It's Our Business: How Colorado Can Reclaim Investment from Corporate Accounting Fraud

7/19/2004

Executive Summary

Qwest. The name of the local phone company for 14 states in the West, is plastered all across Denver's skyline. Locally, Qwest is certainly the most well known, example of questionable corporate practices, having restating its earnings for the years 1999, 2000, and 2001.[1] The restatements resulted in a nearly $1 billion reduction in profit for the years 2000 and 2001 alone and caused the value of Qwest stock to plummet.[2]

Colorado, like all states, is plagued accounting problems that lead to inaccurate corporate audits, an upsurge in "earnings restatements," and a loss of investor confidence.

Most observers are aware of the massive restatements by Enron, Tyco and WorldCom and others that rocked the markets in 2001 and 2002. Locally, Qwest, Vail Resorts, Level 3 Communication, Newmont Mining, Quovadx and many other Colorado-headquartered companies have also restated their earnings.[3] When inaccurate audits are identified, companies are required to produce a restatement of their previously audited financial statements. In the mid-70s through the early 80s, there were only a handful of restatements issued annually.[4] By 1997, restatements began to spike. From January 1997 through June 2002, restatements due to irregularities in accounting grew dramatically, resulting in a 145% increase.[5] In 2000, market value losses due to restatements totaled $31 billion.

These restatements resulted in the immediate loss of billions of dollars in the market capitalization of these corporations, which in turn resulted in the loss of billions of dollars for the individuals who bought shares in these businesses based upon faulty information. Consequently, these restatements call into question the credibility of accounting practices, the quality and oversight of corporate financial disclosure, and erode the confidence of the over 85 million Americans who invest in the stock market.

Despite changes on both the state and federal levels, existing regulation of the securities and accounting industries are still weak.

More effective controls are still needed on both the publicly traded companies and their auditor-accountants to limit the need for restatements The restatements of the past few years appear to have three main causes: first, accounting firms providing both consulting and auditing services; second, the employment "revolving door" between accounting firms and their corporate clients; and third, inadequate rotation of accounting firms off of clients to whom they provide consulting services.

On the federal level, changes must be made to the Securities and Exchange Commission (SEC) and the Sarbanes-Oxley Corporate Reform Act must be strengthened to implement the following changes:

• Increase funding to the SEC, so that it is consistently funded in a manner that allows it effectively and efficiently hire the staff needed to conduct more frequent and in-depth investigations into allegations of accounting fraud.
• Prohibit consulting accountants from auditing their own work.
• Prevent accountants who provide audit or consulting services from going to work for their corporate clients after leaving an accounting firm.
• Require the entire accounting firm handling a specific client's audit to rotate off that client's account.
• Impose criminal penalties on CEOs and CFOs whose actions in certifying corporate financial records are "negligent" or "reckless".

On the state level, changes must be made to the composition, functioning and rule-making powers of the Colorado State Board of Accountancy.

• Alter the composition of the Colorado State Board of Accountancy so that it is composed of a majority of non-accountants.
• Increase resources available to the Board of Accountancy by increasing the accountant licensing and renewal fees.
• Ensure the Colorado Board of Accountancy's subpoena power for relevant documents, including documents not only from the accounting firm under investigation, but also from the corporation whose accounting firm is being investigated.
• Increase the number of ethics hours required for accountants for continuing professional education and institute periodic testing. · Require accountants to properly document their work and keep their records for a set period of time. · Require accountants who are sued to self-report lawsuits to the State Board of Accountancy.

Without these changes, investors remain vulnerable and so will the college savings and retirement funds of the millions of Americans who invest in the stock market.

Notes

[1] Kris Hudson, Qwest to Restate '99-'01 Earnings, The Denver Post, July 29, 2002.
[2] Rob Reuteman, Fallout for Janus and Qwest Likely Will Linger, Rocky Mountain News, September 6, 2003.
[3] For a partial list of Colorado headquartered companies that are on the Bloomberg Colorado Index and have restated their earnings, and/or are the subject of an SEC investigation, see the table printed above.
[4] Consumer Federation of America, Barbara Roper: Investor Protection Lessons from the Enron Collapse and an Agenda for Reform, February 11, 2002.
[5] Financial Statement Restatements: Trends, Market Impacts, Regulatory Responses, and Remaining Challenges, GAO-03-138, October 4, 2002.