. Other 

remedial sanctions are still to be determined. In addition, Mr. Houldsworth 

agreed to SEC’s administrative order, based on the injunction, barring him 

from appearing or practicing before SEC as an accountant, under Rule 

102(e) of SEC’s Rules of Practice. 

In February 2006, SEC filed an enforcement action against other former 

senior executives of Gen Re and AIG for helping AIG mislead investors 

through the use of fraudulent reinsurance transactions. Four of the former 

executives, Ronald Ferguson, Elizabeth Monrad, Robert Graham, and 

Christopher Garand, were with Gen Re; the fifth, Christian Milton, was with 

AIG. The complaint alleges that the defendants and others aided and 

abetted AIG’s violations of the antifraud provisions, and other provisions, 

of the federal securities laws, by helping AIG structure two sham 

reinsurance transactions (see above). Messrs. Ferguson, Graham, and 

Garand; Ms. Monrad; and others at Gen Re worked with Mr. Milton and 

others at AIG to fashion two sham reinsurance contracts between Cologne 

Re Dublin (a Gen Re subsidiary in Dublin, Ireland) and an AIG subsidiary. 

The complaint makes allegations regarding conversations among the 

defendants and the existence of other evidence reflecting the planning and 

implementation of the sham transaction. The complaint charges that the 

defendants understood from the beginning that they were structuring a 

sham transaction involving the creation of phony documents for the 

purpose of providing apparent support for false accounting entries AIG 

made on its books. The defendants, and others at Gen Re and AIG, 

allegedly knew that AIG accounted for the sham transactions as if they 

were real reinsurance contracts that transferred risk from Gen Re to AIG, 

when all parties involved knew that was not true. As a result of AIG’s 

accounting treatment for these transactions, the company’s financial 

results showed false increases in reserves that AIG touted in the company's 

quarterly earnings releases for the fourth quarter of 2000 and the first 

quarter of 2001. According to the complaint, without the phony loss 

reserves, AIG’s financial results in both quarters would have shown further 

declines in its loss reserves. 
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SEC’s complaint charges Messrs. Ferguson, Graham, and Garand; and Ms. 

Monrad, with aiding and abetting AIG's violations of Sections 10(b), 13 (a), 

13(b)(2) and 13(b)(5); and Rules 10b-5, 12b-20, 13a-1, 13a-13 and 13b2-1 of 

the Exchange Act. The complaint seeks permanent injunctive relief, 

disgorgement of ill-gotten gains, if any, plus prejudgment interest, civil 

money penalties, and orders barring each defendant from acting as an 

officer or director of any public company. In connection with the same 

conduct alleged in SEC’s complaint, DOJ has filed federal criminal charges 

against Messrs. Ferguson, Graham, and Milton; and Ms. Monrad, in the U.S. 

District Court for the Eastern District of Virginia.

In a separate matter, NYSOAG and the Superintendent of Insurance of the 

State of New York are suing former AIG executives Mr. Greenberg, former 

CEO, and Mr. Smith, former CFO, for directing and approving various 

fraudulent business practices, including the sham reinsurance transactions 

with Gen Re. The lawsuit, filed on May 26, 2005, in State Supreme Court in 

Manhattan attributes the misconduct at AIG directly to Mr. Greenberg and 

alleges that he directed others at AIG to develop and implement the 

schemes underlying various misleading transactions. The lawsuit, among 

other judgments, seeks to enjoin the defendants from future violations of 

New York State laws, disgorge all gains, and pay all restitution and damages 

caused directly or indirectly by the fraudulent and deceptive acts.
Page 176 GAO-06-678 Financial Restatements

Appendix X

Dynacq Healthcare, Inc. Case Study ApendxiX

Business Overview Dynacq Healthcare, Inc. (Dynacq) is a holding company. Through its 

subsidiaries, the company develops and manages general acute hospitals 

that provide specialized general surgeries. Dynacq’s hospitals include 

operating rooms, pre- and post-operative space, intensive care units, 

nursing units, and modern diagnostic facilities. Dynacq’s facilities are 

designed to handle complex orthopedic and general surgeries, such as 

spine and bariatric surgeries. Dynacq was incorporated in Nevada in June 

1989. In November 2003, the company reincorporated in Delaware and 

changed its name from Dynacq International, Inc. to Dynacq Healthcare, 

Inc. For the fiscal year ended August 31, 2005, Dynacq had total revenues of 

$55.3 million and approximately 302 employees.

Restatement Data On April 6, 2004, Dynacq issued a press release announcing that, in 

connection with an ongoing review by SEC of the company’s periodic 

reports, it would restate its financial statements for the fiscal years ended 

August 31, 2001, and 2002. According to its press release, these 

restatements would reclassify certain accounts receivable to long-term 

status, to the extent that cash collections were expected more than 12 

months after such dates. The restatements also would correct an error in 

the application of an accounting principle related to income tax effect of 

the exercise of stock options, where the income tax benefit of $794,000 

from the exercise stock options was treated as a tax benefit rather than as 

an increase in stockholders’ equity, during the fiscal year ending in 2001. 

Dynacq also said that it corrected this error in the fiscal year ending August 

31, 2002, where the tax provision was increased by $794,000, with a 

corresponding increase to stockholders’ equity. Dynacq further noted that 

the restatement would increase the income tax provision for the fiscal year 

ending August 31, 2001, by $794,000, and reduce the income tax provision 

for the fiscal year ending August 31, 2002, by the same amount, and that 

there would be no cumulative effect on retained earnings as of August 31, 

2002. 

On July 14, 2004, Dynacq announced that it had substantially completed the 

reaudit and restatements for the fiscal years ending August 31, 2001, and 

2002, the restatements of the company’s selected financial information for 

fiscal years 1999 and 2000, and the audit of its financial statements for 

fiscal year 2003. See table 10.
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Page 177 GAO-06-678 Financial Restatements

Table 10: Selected Financial Data for Dynacq, Fiscal Years 1999–2002 

Source: SEC filings.

Note: N/A means not applicable.

Accounting/Audit Firm As of May 31, 2002, Ernst & Young, LLP (E&Y) was the company’s 

independent auditor. On December 15, 2003, E&Y orally communicated to 

certain officers of Dynacq its concerns relating to the company’s disclosure 

controls, accounting controls, and controls over safeguarding of assets. On 

December 17, 2003, E&Y notified Dynacq that it resigned as the company’s 

independent auditor effective immediately. E&Y also orally informed 

Dynacq that the company lacked the internal controls necessary to develop 

reliable financial statements. 

In a letter dated December 23, 2003, E&Y advised the Board of Directors of 

its conclusion that material weakness in internal controls had come to its 

attention during the course of performing its audit of the company’s 

financial statements for the fiscal year ending August 31, 2003. Specifically, 

E&Y noted inadequate communication lines and internal controls relating 

to the authorization, recognition, capture, and review of transactions, facts, 

circumstances, and events that may have a material impact on the 

company’s financial reporting process. E&Y further noted a lack of 

supervision, review, and quality control related to the accounting for 

income taxes, including the preparation of the federal income tax provision

(Dollars in millions)

Fiscal years

Affected financial data 2000 2001 2002

Additional paid-in capital, 

as reported $4.3 $6.7 $9.8

Additional paid-in capital, 

as restated 5.4 11 13.7

Retained earnings,

as reported 11.4 22.4 37.9

Retained earnings,

as restated 12.6 20.4 35.2

Net income, as reported N/A 11.1 15.4

Net income, as restated N/A $7.7 $14.8
Appendix X

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Page 178 GAO-06-678 Financial Restatements

in accordance with Statement of Financial Accounting Standards No 109, 

Accounting for Income Taxes. 

