How a Material Weakness Can Cost You

At companies that disclosure a material weakness, nearly 62 percent of chief financial officers either leave or are pushed out.

When a company reports a material weakness in its internal controls, chances are that the chief financial officer will pay a heavy price.

According to analysis conducted by Netherlands-based research firm A.R.C. Morgan, at companies that disclosure a material weakness, nearly 62 percent of chief financial officers either leave or are pushed out immediately before the announcement or within three months afterward.

The firm added that while its research found that a “fair number” of CEOs departed as well, the number of CFO departures was far higher.

A.R.C. Morgan analyzed more than 500 SEC registrants with reportable conditions/material weaknesses; the study details findings from about 350. All registrants, including those not based in the United States, were judged by U.S. standards and rules.

Other findings:

• More than 86 percent of the material weaknesses appeared to have been discovered by external auditors, not by management or consultants as part of their compliance projects
• More than half of the internal-control weaknesses were fraud-related
• More than 65 percent of the filers that disclosed material weaknesses subsequently restated their earnings, “causing significant shareholder impact”
• Auditor fees typically grew by 150 percent when a material weakness was uncovered, compared with between 30 percent and 50 percent for companies without a material weakness.

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