Excavations in Accounting

To Monitor Internal Controls, Firms Dig Ever Deeper Into Their Books

Rep. Michael G. Oxley (R-Ohio), left, and Sen. Paul S. Sarbanes (D-Md.) co-sponsored the legislation meant to improve corporate accounting. (By Jay Mallin -- Bloomberg News)

The problem, at first, seemed manageable. When auditors at the Mills Corp. found in late 2004 that the company had mistakes in its joint venture accounting, it was the type of issue that in another era might have led the company to adjust a few numbers and tweak a few procedures, with investors none the wiser.

Even when Mills disclosed the error in early 2005, investors yawned, and Mills' stock price marched to an all-time high of $66.44 by early August.

Fast forward six months: Mills has had to restate its results a second time, write off a $4 million loan it could not collect, cancel 10 projects and fire 14 executives; suffered a 40 percent drop in its stock price; and caused a brief run on the business of its lead investor. An informal Securities and Exchange Commission inquiry is underway.

The 2002 Sarbanes-Oxley Act was meant to improve corporate accounting with its threat of criminal penalties for executives. But by upping the consequences for mistakes, it also has created an environment of near-constant internal review, a setting in which companies such as Mills might start pulling on the thread of a problem only to prompt a larger unraveling as other issues are unearthed.

In recent weeks, more than a half-dozen local publicly traded companies along with Mills have been forced to announce their numbers could not be trusted, admitting mistakes both major and minor:

· An Arlington power company checks its tax accounting -- and winds up erasing hundreds of millions of dollars in earnings.

· A Reston government contractor finds it must redo three years of accounting -- and starts encountering takeover pressure from an equity firm.

· A local biotech concludes that the accounting strategy it has used for the past four years isn't the right one after all.

· Mortgage companies Fannie Mae and Freddie Mac struggle still to correct billions of dollars of wrong accounting in a process that is taking years and requiring literally thousands of accountants, auditors and consultants.

Though Mills' most recent restatement will shave only 5 percent from its profit from 2002 to 2004, it has been taken as a sign of larger management issues and has led to calls for the company's sale.

Disclosing the first round of problems in February, Mills chief executive Laurence C. Siegel said the situation, which led auditors to chip ever deeper into the company's books, was "a by-product of the Sarbanes-Oxley environment where everybody is looking at things really closely, wanting to make sure they got it right."

The experience at Mills and elsewhere shows how substantially running a public company has changed since the enactment of Sarbanes-Oxley, a corporate accountability law that is prompting hundreds of accounting restatements and revealing internal problems that might never have been found or acknowledged otherwise, according to accounting and management experts.