On January 19, 2004, the audit committee of the Board of Directors of the 

company engaged Killman, Murrell & Company, P.C. as the company’s new 

independent accountant for the fiscal year ending August 31, 2003.

Stock Prices Dynacq’s stock trades on Nasdaq under the ticker symbol DYII. The stock 

peaked at more than $ 29 per share on January 7, 2002, and closed at less 

than half that price by year’s end (see fig. 15). On December 18, 2003, the 

day Dynacq issued announcements regarding delays in filing its annual 

report on Form 10-K as a result of the sudden resignation of its independent 

auditor E&Y, its stock closed at $8.95—down from $10.99 the day before. 

The following day, December 19, 2003, the stock closed at $4.09, a decline 

of almost 63 percent, but it traded at less than $8 per share for the 

remainder of 2003. Then on March 26, 2004, the stock fell slightly to $5.19, 

down from $5.23 the previous day, as the company announced that it would 

not be releasing its financial results for the quarter ending February 2004 by 

April 2004, the normal filing date for the report. 

The restatement announced on April 6, 2004, had apparently no immediate 

impact on the stock price, as the market had already received bad news 

from the company on February 4, 2004, when it released preliminary 

financial estimates. In the preliminary estimates issued, the company 

indicated that net patient service revenue, net income, and fully diluted 

earnings per share for the fiscal quarter ended November 30, 2003, 

decreased in excess of 50 percent from the previous comparable quarter. 

However, on April 15, 2004, when Dynacq announced that the Nasdaq 

Listing Qualifications Panel had notified the company that its stock would 

be delisted from the Nasdaq as of the opening of business on Friday, April 

16, 2004, its stock decreased to $3.90 down from $7.10 the day before—a 

decline of 45 percent. Finally, on Friday April 16, 2004, the day the stock 

was set to be delisted, it closed at $3.33. 

Following the delisting, Dynacq common stock was quoted on the Pink 

Sheets for unsolicited trading and from November 10, 2004, to May 2, 2005, 

it was quoted on the OTC Bulletin Board under the symbol “DYII.OB” as 

well as on the Pink Sheets. On May 3, 2005, the company’s common stock 

was relisted on the Nasdaq Capital Market System and continues to trade 

under the symbol “DYII”. 
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Figure 15: Daily Stock Prices for Dynacq, January 2, 2002–May 31, 2005

Securities Analysts’ 

Recommendations

Based on historical analyst research we were able to find, one brokerage 

firm covered Dynacq at the time of the restatement. However, the firm did 

not make an investment recommendation because of too much uncertainty 

about the company’s long-term viability. In the fall of 2004, the firm stopped 

covering Dynacq.

Credit Rating Agency 

Actions 

No credit rating agency information was available. 

Legal and Regulatory 

Actions Taken 

Eight lawsuits were filed in the U.S District Court for the Southern District 

of Texas (Houston Division) from December 24, 2003, through January 26, 

2004, alleging federal securities law causes of action against the company 

and various current and former officers and directors. The cases were filed 

5-2-05

11-1-04

9-2-03

5-3-04

7-1-04

9-1-04

1-3-05

3-1-05

11-3-03

9-3-02

1-2-03

3-3-03

5-1-03

7-1-03

1-2-04

3-1-04

11-1-02

1-2-02

3-1-02

5-1-02

7-1-02

Price per share in dollars

Date

Source: Nasdaq.

4-6-04

Announcement date

0

5

10

15

20

25

30
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as class actions brought on behalf of persons who purchased shares of 

company common stock in the open market, generally from January 14, 

2003, through December 18, 2003. Under the procedures of the Private 

Securities Litigation Reform Act, certain plaintiffs have filed motions 

asking to consolidate these actions and be designated as lead plaintiff. The 

court consolidated the actions and appointed a lead plaintiff in the matter. 

An amended complaint was filed on June 30, 2004, asserting a class period 

of November 27, 2002, to December 19, 2003, and naming additional 

defendants, including E&Y. The amended complaint sought certification as 

a class action and alleged that the defendants violated Sections 10(b), 

20(a), 20(A), and Rule 10b-5 under the Securities Exchange Act of 1934, by 

(1) publishing materially misleading financial statements that did not 

comply with GAAP; (2) making materially false or misleading statements or 

omissions regarding revenues and receivables, operations and financial 

results; and (3) engaging in an intentional fraudulent scheme aimed at 

inflating the value of Dynacq’s stock. According to Dynacq, the company 

planned to vigorously defend the allegations and would file a motion to 

dismiss all or some of the claims. The company further noted it could not 

predict the ultimate outcome of the lawsuit, or whether the lawsuit would 

have a material adverse effect on the company’s financial condition. 

On December 18, 2003, Dynacq received a notice of an informal 

investigation from SEC’s Fort Worth, Texas, District Office requesting its 

voluntary assistance in providing information regarding reporting of its 

financial statements, recognition of costs and revenue, accounts 

receivable, allowances for doubtful accounts, and its internal controls. The 

company said that it had been cooperating fully with the continuing 

informal SEC investigation. As of July 2006, no additional action has been 

taken by SEC against the company or any of its officials.
Page 181 GAO-06-678 Financial Restatements

Appendix XI

Federal National Mortgage Association 

(Fannie Mae) Case Study ApendxiXI

Business Overview The Federal National Mortgage Association (Fannie Mae) is a governmentsponsored company that buys residential mortgage loans from lenders and 

packages them into securities. They retain some of those securities and 

sell others to investors. Its customers are primary mortgage lenders 

including mortgage companies, savings and loan associations, savings 

banks, commercial banks, credit unions, and state and local housing 

finance agencies. It provides liquidity in the secondary mortgage market 

through its Credit Guaranty business and through its Portfolio Investment 

business. The Portfolio Investment business has two principal components, 

a mortgage portfolio and liquid investments. To manage the credit risk of 

their mortgages, the Credit Guaranty business uses credit enhancements, 

active management of the mortgage credit book of business, and loan 

management. It also shares mortgage credit risk with third parties. Fannie 

Mae has not filed annual or quarterly financial statements since August 9, 

2004. For the 6 months ending June 30, 2004, interest income (revenue) 

decreased 4 percent to $24.4 billion. Net income from continuing 

operations totaled $3.012 billion for the 6 months ended June 30, 2004. 

Restatement Data On October 29, 2003, Fannie Mae announced that it would file a revised 

Form 8-K with SEC correcting certain “computational errors” made 

primarily in the implementation of Financial Accounting Standard No. 

149—an amendment to Financial Accounting Standard 133 on Derivative 

Instruments and Hedging activities. Correction of these errors had no 

impact on Fannie Mae’s income statement, but did result in increases to 

several balance sheet items, including unrealized gains on securities, 

accumulated other comprehensive income, and total stockholder’s equity 

as of September 30, 2003. The company discovered these errors during the 

course of a standard review in preparation of their form 10-Q for the third 

quarter of 2003. Fannie Mae’s regulator, the Office of Federal Housing 

Enterprise Oversight (OFEHO), issued a statement saying the error 

underscored the need for a special review that they were about to begin 

into the accounting policies, practices, and internal controls of the 

company. 

