Disclosures of Control Weaknesses Way Up from 2003

Fifty-six companies reported material weaknesses or significant deficiencies in internal controls last month, compared with 14 companies one year earlier, according to Compliance Week.

A total of 582 companies made these kinds of disclosures in 2004, the newsletter reported, with about half of them related to financial systems and procedures, such as problems with the financial close process, account reconciliation or inventory processes. Personnel issues accounted for about 30 percent of the disclosures. Other problems included documentation, revenue recognition, and IT systems and controls.

Maintaining a strong set of internal controls has never been more important, as companies are facing stringent new requirements under Section 404 of the Sarbanes-Oxley Act. The corporate reform law says annual reports must include letters from top management and outside auditors verifying the company's internal controls systems and identifying financial problems.

For example, the newsletter pointed to the annual report of electronic manufacturer Sanmina-SCI Corp., which revealed material weaknesses in the areas of personnel and financial systems and procedures: too few employees with the proper accounting qualifications and poor preparation of certain financial statement account reconciliations.

Adelphia, the now-bankrupt cable television operator, disclosed more than 700 deficiencies. Compliance Week reported that many of the issues were related to financial systems, governance procedures and supervision of employees.

Companies that give more detail about their material weaknesses apparently don't suffer as much as companies that are vague, according to a survey by Stanford Law School and consultants Cornerstone Research, as reported by the Financial Times. Of the 141 companies that made such disclosures between November 2003 and October 2004, companies that provided more information saw share prices decline by an average of 1.5 percent; companies that failed to give details suffered an average drop of 3 percent.

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