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The announcement on March 12 by MCI Inc. that it would be restating its 2000 and 2001 earnings by $74.4 billion due to accounting errors discovered at WorldCom is believed to be the largest and most complex financial restatement in corporate history. It has stimulated conversation in executive suites and corporate boardrooms nationwide regarding the process of identifying necessary grounds for a financial restatement, determining the extent of the restatement and then communicating it to the financial community, investors and other stakeholders. There are a number of key steps that in-house counsel should take in order to assess a potential financial restatement and implement a comprehensive strategy for managing the restatement. These steps are informed by lessons learned from a number of recent examples that have revealed what to do-and what not to do-in the face of a restatement. By following this road map and insisting that any financial restatements be timely and accurate, in-house counsel can go a long way toward protecting the image of the company and the reputation of its executives. When a sign of the need for a possible restatement emerges, the first step for in-house counsel is to be sure that the company is aggressively and thoroughly assessing all available information. One might think of this as a triage stage. This requires detailed interviews with the corporate financial personnel, outside accountants and auditors, and other individuals involved with corporate fiscal management. Once the internal triage has yielded enough information from which to draw conclusions about the severity of the situation, in-house counsel can determine whether an actual restatement task force is needed. If the situation is indeed serious enough to require a financial restatement, it’s a good idea for in-house counsel to establish a task force of employees that is dedicated to the restatement. Typically, the company’s chief financial officer (CFO) leads the task force, which reports to the audit committee or a special ad hoc committee and should include both in-house and outside counsel. This group is responsible for ensuring that the restatement process is robust and is progressing satisfactorily. In place of the CFO, in-house counsel may want to recommend the appointment of a task force coordinator who is independent from the issues in question, ideally a person from outside the company who has integrity and accounting expertise or a senior accounting person from an unrelated division. It is counterproductive to use a coordinator who is the focus of an investigation that triggered the restatement initially. If someone from outside the company is hired to lead the restatement effort, in-house counsel must thoroughly vet his or her qualifications and background. For example, in a recent situation involving QuadraMed Corp., the company hired an individual to lead its restatement process in order to provide dedicated resources to the process and to enable senior management to focus on the day-to-day operations of the business. Four months into the restatement, the task force leader resigned after the company uncovered serious inaccuracies he made about his background. Furthermore, the company had reason to believe that he had a criminal record under another name. This threw the first four months of work into question. The company was forced to backtrack on the work completed and to evaluate the impact of his departure on the proposed timing, hindering the entire process. A company should consider bringing in additional temporary accounting resources to allow it to get through the process without unduly affecting the ongoing business and financial reporting. In addition, if the restatement issues are complex or suggest possible fraud, it is essential to bring in forensic accountants to assist with the review of accounting policies, internal controls, financial reporting process, corporate governance standards and investigative issues. Complete and accurate data are critical for a successful and precise restatement. While a company’s financial systems provide the most important data, there may be other sources of relevant information. In-house counsel should consider outside technical expertise to manage and understand the electronic data aspect of a restatement. Technical experts can perform a systems assessment to gain a high-level working knowledge of the information technology infrastructure. A company should identify a technical team with the appropriate skills to handle the various systems to support restatement efforts. Skills may include data analysis, corporate document-retention policy analysis, database programming, computer forensics and technical project management. In addition, it’s important to identify data sources that might contain information relevant to the restatement. A company should look beyond the databases of its financial systems and consider electronic backups of server data, e-mail and hard drives, including imaging of certain PCs. Electronic evidence becomes even more important if an investigation follows the restatement. Consider ad hoc methods of communication such as e-mail, which is sometimes used when commuting, and instant messaging services. This information can sometimes provide valuable insight into undocumented corporate procedures. Finally, it is essential to create and fully document a detailed preservation plan for securing all relevant sources of data. Consider forensic acquisition methods when appropriate and establish a data repository for relevant information, such as an intranet with restricted access. A single repository providing easy access to all e-mail and user files (Word, Excel, etc.) may be an option. A company should review current data-retention policies and compare them with actual practices and, if necessary, add controls that preserve data during a restatement. Untimely data destruction can lead to harsh sanctions and inaccurate or incomplete restatements. Data kept longer than required can become a liability, but under no circumstances can data relevant to the restatement be destroyed. This immediately becomes a high-stakes problem if regulators are involved. Keep tabs on progress In-house counsel should take responsibility for developing a schedule of events and phases to be completed. They should develop realistic milestones that include the completion of booking entries, the review by auditors and completion of restatement and public disclosures. Along the way, it’s useful to review and revise the timetable based on accomplishments. While it may be difficult to estimate the exact length of time required to complete the restatement, a realistic assessment of the time required can help to avoid multiple timing-revision announcements, which may undercut the company’s credibility and the extent of