On September 22, 2004, OFHEO made public a report that was highly 

critical of accounting methods at Fannie Mae. OFHEO charged Fannie Mae 

with not following generally accepted accounting practices in two critical 

areas: (1) amortization of discounts, premiums, and fees involved in the 

purchase of home mortgages, and (2) accounting for financial derivatives 

contracts. According to OFHEO, management intentionally developed
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accounting policies and selected and applied accounting methods to 

inappropriately reduce earnings volatility and to provide themselves with 

inordinate flexibility in determining the amount of income and expense 

recognized in any accounting period. In this regard, the amortization 

policies that management developed, and the methods they applied, 

created a “cookie jar” reserve. In 1998, management inappropriately 

deferred $200 million of estimated amortization expense, which allowed 

for Fannie Mae to pay out the maximum in bonus awards to Fannie Mae 

executives. According to OFHEO, these deviations from standard 

accounting rules—Statement of Financial Accounting Standards (SFAS) 91 

“Accounting for Nonrefundable Fees and Costs Associated with Originating 

or Acquiring Loans and Initial Direct Costs of Leases” and SFAS 133 

“Accounting for Derivative Instruments and Hedging Activities” 

respectively—allowed Fannie Mae to reduce volatility in reported earnings, 

present investors with an artificial picture of steadily growing profits, and 

in one case, to meet financial performance targets that triggered the 

payment of bonuses to Fannie Mae’s senior executives. That same day, 

Fannie Mae acknowledged that OFHEO’s review found serious accounting 

problems and earnings manipulation, and disclosed the existence of a SEC 

investigation into the company’s accounting. The following week a 

criminal investigation by DOJ was made public. 

On October 6, 2004, Fannie Mae’s CEO and chairman, and CFO, defended 

the company’s accounting in sworn testimony at a congressional hearing, 

stating that allegations of accounting improprieties and management 

misdeeds were a matter of interpreting complex rules. A month later, on 

November 15, 2004, Fannie Mae missed an SEC deadline for filing its thirdquarter financial results. Press sources indicated that its independent 

auditor, KPMG LLP (KPMG), refused to sign off on a review of the 

company’s unaudited quarterly financial statements. The company 

acknowledged that some of its accounting practices did not comply with 

GAAP and announced it would show a net loss of $9 billion if SEC decided 

it had improperly accounted for derivatives. 

On December 15, 2004, SEC’s chief accountant announced that an agency 

review determined that Fannie Mae must restate earnings back to 2001 

because it violated accounting rules for derivatives and certain prepaid 

loans. SEC became involved in Fannie Mae’s financial reporting after its 

CEO—motivated by a report issued by the company’s regulator, which 

highlighted irregularities in its accounting policies—requested that the 

Commission render an opinion about the company’s historical financial 

statements. Shortly after SEC’s December announcement, the company’s 
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(Fannie Mae) Case Study

Page 183 GAO-06-678 Financial Restatements

CEO and CFO resigned. Estimates suggested that earnings since 2001 will 

be revised downwards by as much as $12 billion, but the formal 

restatement of earnings is not expected before late 2006. 

Almost two years after SEC’s determination, Fannie Mae is in the final 

stages of completing its restatement—an undertaking that cost the 

company $800 million in 2005 alone. Fannie Mae has filed neither annual 

nor quarterly reports since August 9, 2004. The restated financial 

statements are expected to be filed with SEC in late 2006. 

Accounting/Audit Firm In November of 2004, Fannie Mae’s independent auditor, KPMG, advised 

the firm that it would be unable to complete its review of Fannie Mae’s 

interim unaudited financial statements for the quarter ended September 30, 

2004. Press sources stated that the public accounting firm had refused to 

sign off on the statements. As a result, Fannie Mae announced that it would 

not be able to file its Form 10-Q for the September 30, 2004, in a timely 

fashion. A month later, KPMG alerted Fannie Mae that there existed strong 

indicators of material weakness in the company’s internal control of 

financial reporting. Fannie Mae switched auditors and engaged Deloitte & 

Touche LLP on January 28, 2005, to be the company's independent auditor. 

Stock Prices Fannie Mae’s stock is traded on the NYSE under the ticker symbol FNM. 

Fannie Mae’s stock traded at $75 around the time it announced 

computational errors in October of 2003 and remained stable during the 

days before and after the company’s announcement. On September 22, 

2004—the day Fannie Mae announced that OFHEO’s review found serious 

accounting problems and earnings manipulation—the company’s share 

price dropped 7 percent, from $75.65 per share to $70.69. About a week 

later, on September 30, 2004—the day the press announced that an 

investigation into the company’s accounting practice by DOJ had been 

confirmed—the company’s share price fell again, to $63.05. By December 

of 2004, the company’s stock rebounded. The day before Fannie Mae’s 

restatement announcement, December 15, 2004, the share price was $70.69. 

On December 16, 2004, the day the company officially announced it would 

have to restate, the share price dropped slightly to $69.30. On June 1, 2006, 

the company’s share price was $51.44—down 27 percent since December 

of 2004, when the company formally announced that it would have to 

restate four years of earnings (see fig. 16).
Appendix XI

Federal National Mortgage Association 

(Fannie Mae) Case Study

Page 184 GAO-06-678 Financial Restatements

Figure 16: Daily Stock Prices for Fannie Mae, October 1, 2002–February 28, 2006

Fannie Mae has not filed annual or quarterly reports since August 9, 2004, 

nor has it filed restated financial statements for 2001 through 2004. 

However, the company’s stock continues to be listed and traded on the 

NYSE. Under its listing standards, the NYSE may initiate suspension and 

delisting proceedings when a company, such as Fannie Mae, fails to file its 

financial statements in a timely manner. In certain very limited 

circumstances, however, NYSE, at its sole discretion, may determine to 

allow a company to continue listing if it has not timely filed. At the time 

this report was published, Fannie Mae’s stock continued to be listed and 

traded on the NYSE. 

Security Analysts’ 

Recommendations

In September of 2004, after OFHEO made public a report that was highly 

critical of accounting methods at Fannie Mae, securities analysts at four 

firms downgraded the company’s rating. About a year later, in November of 

2005, one firm upgraded Fannie Mae’s rating, and in January of 2006 

another firm downgraded Fannie Mae once again. Ratings for the company 

in 2006 have followed no particular trend, with one firm upgrading Fannie 

8-1-05

2-1-06

10-3-05

12-1-05

6-1-04

8-2-042-1-05

4-1-05

6-1-05

10-1-04

12-1-04

2-2-04

4-1-04

10-1-03

12-1-03

2-3-03

4-1-03

6-2-03

8-1-03

10-1-02

12-2-02

Price per share in dollars

Date

Source: Nasdaq.

10-29-03

Announcement date

12-16-04

Announcement date

0

10

20

30

40

50

60

70

80
Appendix XI

Federal National Mortgage Association 

(Fannie Mae) Case Study

Page 185 GAO-06-678 Financial Restatements

Mae’s rating in May 2006 and another firm downgrading the company’s 

rating in June of 2006. 

Credit Rating Agency 

Actions

Two major credit rating agencies, Standard & Poor’s and Moody’s rate 

Fannie Mae. On September 28, 2004, the same month OFEHO’s review 

exposed Fannie Mae’s accounting problems, Moody’s revised the ratings 

outlooks for Fannie Mae’s subordinated debt and preferred stock to 

negative, and affirmed senior debt at Aaa with a stable outlook. On 

December 23, 2004, approximately a week after the company announced 

that it would have to restate, Moody’s affirmed Fannie Mae’s rating with a 

stable outlook, placed their financial strength rating under review, and 

maintained a negative rating outlook for their subordinated debt and 

preferred stock. On August 11, 2005, Moody’s affirmed Fannie Mae’s senior 

debt and downgraded their financial strength ratings. It continued to 

review Fannie Mae’s subordinated debt and preferred stock ratings for a 

possible downgrade. On December 15, 2005, Moody’s confirmed Fannie 

Mae’s subordinated debt, preferred stock, and senior debt, and affirmed 

their financial strength rating. 

Standard & Poor’s current “risk to the government” rating for Fannie Mae is 

AA- and on CreditWatch Negative.1

 The rating has remained on 

CreditWatch Negative since September 23, 2004. Moody’s current “Bank 

Financial Strength Rating” for Fannie Mae is B+ with a stable outlook. 

