The Securities Act of 1933 (Securities Act) and the Securities Exchange Act of 1934 (Exchange Act) establish the principle of full disclosure, which requires that investors receive sufficient information on investment opportunities to help them make informed investment decisions. The Securities Act requires that a public offering of securities be registered with SEC. Although the Securities Act establishes a full disclosure regulatory requirement applicable to the initial offering of securities, it does not require any periodic reporting thereafter. The Exchange Act, designed to facilitate subsequent trading of securities by investors, requires public companies to comply with certain periodic reporting requirements to ensure an ongoing flow of meaningful information that investors can use in making investment decisions. To fulfill its mission, SEC also reviews certain offering documents and periodic filings of selected companies to determine whether they contain the required information. The self-regulatory structure is premised on the concept of corporate governance. Officers and directors of a public company are responsible for ensuring that the preparation and content of financial statements fully and accurately depict the company’s financial condition and the results of its activities. However, the board of directors—particularly the audit committee—and the public company’s internal auditor play important roles in oversight. The primary role of the corporate board of directors is to oversee the management of a company and to protect the interests of its shareholders. Internal auditors offer another internal check on the operations and control systems within a company. Independent external auditors are to provide an additional safeguard in connection with all public companies and many other entities. All public companies registered with SEC are required to have their financial statements audited by an independent public accountant. Although a public company’s management is responsible for the preparation and content of the public company’s financial statements, the independent external auditor is responsible for auditing the financial statements in accordance with generally accepted auditing standards (GAAS). The purpose of the audit is to provide reasonable assurance that a company’s financial statements are fairly presented in all material respects in accordance with GAAP. As we testified before the Senate Committee on Banking, Housing, and Urban Affairs on March 5, 2002, for over 70 years, the public accounting profession, through its independent audit function, has played a critical role in enhancing a financial reporting process that facilitates the effective functioning of our capital markets. Independent audits give the public confidence that issuers’ financial statements are reliable and contribute to an efficient market for public companies’ securities. This sense of confidence can exist only if reasonable investors perceive auditors as independent and expert professionals who have neither interests in the entities they are auditing nor other conflicts of interest. Investors and other users expect auditors to bring integrity, independence, objectivity, and professional competence to the financial reporting process, and to prevent the issuance of misleading financial statements. SEC has traditionally relied on the private sector to set standards for financial reporting and independent audits, retaining largely oversight responsibilities. As mentioned earlier, the Securities Act and the Exchange Act require companies that sell securities in the United States to register with SEC and make periodic filings disclosing the companies’ financial status and changes in condition. Although the registration process requires the accuracy of the facts represented in the registration statements and prospectuses, this registration process does not guarantee accuracy. As part of its oversight of the registration and filing process, SEC staff review selected issuers’ filings for compliance with accounting and disclosure requirements. Disclosure documents include registration statements for new offers of securities, proxy materials sent to shareholders before an annual meeting, annual reports to shareholders, quarterly statements of financial condition, current reports on significant occurrences, documents concerning tender offers, and filings related to mergers and acquisitions. SEC’s review of corporate filings may be a full review, a full financial review, or monitoring of certain filings for specific disclosure items. SEC’s Division of Corporation Finance (CorpFin) is responsible for this function and reviews filings on a selective basis. CorpFin performs full reviews of financial information, public disclosures, and related filings, as appropriate, for substantially all registrations of initial public offerings (IPO) of securities. As reported in our March 2002 report on SEC’s operations, during the 1990s, the number of IPOs grew substantially, which contributed to a 59 percent increase in corporate filings from 1991 to 2000. Full reviews are also required for all current reports of a change in a registrant’s certifying accountant. Experienced staff select or “screen” other filings for review on the basis of certain financial and qualitative screening criteria. SEC’s goal in 2001 was to perform a full financial review—a review of the companies’ financial statements, related footnotes, and management’s discussion and analysis of financial condition and results of operations—of about one-third of all public companies’ annual reports. Earlier this year, we reported that SEC reviewed half that amount in 2001. Finally, using screening criteria, experienced