the financial reporting issues. If multiple issues are at hand, consider establishing teams by issue or business area to alleviate the significant time pressures. In-house counsel should also assume responsibility for conducting weekly or even daily meetings with the restatement task force to chart progress, identify and resolve issues and update the auditors and senior management. This can help to avoid last-minute issues arising that may delay the process. In order to promote openness throughout this process, in-house counsel may want to consider having the CFO or controller send out a broad request to employees or an “amnesty letter.” This could be the means by which any other issues that have not been identified can surface and be addressed. This can take the form of an e-mail to all relevant accounting and financial personnel who may have information on the restatement issues or related issues that might affect financial results. The company should request that responses be coordinated through in-house counsel. In negotiating the restatement process, one of the keys for in-house counsel is to establish realistic expectations about when a restatement is likely to occur. This is because managing external perceptions is crucial in order for a financial restatement to have as limited an impact on the company as possible. For instance, in March 2003, Network Associates Inc. announced that it would postpone the filing of its 2002 Form 10-K and would restate prior years’ financial results “as promptly as reasonably possible.” In June 2003, Network Associates announced the revised timing for the filings and stated that it expected to file with the SEC by the end of September 2003. At the end of September, the company announced again that the timing of the filing of the financials was revised and that it expected to file by the end of October 2003. Finally, on Nov. 1, 2003, it announced the completion of the restatement. Repeated delays can have the effect of weakening a company’s institutional support and creating credibility issues for it to overcome on Wall Street. Beware of collateral damage Next, in-house counsel should conduct a review of the company’s critical accounting policies, internal controls, financial reporting process and corporate governance standards. This is crucial because the matters will inevitably be scrutinized by regulators and third parties as a consequence of the restatement. Depending on the causes of the restatement, in-house counsel and the CFO should advise management along with the board of directors on anticipating additional costs for employee retention, strengthening controls and establishing and communicating new policies and on unforeseen financial reporting costs. For example, as a result of its restatement, Peregrine Systems Inc. hired new senior management, replaced its independent accountants, adopted a corporate compliance policy and established a corporate compliance officer reporting to the board’s audit committee. The Interpublic Group of Companies Inc. brought in a new CFO and several new controllers, and it took appropriate personnel actions within the company. Bristol-Myers Squibb Co. revised its budgeting process, implemented a review and certification process of its financial reports, and expanded its business risks and disclosure group. In-house counsel should also anticipate that the restatement process and auditor’s review may bring to light additional information that needs to be evaluated as part of the restatement, such as previously immaterial amounts that now appear to be material amounts. As a result of the restatement of various items, there may be a cascading effect of accounting entries that needs to be recorded. From a legal standpoint, it is imperative continually to encourage all employees to cooperate with the restatement process and to preserve all electronic and hard-copy data. Also, a company should establish close coordination and a good working relationship with the independent auditors by defining the issues and understanding their positions. If a new auditor is in place, the company should make efforts to obtain or review the previous auditor’s work papers for the relevant issues. Forensic accountants can be very effective in interfacing with the auditors. It’s also important to develop a strategy to deal with outside business partners including vendors, customers, lenders, the investment community, rating agencies, stock exchanges and federal and state regulators. Outside legal counsel will be instrumental in this process and in developing appropriate and adequate disclosures about the restatement. Meanwhile, a company should involve the investor relations department and consider the use of an outside public relations firm. It should also consider developing a question-and-answer script that is responsive to the anticipated and difficult inquiries from analysts, shareholders, customers, vendors and the media. Some of the common questions encountered by corporate executives facing financial restatements include the following: How did you discover the problem? What did you do when you discovered the problem? How quickly did you respond to the problem? What was the extent of your investigation? Are you certain that the full extent of the problem has been identified? What disciplinary actions have been taken against the individuals responsible? What steps have you taken to ensure this problem does not occur again? A company should be prepared to discuss and present the restatement issues and their resolution with the board of directors and the Securities and Exchange Commission on a frequent basis. Once the restatement process is complete, it is essential to communicate clearly the results and the restated financial information to the company’s various constituencies, and to restore confidence in the company’s ability to provide reliable, transparent reporting in the future. Although many companies have successfully dealt with a financial restatement, the toll that it takes on employees, management and resources cannot be underestimated. In addition, a company’s reputation can be put at risk if the process is handled poorly. If in-house counsel creates a clear road map and adheres to it, works efficiently through difficult times and partners effectively with outside counsel and accountants, it is possible for a company not only to survive a restatement and protect the company’s legal position, but to improve itself and its reputation in the process. James Barratt is senior managing director in FTI Consulting Inc.’s forensic and litigation advisory practice in Washington. He is a certified public accountant and a former staffer at the Securities and Exchange Commission. His areas of expertise include internal investigations, SEC enforcement proceedings and complex accounting matters.

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