Legal and Regulatory 

Actions Taken

As a result of the findings of OFHEO’s special examination report issued in 

September of 2004, and as part of its continuous supervisory program, 

OFHEO directed Fannie Mae to take a number of actions. OFHEO’s 

primary remedial actions include increasing its capital levels, changing its 

corporate governance structure, and restating past financial statements. 

In an agreement with Fannie Mae’s Board of Directors reached in 

September 2004, OFHEO directed Fannie Mae to maintain an additional 30 

percent of capital above the minimum capital requirement to compensate 

for the additional risk and challenges facing the enterprise. In addition to 

the capital requirements, OFHEO directed the Board of Directors of Fannie 

Mae to make significant changes to its corporate governance structure. 

1

A negative watch means that the credit rating may be lowered.
Appendix XI

Federal National Mortgage Association 

(Fannie Mae) Case Study

Page 186 GAO-06-678 Financial Restatements

Those changes include, but are not limited to, separating the chairman of 

the board and CEO positions, creating a new independent Office of 

Compliance and Ethics to conduct internal investigations, and creating a 

Compliance Committee of the Board of Directors to monitor and 

coordinate compliance with the Fannie Mae’s agreements with OFHEO. 

To address accounting problems, OFHEO directed Fannie Mae to restate 

inappropriate past financial statements, to meet all applicable legal and 

regulatory requirements (including having the new financial statements 

reaudited by Fannie Mae’s new external auditor), and to cease engaging 

inappropriate hedge accounting. OFHEO also directed Fannie Mae to 

implement an appropriate policy for SFAS 91 and develop and implement a 

plan to address the deficiencies in the accounting systems for Fannie Mae’s 

portfolio. 

On December 15, 2004, the chief accountant of SEC announced that the 

agency’s review of Fannie Mae’s historical financial statements found that 

the accounting policies of Fannie Mae for both FAS 91 and FAS 133 

departed from GAAP in material respects, and advised Fannie Mae to 

restate its financial statements for the years 2001 through 2004. In a followup announcement that occurred on May 23, 2006, SEC and OFHEO 

informed the public that Fannie Mae agreed to settle charges relating to the 

misstatement of its financial statements from 1998 through 2004, and that 

Fannie Mae had entered into a consent decree with OFHEO and consented 

to the entry of judgment in our action, which included injunction from 

violations of the antifraud, books and records, internal controls provisions 

of the federal securities laws and a $400 million civil penalty. Fannie Mae 

has agreed, without admitting or denying these allegations, to a fraud 

injunction for violations of Section 10(b) of the Securities Exchange Act of 

1934 and Rule 10b-5, and to an injunction for violations of Section 17(a)(2) 

and (3) of the Securities Act of 1933. As a result of the violations described 

in the Commission's complaint, Fannie Mae expects to restate its historical 

financial statements for the years ended December 31, 2003, and 2002; and 

for the quarters ended June 30, 2004, and March 31, 2004. 

OFHEO’s special examination of Fannie Mae’s accounting policies is 

ongoing, and SEC and the U.S. Attorney’s Office for the District of 

Columbia also continue to investigate matters related to the misstatement 

of the company’s financial statements. In addition, a number of lawsuits 

have been filed against Fannie Mae and certain current and former officers 

and directors of the company relating to the company’s restatement. These 

lawsuits are currently pending in the U.S. District Court for the District of 
Appendix XI

Federal National Mortgage Association 

(Fannie Mae) Case Study

Page 187 GAO-06-678 Financial Restatements

Columbia and fall within three primary categories: a consolidated 

shareholder class action and related opt-out lawsuits, a consolidated 

shareholder derivative lawsuit, and a class action lawsuit based on the 

Employee Retirement Income Security Act of 1974 (ERISA). 

The consolidated shareholder class action and two related opt-out lawsuits 

generally allege that Fannie Mae and certain former officers and directors 

made false and misleading statements in violation of the federal securities 

laws in connection with certain accounting policies and practices. In 

addition, the opt-out lawsuits assert various federal and state securities law 

and common law claims against Fannie Mae and certain current and former 

officers and directors based upon the same alleged conduct, and also assert 

insider trading claims against certain former officers. The opt-out cases 

were filed by institutional investors seeking to proceed independently of 

the putative class of shareholders in the consolidated shareholder class 

action. 

The consolidated shareholder derivative lawsuit asserts claims, 

purportedly on behalf of Fannie Mae against certain current and former 

officers and directors. Generally, the complaint alleges that the defendants 

breached their fiduciary duties to Fannie Mae and that the company was 

harmed as a result. The company’s and the other defendant’s motions to 

dismiss the consolidated shareholder derivative lawsuit are pending. 

The ERISA-based class action lawsuit alleges that Fannie Mae, and certain 

current and former officers and directors, violated ERISA. The plaintiffs in 

the ERISA-based lawsuit purport to represent a class of participants in 

Fannie Mae’s Employee Stock Ownership Plan. Their claims are also based 

on alleged breaches of fiduciary duty based on the accounting matters 

discussed in OFHEO’s interim report. A motion to dismiss that lawsuit is 

pending. 
Page 188 GAO-06-678 Financial Restatements

Appendix XII

Qwest Communications International, Inc. 

Case Study ApendxiXI

Business Overview Qwest Communications International, Inc. (Qwest) is a developer and 

operator of telecommunications networks and facilities. It provides local, 

long distance, wireless, and data services within its 14-state local service 

area. It also provides long distance services, broadband, data, voice, and 

video communications outside its local service area. The company has 

about 41,000 employees and is headquartered in Denver, Colorado. For the 

years ending December 31 2004, and 2005, Qwest had total revenues of 

$13.8 billion and $13.9 billion, respectively.

Restatement Data On April 3, 2002, SEC issued an order of investigation of the company that 

made formal an informal investigation begun on March 8, 2002. The 

investigation included an inquiry into several specifically identified Qwest 

accounting practices and transactions. On July 28, 2002, Qwest announced 

that, based on analysis to that date, the company had determined (1) it had 

incorrectly applied accounting polices with respect to certain optical 

capacity asset sale transactions in 1999, 2000, and 2001; (2) further 

adjustments were required to account for certain sales of equipment in 

2000 and 2001 that the company had previously determined had been 

recorded in error; and (3) that in a limited number of transactions, it did 

not properly account for certain expenses incurred for services from 

telecommunications providers in 2000 and 2001. The company expected to 

restate its financial statements for these periods after it completed its 

analysis of its accounting policies and practices.

In a press release on September 22, 2002, Qwest, in restating its 2000 and 

2001 financial statements, announced it would reverse $950 million in 

revenues and related costs associated with exchanges of optical capacity 

assets previously recognized. On October 28, 2002, Qwest announced the 

$950 million in revenues being reversed would be spilt into $265 million and 

$685 million in 2000 and 2001, respectively. In addition, the company 

announced that the $531 million previously recognized on sales of optical 

capacity assets for cash ($200 million in 2000 and $331 million in 2001) 

should be deferred. Finally, the company was taking a $10.8 billion asset 

impairment charge, where approximately $8.1 billion was a write-down of 

telephone network, global fiber optic broadband network, and other 

related assets, and approximately $2.7 billion was a reduction in the 

carrying value of intangible assets related to customer lists and product 

technology associated with the company’s inter-exchange carrier business. 

On February 11, 2003, Qwest announced additional results of its internal 

review of the 2001 and 2000 financial statements, and further announced 
Appendix XII

Qwest Communications International, Inc. 

Case Study

Page 189 GAO-06-678 Financial Restatements

that its board of directors expanded the review to include an assessment of 

internal controls, as well as accounting policies, practices, and procedures. 