staff may select other filings for monitoring, which involves reviewing a specific portion of the filing. The stock exchanges and markets, which are self-regulatory organizations (SRO) whose registrations are approved by SEC under the Exchange Act, also have an oversight role. A stock exchange or market establishes listing standards, which are minimum quantitative and qualitative requirements that companies must meet for their stock to be eligible for initial and continued listing for trading. Listing standards prescribe the corporate governance structures and accounting and auditing regulations that companies listed on a stock exchange or market are expected to follow. For example, listing requirements generally address conflicts of interest by corporate insiders, the composition of audit committees, and shareholder approval of corporate actions. The large exchanges also require their listed companies to have boards of directors with an independent audit committee to, among other duties, oversee the company’s internal controls over financial reporting processes. Securities analysts, through their research and stock recommendations, play an important role in providing investors with information that may affect investment decisions. Analysts typically research the current and prospective financial condition of certain publicly traded companies and make recommendations about investing in those companies’ securities based on their research. This research is likely to include all publicly available information about the company and its businesses, including financial statements; research on the company, industry, product or sector; and public statements by and interviews with executives of the company and its customers and suppliers. The analysis and opinions are generally presented on a relative basis and compare companies’ performance within a sector or industry. Credit ratings produced by rating agencies are widely circulated; many investors rely on these ratings to make investment decisions. These ratings include opinions about the creditworthiness of certain public companies and their financial obligations, including bonds, preferred stock, and commercial paper. The credit ratings that result from analyses of this information can affect securities markets in a number of important ways, including an issuer’s access to and cost of capital, the structure of financial transactions, and the ability of certain entities to invest in certain rated obligations. According to SEC, the importance of credit ratings in securities markets has increased significantly as markets have become more complex. Although rating agencies, as a matter of policy, may rate the debt of certain large corporate issuers, any company can hire a rating agency to rate its debt before the debt is issued. Credit rating agencies rely on a variety of public and nonpublic information, including company presentations, audited and interim financial statements, and other relevant industry materials. Pursuant to the Investment Advisers Act of 1940, as amended, (Advisers Act), Nationally Recognized Statistical Rating Organizations (NRSRO) register as investment advisers, are required to have an adequate basis for their ratings, and are prohibited from having undisclosed conflicts with respect to the ratings. Although on a yearly basis the number of companies restating their financial statements due to accounting irregularities makes up only a small percentage of publicly listed companies, we found that the number of restatements has grown significantly since 1997. In addition, of the 919 announced restatements we identified (app. III), the percentage of large companies restating has grown rapidly since 1997. Whether large or small, companies restate their financial results for varying reasons, but we identified revenue recognition as the most frequently cited reason for restating. Finally, in reviewing these restatement announcements, we found that different parties can prompt a restatement, including the restating company’s management, an external auditor, or SEC. The number of announcements of financial statement restatements has increased significantly each year, rising from 92 in 1997 to 225 in 2001—an increase of approximately 145 percent (fig. 1). Based on the number of restatement announcements we have identified for the first half of 2002, we project the increase since 1997 to rise to more than 170 percent by the end of 2002. While the average number of companies listed on NYSE, Nasdaq, and Amex decreased 20 percent from 9,275 in 1997 to 7,446 in 2002, the number of listed companies restating their financials increased from 83 in 1997 to a projected 220 in 2002 (a 165 percent increase) (table 1). Based on these projections, the proportion of listed companies restating on a yearly basis is expected to more than triple from 0.89 percent in 1997 to almost 3 percent by the end of 2002. In total, the number of restating companies is expected to represent about 10 percent of the average number of listed companies from 1997 to 2002. A number of research reports also found that financial statement restatements had increased since 1997. Each of the reports used somewhat different search methodologies and included slightly different types of restatements but arrived at similar conclusions. Financial Executives International (FEI) and M. Wu (2001) identified 523 restatements from 1997 to 2000 and noted a significant increase in restatements from 1997 to 1998 and continuing increases from 1999 to 2000. The Huron Consulting Group (2002) identified 993 financial statement restatements from 1997 to 2001; it also found that the number of restatements increased substantially from 1997 to 2001.