Raising Red Flags

As they identify control weaknesses, companies find a common one: inadequate finance staffs.

More seriously, the SEC interest in such disclosures will surely carry consequences. “The SEC enforcement staff will increasingly try to make examples of outside directors in cases where companies have inadequate control over financial reporting,” says Poss. The internal control environment was also included among the factors judges should use in deciding sentences for corporate defendants, he notes, in the U.S. Sentencing Commission’s new guidelines.

At least until the first 404 audits, then, experts advise companies to disclose early and often. “This time next year,” says Poss, “I have a feeling the market’s going to be a lot less tolerant.”

Alix Nyberg is a CFO contributing editor.

Loss of Control

A sampling of how companies are reporting internal-control weaknesses.

Company: Adecco. Problems: 01/12/04. “The reasons for the delay in completion of the audit include: the identification of material weaknesses in internal controls in the company’s North American operations of Adecco Staffing…”.
Impact on Stock Price: 01/09 — open: 16.47; close: 16.93

01/12 — open: 10.10; close: 11.70

01/13 — open: 11.78; close: 11.76

Company: AXA. Problems: 06/25/04. “In June 2004, PwC reported to AXA’s Audit Committee and management that it had identified…two reportable conditions: …instances of inadequate procedures for appropriately assessing and applying certain SEC disclosures and requirements, and…in PwC’s view, the Company and certain of its subsidiaries have insufficient personnel in the corporate accounting department with sufficient knowledge and experience of U.S. GAAP accounting principles and SEC requirements.”
Impact on Stock Price:: 06/24 — open: 21.59; close: 21.66

06/25 — open: 21.65; close: 21.52

06/28 — open: 22.17; close: 22.05

Company: BMC Software. Problems: 06/14/04. Management and Ernst & Young “identified during the course of the year-end audit a significant internal control deficiency involving inadequate staffing of qualified accounting personnel. We believe this deficiency is temporary and is due to a unique combination of factors, including larger than normal turnover of accounting personnel. Management is actively working to strengthen our accounting and finance team to correct the internal control deficiency identified and such efforts include: the recent hiring of additional senior financial management, including a new chief financial officer….”
Impact on Stock Price: 06/10 — open: 17.33; close: 17.50

06/14 — open: 17.29; close: 17.15

06/15 — open: 17.15; close: 16.99

Company: Bristol-Myers Squibb. Problems: 06/28/04. “In 2003…the Company has devoted substantial resources towards remedying the reportable condition in relation to taxes…. The Company expects to complete remediation of the reportable condition by the end of 2004.”
Impact on Stock Price:: 06/25 — open: 24.78; close: 24.55

06/28 — open: 24.70; close: 24.74

06/29 — open: 24.74; close: 24.65

Company: EDS. Problems: 05/10/04. In April 2004, management learned of errors in contract accounting models and processes that “resulted in the untimely recognition of the purchase of certain hardware and assets under construction…. Other instances of breakdowns in our internal controls and procedures could occur or be identified in the future. Any such breakdowns may have an adverse effect on us and the market price of our securities….”
Impact on Stock Price:: 05/07 — open: 18.05; close: 17.79

05/10 — open: 17.79; close: 17.51

05/11 — open: 16.91; close: 16.48

Company: Mirant. Problems: 12/22/03. “Our internal-control deficiencies relate to the account reconciliation process and procedures, proper supporting transaction detail relating to journal entries and the controls over certain complex areas of accounting for derivatives and income taxation…. The current internal-control solution is not an optimal correction….”
Impact on Stock Price: 12/19 — open: 0.42; close: 0.42

12/22 — open: 0.40; close: 0.40

12/23 — open: 0.40; close: 0.40

Company: Nortel Networks. Problems: 11/19/03. In the 2003 audit, D&T informed the audit committee of material weaknesses in internal control: “…lack of compliance with established…procedures for monitoring and adjusting balances relating to certain accruals and provisions, including restructuring charges; and lack of compliance with established…procedures for appropriately applying generally accepted accounting principles to the initial recording of certain liabilities….”
Impact on Stock Price: 11/18 — open: 4.08; close: 4.04

11/19 — open: 4.07; close: 4.10

11/20 — open: 4.10; close: 4.07

Sources: Company filings; Compliance Week

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