In connection with this review, the company discovered additional 

restatement entries to the 2001 and 2000 financial statements involving 

revenue and expense recognition and cost accrual issues for 2001 and 2000, 

among other things. In a SEC Form 10-K filing on November 8, 2004, Qwest 

presented its restated financial statements for the years ending December 

31, 2000, and December 31, 2001. Table 11 summarizes the revenue, net 

income (or loss), and total asset changes for 2000 and 2001.

Table 11: Selected Financial Data for Qwest, 2000 and 2001

Source: SEC filings.

Accounting/Audit Firm Arthur Andersen LLP (Arthur Andersen) was the company’s auditor and 

wrote unqualified opinions for the company during the periods that were 

eventually restated (2000 and 2001). On May 29, 2002, Qwest’s Board of 

Directors decided not to re-engage Arthur Andersen as Qwest’s 

independent auditor for 2002 and instead engaged KPMG LLP. KPMG has 

continued to be the independent auditor through the fiscal year ending 

December 31, 2005. In 1999, 2000, and 2001, Arthur Andersen signed the 

audit reports for Qwest, with unqualified opinions. 

Stock Prices Qwest trades on the NYSE under the ticker symbol Q. Starting in the 

second quarter of 2001, Qwest’s stock generally trended downward, from a 

price of roughly $35. The stock hit a low of near $11 in the middle of the 

fourth quarter of 2001. The stock rallied to more than $14 in January of 

2002, then fell below $10, and leveled off near $7 in early April. At the time 

(Dollars in millions; negative values in parentheses)

Fiscal years

Affected financial data 2000 2001

Revenue, as reported $16,610 $19,695

Revenue, as restated 14,148 16,524

Net income (loss), as reported (81) (4,023)

Net income, as restated (1,037) (5,603)

Total assets, as reported $73,501 $73,781

Total assets, as restated $72,816 $72,166
Appendix XII

Qwest Communications International, Inc. 

Case Study

Page 190 GAO-06-678 Financial Restatements

of the announcement of a formal SEC investigation into its accounting 

practices on April 3, 2002, the stock price fell sharply from $7.63 to hit a 

yearly low of $1.11 in August of 2002—a decrease of around 85 percent. 

From this bottom the stock price rallied until in hit a yearly high in 2003 of 

$6.02. From this high, the stock has varied from $2.69 to $7.09 (see fig. 17).

Figure 17: Daily Stock Prices for Qwest, January 2, 2001February 28, 2004

Securities Analysts’ 

Recommendations

Based on historical securities analysts’ recommendations that we were 

able to identify around the time SEC began it formal investigation, we 

found information on five firms that researched the company. In April 2002, 

when SEC began its formal investigation into Qwest’s accounting practices, 

five securities firms had initial ratings on Qwest. Two of the five were buy 

ratings—one was a strong buy, one was a long-term buy, and the fifth was 

market outperform. On April 19, 2002, all five lowered their ratings. Two 

went from buy to hold, one went from strong buy to buy, one went from 

long-term buy to long term neutral, and the fifth went from market 

outperform to market perform. After July 28, 2002, when Qwest announced 

6-3-03

2-2-04

10-1-03

6-3-02

2-3-03

10-1-01

10-1-02

1-2-01

2-1-01

6-1-01

2-1-02

Price per share in dollars

Date

Source: Nasdaq.

7-29-02

Announcement date

2-11-03

Announcement date

0

10

20

30

40

50
Appendix XII

Qwest Communications International, Inc. 

Case Study

Page 191 GAO-06-678 Financial Restatements

that it would it would restate its earnings for 2000 and 2001, three firms 

lowered their ratings between July 29 and August 8, 2002. 

Credit Rating Agency 

Actions

Moody’s Investors Service, Inc. (Moody’s), Standard and Poor’s (S&P), and 

Fitch Ratings (Fitch) rated Qwest’s long-term debt. During 2002 when the 

SEC investigation began, the three agencies lowered Qwest’s credit ratings 

on multiple occasions. For instance, from December 2001 to December 

2002, Moody’s downgraded Qwest’s rating from A2 to Ba, S&P downgraded 

from BBB+ to B-, and Fitch lowered its ratings from A to B. Moody’s Ba 

rating indicates a security has speculative elements. Similarly, for S&P, any 

rating below BBB indicates that the security is speculative in nature. 

According to S&P, a B- rating indicates that the issuer currently has the 

capacity to meet financial commitments on the obligation but adverse 

business, financial, or economic conditions likely would impair its capacity 

or willingness to meet financial commitments on the obligations. Finally, 

any Fitch rating below BBB is considered speculative in nature, and a B 

rating is highly speculative, meaning that significant credit risk is present. 

Legal and Regulatory 

Actions Taken

On October 21, 2004, Qwest entered a settlement with SEC, concluding a 

formal investigation concerning Qwest’s accounting and disclosures, 

among other subjects, that began in April 2002. In connection with this 

settlement, SEC filed a complaint against Qwest in federal district court in 

Denver, Colorado. The complaint alleged that between 1999 and 2002 

Qwest fraudulently recognized more than $3.8 billion in revenue and 

excluded $231 million in expenses as part of a multifaceted fraudulent 

scheme to meet optimistic and unsupportable earnings projections. 

Without admitting or denying the allegations in the complaint, Qwest 

consented to the entry of a judgment by the court.1

The final judgment, which was entered on November 4, 2004, enjoins 

Qwest from future violations of certain provisions of the securities laws 

and requires Qwest to pay a civil penalty of $250 million and a $1 

disgorgement. This penalty amount is to be distributed to defrauded 

investors pursuant to the Fair Funds provision of the Sarbanes Oxley Act of 

2002, which allows SEC to place civil penalties and disgorgements levied 

1

This summary does not include other pending actions, including actions filed by the 

retirement plans in states such as California, Illinois, and Louisiana.
Appendix XII

Qwest Communications International, Inc. 

Case Study

Page 192 GAO-06-678 Financial Restatements

on a company that commits fraud into a fund on behalf of harmed 

shareholders. In addition, Qwest is required to maintain a Chief 

Compliance Officer, who is to report to a committee of outside directors 

and who is responsible for ensuring that the company conducts its business 

in compliance with federal securities laws.

On July 9, 2002, the U.S. Attorney’s Office for the District of Colorado 

informed Qwest of a criminal investigation thought to relate to various 

matters that SEC was investigating. 

Twelve putative actions filed since July 2001 on behalf of purchasers of 

Qwest’s publicly traded securities between May 24, 1999, and February 14, 

2002, were consolidated into a consolidated securities action pending in 

federal district court in Colorado. Named in this action were Qwest, its 

former chairman and CEO, former CFOs, other former officers and current 

directors, and Arthur Andersen. The consolidated action alleged from May 

24, 1999, to February 14, 2002, the putative class period, that 

• Qwest and certain of the individual defendants made materially false 

statements regarding the results of the firm’s operations in violation of 

Section 10(b) of the Exchange Act, 

• certain of the individual defendants were liable as control persons under 

Section 20(a) of the Exchange Act, and during the earlier stated period, 

and

• certain individual defendants sold some of their shares of common 

stock in violation of section 20A of the Exchange Act. 

The suit also alleges that the financial results during the putative class 

period and statements regarding those results were false and misleading 

due to the alleged (1) overstatement of revenue, (2) understatement of 

costs, (3) manipulation of employee benefits to increase profitability, and 

(4) misstatement of certain assets and liabilities. In addition, the suit 

alleges that Qwest and certain individual defendants violated Section 11 of 

the Securities Act and that certain individual defendants were liable as 

control persons under Section 15 of the Securities Act by preparing and 

disseminating false registration statements. The plaintiffs are seeking 

unspecified compensatory damages and other relief. According to the 

plaintiffs’ lead counsel, the plaintiffs are seeking damages worth billions of 

dollars.
Appendix XII

Qwest Communications International, Inc. 

