Back in June, we alerted our readers that the problems faced by Hertz (HTZ) were likely far from over and that the stock still had a significant accounting and regulatory risk. We based our assessment on numerous indicators, including a CFO resignation, two recent restatements and a string of non-timely filings. We also noted that by the time news of a restatement hits the market, in many cases it is already too late to sell.
On August 19th, in a regulatory filing, Hertz (HTZ) withdrew its previous earnings guidance and revealed that a review was still underway. In the same filing, Hertz stated that it hired four VP-level accounting professionals to strengthen its accounting department – a move that frequently follows significant restatements caused by internal control weaknesses. The stock plummeted more than 10% in the early trading. But then something interesting happened. On the news that Carl Icahn, the famed investor, had acquired an 8.5% stake in the company, the stock rallied. What did Icahn see in this troubled stock? It does not appear that he acquired the stake because Hertz is a great company with strong fundamentals. Quite the opposite: in the form 13D filing, Icahn stated that:
The Reporting Persons intend to have discussions with representatives of the Issuer’s management and board of directors relating to shareholder value, accounting issues, operational failures, underperformance relative to its peers and the Reporting Persons’ lack of confidence in management.
Based on the most recent press release and withdrawn guidance, it is obvious that the accounting review and investigation are taking a toll on the operational side as well. But is it possible to predict the future by looking at the past? Based on the limited information available, can we guess how costly the remediation process is going to be? First, let’s try to identify a couple objective metrics we can use to evaluate the materiality of the Hertz restatement.
• The most recent restatement undermined reliance on previously-filed financial statements (i.e., an 8-K Item 4.02 was issued). Based on a 2014 Audit Analytics restatement report, only about 30% of recent restatements fall into that category
• The restatement affected three years of financial data. Again, referring to our 2013 report, companies on average had to go back only 1.5 years to correct financial statements
• Hertz has been delinquent in regulatory filings for two consecutive quarters, and the number of days from the first restatement announcement is already 110. In 2013, it took companies on average about 6 days to file restated financial statements. For non-reliance restatements, that number was around 18 days – still well below 110.
• The remediation process involves an internal investigation led by the Board of Directors. In a 2008 paper, “The Importance of Distinguishing Errors from Irregularities,” Hennes et al. identified restatements involving internal investigations as “irregularities”, citing the high costs of such an investigation. Irregularities are generally associated with a much higher rate of SEC enforcement actions
So how much does it cost to restate? Let’s take a look at some other companies that had recent restatements sharing similar characteristics. For example, Tech Data (TECD) disclosed a restatement on March 21, 2013. In its most recent 10-K, the company disclosed more than $50 million of direct restatement-related expenses. The company also disclosed an SEC investigation related to this restatement.
Restatement-related expenses primarily include legal, accounting and third party consulting fees associated with (i) the restatement of certain of the Company’s consolidated financial statements and other financial information from fiscal 2009 to fiscal 2013, (ii) the Audit Committee investigation to review the Company’s accounting practices, (iii) supplemental procedures to assist in reviewing the Company’s financial statements and accounting practices, and (iv) other related activities. During fiscal 2014, the Company incurred restatement-related expenses of approximately $53.8 million. The Company expects to incur restatement-related expenses during fiscal 2015 in connection with continuing to perform supplemental procedures to assist in reviewing its financial statements, accounting practices and in connection with other restatement-related activities.
The SEC has requested information from the Company with respect to the restatement of certain of our consolidated financial statements and other financial information from fiscal 2009 to fiscal 2013, and the Company is cooperating with the SEC request. See Item 3, “Legal Proceedings.” This pending SEC request for information and other potential proceedings could result in fines and other penalties. The Company has not reserved any amount in respect of these matters in its consolidated financial statements.
As high as they might be, direct costs are not the only post-restatement risks that companies face. In a January 2014 WSJ article, Emily Chasan stated that companies on average lose more than a quarter of their market value following a material financial restatement. Citing a recent academic study, the article suggested that companies should take prompt actions to improve their corporate governance and rebuild reputation. Hertz took a step in this direction by strengthening its internal controls, but according to Carl Icahn and Fir Tree, much more is needed to restore shareholders trust.