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Treasury Targets Financial Fixes
Paulson Sets Study on Rise In Corporate Restatements And the Impact on Markets
By Deborah Soloman
The Wall Street Journal
Friday, May 18, 2007

WASHINGTON -- Treasury Secretary Henry Paulson, concerned that the number of corporate financial restatements has "soared" in the past decade, has ordered a study into the cause of the increase and its impact on investors and the U.S. capital markets.

Mr. Paulson said restatements impose significant costs on capital markets and can confuse investors and erode public confidence in financial reporting.  "When you have 1,500 or so restatements in the course of a year, this is confusing to investors and tells us that the system isn't working the way it needs to be," he said.

The focus is part of a broader move aimed at reducing legal and regulatory burdens that Mr. Paulson, backed by a chorus of business executives, says are making the U.S. a harder place in which to do business.  While more steps are expected in the coming months, for now the Treasury seems focused on finding ways to ease financial-reporting requirements, largely by relaxing rules that apply to the accountants who audit those financial reports.

As part of that effort, Mr. Paulson wants a separate review of the accounting industry by a special advisory committee that would recommend changes, such as limiting the liability of public accountants and reducing the concentration of auditors in the hands of a few big firms.

Treasury officials and corporations are concerned that accounting firms shoulder too much risk and, in turn, take an aggressive approach to the companies they audit. That can lead to financial restatements and make companies wary of taking risks for fear of running afoul of auditors, said Mike Ryan, executive director of the U.S. Chamber of Commerce's Center on Capital Market Competitiveness.

"The reason auditors are taking a rigid approach is because they are themselves exposed to very significant litigation. Until that is addressed, auditors are going to be playing defense," Mr. Ryan said.

The Treasury's committee, which is expected to make recommendations by year end, will be headed by former Securities and Exchange Commission Chairman Arthur Levitt and Donald Nicolaisen, a former SEC chief accountant.

Meanwhile, the SEC, in a move supported by Mr. Paulson, is already engaged in a process to pare back the most debated Sarbanes-Oxley corporate-governance rule, which requires that companies have strong internal controls over their financial reporting.  The rule has drawn fire from businesses, which say auditors are too strict in how they enforce the rule and require them to document things not connected with preventing fraud or mistakes.

Robert Steel, the Treasury's undersecretary for domestic finance, said the moves are all aimed at improving financial reporting so that investors get the most useful information possible.  In a speech before the Council on Competitiveness here, he said the U.S. needs to take "a new approach" to regulation and structure its rules so that regulators weigh costs and benefits and focus on issues that are material to investors.

Investor advocates say the efforts seem aimed more at weakening the financial-reporting system.  While the Treasury said the number of restatements reached 1,876 in 2006, up from 116 in 1997, accounting experts say that is largely a result of tougher accounting oversight that has helped uncover weaknesses and problems investors are entitled to know about.

Lynn Turner, managing director of accounting-research firm Glass Lewis, who has studied corporate restatements, said many of the restatements didn't stem from minor problems or small errors.  Instead, he said, the rise is a result of companies being forced, post-Enron, to examine their financial reporting and correct deficiencies.

"What we've gone through here is a period of some pretty significant findings of things that need to be fixed, and that's what's really driving the restatements," said Mr. Turner, who is also a former SEC chief accountant.

With others, he worries Washington is on the cusp of pushing corporate accountability back to pre-Enron days.  "We have this history of doing things, and when things start looking good, we have very short memories, and then we pull back, and then along comes the next implosion," he said.

Write to Deborah Solomon at deborah.solomon@wsj.com

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