Case Study

Page 193 GAO-06-678 Financial Restatements

On October 22, 2001, a purported derivative lawsuit was filed in the U. S. 

District Court for the District of Colorado. The complaint, as amended, 

named as defendants certain of Qwest's present and former directors and 

certain former officers and named Qwest as a nominal defendant. This 

derivative lawsuit, referred to by Qwest as the Federal Derivative 

Litigation, was based on the allegations made in the consolidated securities 

action. The suit alleges that board members intentionally or negligently 

breached their fiduciary duties to the firm by causing or permitting the firm 

to commit alleged securities violations, thus causing the firm to be sued for 

such violations, subjecting the firm to adverse publicity, and increasing the 

cost of raising capital and impairing earnings. This derivative complaint 

further alleges that certain directors sold shares between April 26, 2001, 

and May 15, 2001, using nonpublic information about the firm. In 

connection with the settlement of the Colorado Derivative Litigation 

(defined below), the Federal Derivative Litigation was dismissed with 

prejudice by agreement.

On March 6, 2002, and November 22, 2002, a purported derivative lawsuit 

was filed in the Colorado District Court for the City and County of Denver, 

naming as defendants certain of Qwest’s current and former officers and 

directors and Anschutz Company and naming Qwest a nominal defendant 

(referred to as the Colorado Derivative Litigation). This complaint was 

based on the allegations made in the consolidated securities action and 

alleged that various individual defendants breached their legal duties to 

Qwest by engaging in self-dealing, failing to oversee compliance with laws 

that prohibit insider trading and self-dealing, and causing or permitting 

Qwest to commit alleged securities laws violations—causing Qwest to be 

sued for such violations and subjecting Qwest to adverse publicity and 

thereby increasing its cost of raising capital and impairing earnings. The 

two purported derivative actions were consolidated on February 17, 2004. 

On October 30, 2002, two purported derivative lawsuits, which initially 

were filed in the Court of Chancery of the State of Delaware in August 2002, 

naming certain of Qwest’s current and former officers and directors and 

naming Qwest as a nominal defendant, were consolidated (referred to as 

the Delaware Derivative Litigation). The plaintiffs alleged that the 

individual defendants (1) breached their fiduciary duties by allegedly 

engaging in illegal insider trading in Qwest’s stock; (2) failed to ensure 

compliance with federal and state disclosure, anti-fraud and insider trading 

laws within Qwest; (3) appropriated corporate opportunities, wasted 

corporate assets and self-dealt in connection with investments in initial 

public offering securities through Qwest’s investment bankers; and (4) 
Appendix XII

Qwest Communications International, Inc. 

Case Study

Page 194 GAO-06-678 Financial Restatements

improperly awarded severance payments to Qwest's former Chief 

Executive Officer, Joseph P. Nacchio, and Qwest's former Chief Financial 

Officer, Robert S. Woodruff. The plaintiffs sought recovery of incentive 

compensation allegedly wrongfully paid to certain defendants, all 

severance payments made to Nacchio and Woodruff, disgorgement, 

contribution and indemnification, repayment of compensation, injunctive 

relief, and all costs including legal and accounting fees. 

The Denver District Court entered an Order and Final Judgment effective 

June 15, 2004, approving the proposed settlement among the parties to the 

Colorado Derivative Litigation and the Delaware Derivative Litigation. The 

settlement provided that upon dismissal with prejudice of the Delaware 

Derivative Litigation and the Federal Derivative Litigation, $25 million of 

the $200 million fund from the insurance settlement with certain Qwest 

insurance carriers would be designated for the exclusive use of Qwest to 

pay losses and Qwest would implement a number of corporate governance 

changes. The settlement also provided that the Denver District Court could 

enter awards of attorneys' fees and costs (in amounts not to exceed $7.625 

million in the aggregate) to derivative plaintiffs' counsel from the $25 

million. Pursuant to the settlement, by agreement the Delaware Derivative 

Litigation and the Federal Derivative Litigation have been dismissed with 

prejudice.

On March 15, 2005, in three separate but related civil actions, SEC charged 

Joseph P. Nacchio, former Co-Chairman and CEO of Qwest, and eight other 

former Qwest officers and employees, with fraud and other violations of 

federal securities laws. The defendants included former CFOs Robert S. 

Woodruff and Robin R. Szeliga, former Chief Operating Officer, Afshin 

Mohebbi, and former officers George M. Casey, and William L. Eleveth. The 

complaints sought injunctions, disgorgement of ill-gotten gains (plus 

prejudgment interest), and civil penalties against all of the defendants and 

officer/director bars against Nacchio, Woodruff, Mohebbi, Casey, Eleveth, 

and Szeliga. Two of the nine defendants consented to the entry of 

judgments against them without admitting or denying the allegations 

against them. The complaints allege that the defendants violated Section 

17(a) of the Securities Act, and Sections 10(b) and 13(b)(5) of the 

Exchange Act, and Exchange Act Rules 10-b5 and 13b2-1; complaints also 

allege that the defendants aided and abetted Qwest’s violations of Sections 

13(a) and 13(b)(2) of the Exchange Act and Exchange Act Rules 12-b-20, 

13a-1, 13a-11, 13a-13. SEC complaints allege that Nacchio, Woodruff, 

Mohebbi, Casey, and Szeliga violated Exchange Act Rule 13b2-2, and that 

Mohebbi and Casey aided and abetted Qwest’s violations of Section 10(b) 
Appendix XII

Qwest Communications International, Inc. 

Case Study

Page 195 GAO-06-678 Financial Restatements

of the Exchange Act and Exchange Act Rule 10b-5. SEC has instituted 

numerous other civil and administrative actions against former officers and 

employees of Qwest and it subsidiaries, which are not summarized here.

Pursuant to an administrative order dated March 29, 2005, SEC instituted 

administrative proceedings against Mark Iwan, a Global Managing Partner 

for Arthur Anderson for Qwest. SEC found that he engaged in improper 

professional conduct within the meaning of Rule 102(e)(1)(ii) of SEC’s 

Rules of Practice by engaging in repeated instances of unreasonable 

conduct, each resulting in a violation of applicable professional standards, 

which indicate a lack of competence to practice before SEC. In anticipation 

of the institution of these proceeding, Iwan submitted an offer of 

settlement that SEC accepted. SEC also denied him the privilege of 

appearing or practicing before SEC as an accountant, but stated that under 

certain conditions he might be reinstated to appear or practice before SEC. 
Page 196 GAO-06-678 Financial Restatements

Appendix XIII

Starbucks Corporation Case Study ApendxiXI

Business Overview Starbucks Corporation (Starbucks) sells coffee and tea beverages and 

products, along with a variety of complementary food items including a line 

of premium ice cream, coffee-related accessories and equipment, and a line 

of compact discs. The corporation sells these products primarily through 

approximately 6,000 company-operated retail stores, which accounted for 

85 percent of total revenues in fiscal year 2005. Starbucks also sells coffee 

and tea products and licenses its trademark through other channels, such 

as grocery stores. The company’s retail sales mix, by product type, during 

fiscal year 2005, was 77 percent beverages, 15 percent food, 4 percent 

whole bean coffees, and 4 percent coffee-making equipment and other 

merchandise. Based in Washington State, Starbucks has expanded 

internationally in recent years—primarily in Canada, the United Kingdom, 

Australia, and China—and has approximately 115,000 employees 

worldwide. For fiscal year 2005, the Company reported total net revenues 

of $6.4 billion and net earnings of almost $500 million. 

The Company’s business is subject to seasonal fluctuations. Significant 

portions of the corporation’s net revenues and profits are realized during 

the first quarter of the fiscal year, which includes the December holiday 

season. The timing of the opening of new stores and the supply and price of 

coffee beans also has significant impact on the company’s revenues and 

profits.

Restatement Data In a February 7, 2005, letter to the American Institute of Certified Public 

Accountants, the chief accountant of SEC clarified SEC staff’s 

interpretation of certain operating lease-related accounting issues and their 

application under GAAP. As a result of this clarification, Starbucks’ 

management and audit committee agreed to evaluate the company’s 

accounting practices for operating leases. On February 11, 2005, the due 

date for filing Form 10-Q, Starbucks filed for a 5-day extension. On 

February 16, 2005, Starbucks’ management, audit committee, and external 

auditor announced that the company’s then-current method of accounting 

for tenant improvement allowances and rent holidays was not in 

accordance with GAAP. Lease terms may allow for a period of free or 

reduced rents—typically known as rent holidays. On February 18, 2005, 

Starbucks filed a Form 10-K/A for fiscal year 2004, in which the company 

restated its consolidated financial statements for fiscal years 2002, 2003, 

and 2004. Starbucks also announced that the restatements would not affect 

its previously reported first quarter (per share) earnings for fiscal year 

2005.
Appendix XIII

Starbucks Corporation Case Study

Page 197 GAO-06-678 Financial Restatements

Starbucks does not franchise its product. The corporation operates the 

majority of its retail stores, typically in rented commercial space that has 

been renovated to reflect the personalities of the communities in which 

they are located. Starbucks had historically recognized rent holiday periods 

on a straight-line basis over the lease term commencing with the initial 

occupancy date, or the opening date for company-operated retail stores, 

rather than commencing with the date the company takes possession of the 

leased space for construction purposes. Starbucks also reviewed the 

FASB’s Technical Bulletin No. 85-3, “Accounting for Operating Leases with 

Scheduled Rent Increases,” for additional guidance. According to the 

company’s Form 10-K/A, because Starbucks generally takes possession of a 

leased space 2 months prior to a store opening date in order to transform it 

into the Starbucks style, the company should have been recording 

additional deferred rent in “accrued occupancy costs” and “other long-term 

liabilities” and adjusted “retained earnings” on the consolidated statements 

of earnings for fiscal years 2002, 2003, and 2004. According to the 

company’s Form 10-K/A, these accounting changes resulted in a reduction 

to retained earnings of $8.6 million as of the beginning of fiscal year 2002, 

and decreases to retained earnings of $1.3 million, $1.5 million, and $1.2 

million for fiscal years 2002, 2003, and 2004, respectively. See table 12.

Table 12: Selected Reported Financial Data for Starbucks, 2002–2004

Source: SEC filing.

(Dollars in thousands)

Fiscal years

Affected financial data

Ending

Sept. 29, 2002

Ending

Sept. 28, 2003

Ending

Oct. 3, 2004

Cost of sales including occupancy 

costs, as reported $1,350,011 $1,685,928 $2,198,654

Cost of sales including occupancy 

costs, as restated 1,346,972 1,681,434 2,191,440

Depreciation and amortization 

expenses, as reported 205,557 237,807 280,024

Depreciation and amortization 

expenses, as restated 210,702 244,671 289,182

Net earnings, as reported 212,686 268,346 391,775

Net earnings, as restated 211,391 266,848 390,559
Appendix XIII

Starbucks Corporation Case Study

Page 198 GAO-06-678 Financial Restatements

Accounting/Audit Firm Deloitte and Touche LLP was the independent auditor for Starbucks during 

the relevant period.

Stock Prices Starbucks is traded on the Nasdaq Stock Market under the symbol SBUX. 

Since going public in 1992, Starbuck’s stock value has climbed steadily as 

the corporation expanded nationally and internationally. By 2002, 

Starbucks had split its stock four times. On December 29, 2004, the stock 

reached a high of $63.87, reflecting a profitable December holiday season. 

Starbucks’ February 2005 announcement of its intention to restate its 

financial statement for fiscal years 2002–2004 did not adversely affect its 

stock value. On February 7, 2005, when SEC released its letter, Starbucks’ 

stock traded at $51.07. On February 11, 2005, when Starbucks requested a 

filing extension with SEC, its stock value decreased to $49.68. With some 

fluctuations, the stock traded at $49.90 on February 18, 2005, when the 

company filed an amended Form 10-K that contained the restated 

consolidated balance sheets for 2003 and 2004, as well as its consolidated 

statements of earnings and cash flows for fiscal years 2002, 2003, and 2004. 

The Company’s stock value remained briefly around $49 until February 25, 

2005, when it increased to $51.24, and remained slightly above that level for 

the next month. On September 21, 2005, the company announced a two-forone stock split (see fig. 18).
Appendix XIII

Starbucks Corporation Case Study

Page 199 GAO-06-678 Financial Restatements

Figure 18: Daily Stock Prices for Starbucks, June 1, 2004–April 28, 2006

Securities Analysts’ 

Recommendations

Based on historical securities analysts’ recommendations that we were 

able to identify, at least 10 research firms covered Starbucks during the 

relevant period. All maintained recommendations ranging from hold to buy. 

Analysts generally have rated Starbucks favorably. Data from 1998 show 

analysts generally recommending buying Starbuck’s stock or holding it. On 

February 11, 2005, a few days before Starbuck’s restatement 

announcement, one analyst recommended holding the stock. On February 

18, 2005, when Starbucks filed its Form 10-K/A with the restated financial 

statements, another analyst noted that the stock was “in-line,” which means 

the earnings adhered to the analyst’s expectations. Over the next few 

months, several analysts upgraded their actions to outperform or buy.

Credit Rating Agency 

Actions

At the time of the relevant period, Starbucks was not rated by any credit 

rating agencies. According to one credit rating agency analyst, Starbucks 

was not rated because it did not have any public debt. 

2-1-06

4-3-06

10-3-05

12-1-05

4-1-05

6-1-05

8-1-05

12-1-04

2-1-05

10-1-04

6-1-04

8-2-04

Price per share in dollars

Date

Source: Nasdaq.

2-16-05

Announcement date

0

5

10

15

20

25

30

35

40
Appendix XIII

Starbucks Corporation Case Study

Page 200 GAO-06-678 Financial Restatements

Legal and Regulatory 

Actions Taken

As of July 2006, there has been no civil or regulatory action taken with 

regard to Starbucks’ restatement announcement.
Page 201 GAO-06-678 Financial Restatements

Appendix XIV

Sterling Bancshares, Inc. Case Study ApendxiXIV

Business Overview Sterling Bancshares, Inc. (Sterling Bancshares) provides financial services 

for small- to mid-sized businesses and consumers through 40 banking 

offices in the greater metropolitan areas of Houston, San Antonio, and 

Dallas, Texas.1

 It provides a wide range of commercial and consumer 

banking services, including demand, savings and time deposits; 

commercial, real estate, and consumer loans; merchant credit card 

services; letters of credit; and cash and asset management services. In 

addition, it facilitates sales of brokerage, mutual fund, alternative 

financing, and insurance products through third-party vendors. As of 

December 31, 2005, the company had total assets of $3.7 billion with a net 

income for the year of $36.2 million and just over 1,000 employees.

Restatement Data Sterling Bancshares made one restatement announcement on October 21, 

2003, in its announcement of quarterly results for the quarter ended 

September 30, 2003. Sterling Bancshares announced that upon the sale of 

its banking offices in Eagle Pass, Carrizo Springs, Crystal City, and Pearsall 

(South Texas offices) on July 15, 2002, and November 5, 2002, it initially 

determined that the sale of the offices met the accounting requirements for 

presentation as discontinued operations. However, after further 

consideration, the company determined that the sale of the South Texas 

offices did not meet the requirements for such presentation. The company’s 

total net income, basic and diluted earnings per share and shareholders 

equity for this period was not affected by the restatement.

The company determined that it was necessary to amend its Form 10-Qs for 

the quarters ended March 31, 2003, and June 30, 2003, as well as its 2002 

Form 10-K, so that the financial results and condition pertaining to these 

offices were not separately presented as discontinued operations. The 

company’s October 2003 earning’s release contained the restated financial 

information with respect to these prior periods in order to present the 

South Texas offices in continuing operations. The amendments to the 

March 31 and June 30 Forms 10-Q, and the Form 10-K for fiscal year 2002, 

were ultimately filed on November 14, 2003—the same date the quarterly 

report Form 10-Q for the period ended September 30, 2003, was filed. 

1

Sterling Bancshares was incorporated under the laws of the State of Texas in 1980 and 

became the parent bank holding company of Sterling Bank in 1981.
Appendix XIV

Sterling Bancshares, Inc. Case Study

Page 202 GAO-06-678 Financial Restatements

The company’s consolidated income statement filed with the original Form 

10-Q for the quarter ended March 31, 2003, included $9.2 million as income 

from continuing operations and $2.0 million as income from discontinued 

operations. As a result of including the South Texas offices in continued 

operations, the line item for income from discontinued operations was 

deleted from the restated income statement, and the amount presented as 

income from continuing operations increased by the $2.0 million that had 

initially been presented as income from discontinued operations. 

Additionally, the $16.2 million and $43.4 million included on the 

consolidated balance sheet filed with the original Form 10-Q as assets and 

liabilities of discontinued operations, respectively, were deleted, and such 

amounts were redistributed to the appropriate line items on the restated 

balance sheet.

Sterling Bancshares’ consolidated income statement original Form 10-Q for 

the quarter ended June 30, 2003, included $6.2 million as income from 

continuing operations and $1.585 million as a loss from discontinued 

operations. Additionally, it included $98.8 million as assets related to 

discontinued operations and $172.7 million as liabilities related to 

discontinued operations. On the restated income statement, income from 

continuing operations decreased $35 thousand to $6.19 million while the 

loss from discontinued operations decreased $35 thousand to $1.550 

million. Additionally, the restated assets related to discontinued operations 

decreased 43 percent, or $43 million, to $56.1 million. Liabilities related to 

discontinued operations decreased 81 percent, or $140 million, to $32 

million.

The company’s consolidated income statement filed with the original Form 

10-K for the year ended December 31, 2002, included $36.7 million as 

income from continuing operations and a loss of $122 thousand from 

discontinued operations. Additionally, it included $42.8 million as assets 

related to discontinued operations and $140.3 million as liabilities related 

to discontinued operations. On the restated income statement, income 

from continuing operations decreased $122 thousand, to $36.5 million, 

while the restated income from discontinued operations increased $122 

thousand. Additionally, the restated assets related to discontinued 

operations and liabilities related were eliminated. Table 13 summarizes the 

related financials.
Appendix XIV

Sterling Bancshares, Inc. Case Study

Page 203 GAO-06-678 Financial Restatements

Table 13: Selected Financial Data for Sterling Bancshares (Fiscal Year 2002, the First Two Quarters of Fiscal Year 2003)

Source: SEC filings.

Independent Auditor Deloitte & Touche LLP was the company’s independent auditor during the 

restatement period.

Stock Prices Sterling Bancshares stock is traded on the Nasdaq under the ticket symbol 

SBIB. On October 20, 2003, the date before the restatement announcement, 

the stock price closed at $11.42. On the day of the restatement, the stock 

price closed at $11.50. The following day, the stock price closed at $11.12. 

However, the stock had been decreasing since October 9, when its price 

was $12.36. The announcement of the restatement appeared to have little 

longer-term impact on the stock price, as it continued to trend upward over 

the next 3 months. The trends in Sterling Bancshares’ stock price are 

shown in figure 19.

(Dollars in thousands; negative values in parentheses)

Affected financial data Fiscal year 2002 First quarter 2003 Second quarter 2003

Income for continuing operations, as reported $36,673 $9,210 $6,226

Income for continuing operations, as restated 36,551 11,237 6,191

Income (loss) for discontinued operations, as reported (122) 2,027 (1,585)

Income (loss) for discontinued operations, as restated 0 0 (1,550)

Asset related to discontinued operations, as reported 42,772 16,223 98,831

Asset related to discontinued operations, as restated 0 0 56,059

Liabilities related to discontinued operations, as reported 140,340 43,402 172,746

Liabilities related to discontinued operations, as restated 0 0 32,406
Appendix XIV

Sterling Bancshares, Inc. Case Study

Page 204 GAO-06-678 Financial Restatements

Figure 19: Daily Stock Prices for Sterling Bancshares, April 1, 2003–April 30, 2004

Securities Analysts’ 

Recommendations

Based on historical securities analyst rating information we identified, one 

analyst downgraded Sterling Bancshares stock from a buy to hold on 

October 22, 2003—the day after Sterling Bancshares’ restatement.

Credit Rating Agency 

Actions

No credit rating agency information was available.

Legal and Regulatory 

Actions Taken

As of July 2006, there has been no legal or regulatory action taken with 

regard to Sterling Bancshares’ restatement.

2-2-04

4-1-04

10-1-03

12-1-03

4-1-03

6-2-03

8-1-03

Price per share in dollars

Date

Source: Nasdaq.

10-21-03 Announcement date

0

3

6

9

12

15
Page 205 GAO-06-678 Financial Restatements

Appendix XV

GAO Contact and Staff Acknowledgments ApendxiXV

GAO Contact Orice M. Williams (202) 512-8678, williamso@gao.gov

Staff 

Acknowledgments

In addition to the individuals named above, Daniel Blair and John

Reilly, Jr. (Assistant Directors); Allison Abrams, Marianne Anderson, 

Heather Atkins, Angela Barnett, Martha Chow, M’Baye Diagne, Lawrance 

Evans, Jr.; Sonya Hockaday, Tiffani Humble, Joe Hunter, Debra Johnson, 

May Lee, Kimberly McGatlin, Andrew J. McIntosh, Marc Molino, Andrew 

Nelson, Charles Perdue, Robert Pollard, Omyra Ramsingh, Barbara 

Roesmann, John Saylor, Christopher Schmitt, Gloria Sutton, Kaya Leigh 

Taylor, Dave Tarosky, Richard Vagnoni, and Nicolas Zitelli made key 

contributions to this report.
Page 206 GAO-06-678 Financial Restatements

Glossary

Asset write-down/write off To charge an asset amount to an expense or loss in order to reduce the 

value of the asset and, therefore, earnings. Occurs when an asset was 

initially overvalued or loses value. 

Derivative A security whose value depends on the performance of underlying, 

previously issued securities. Used properly, these instruments can be 

useful in reducing financial risk. Examples include options, swaps, and 

warrants. 

Goodwill The excess of the purchase price over the fair market value of an asset. 

Goodwill arises when the price paid for a company exceeds that suggested 

by the value of its assets and liabilities. 

Impairment Generally refers to a reduction in a company’s stated capital, however, 

impairment can be used in any context, e.g., “asset impairment” or 

“goodwill impairment.” Impairment is usually the result of poorly 

estimated gains or losses. 

Option Contracts that give the holder the option, or right, to buy or sell the 

underlying financial security at a specified price—called the “strike” or 

“exercise” price—during a certain period of time or on a specific date. 

Options on individual stocks are called “stock options.”

Round-trip transactions A method used to inflate transaction volumes or revenue through the 

simultaneous purchase and sale of products between colluding companies. 

Warrant A security that gives the holder certain rights under certain conditions, 

both determined by the issuer of the warrant. For example, an exchange 

pprivilege may allow the holders to exchange one warrant plus $5 in cash 

for 100 shares of common stock in a corporation any time after some fixed 

date, and before some other designated date.

(250250)
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