Bubbly? Shares Surge For Companies With Weak Accounting Systems

By Mani
Updated on

The share prices of nearly 32 companies – from GrubHub to GoPro — that reported material weaknesses in their accounting systems last year have surged by an average of 42% since their stock debuts, reveals a Proskauer Rose study. The study from the New York law firm found that about 30% of companies that went public last year acknowledged that they were at serious risk of incorrectly reporting their financial information.

Investors’ risk-taking mindset overlooks key metrics

Ever since the passage of the Sarbanes-Oxley Act in 2002, companies are required to report material weaknesses, with public companies required to satisfy their auditors that they have the processes and people in place that can prevent or detect accounting errors. According to the Proskauer study, compare to 17% of issuers in 2013, about 30% of companies that went public in 2014 acknowledged that they were at serious risk of incorrectly reporting their financial information.

Punctuated with several examples, a Bloomberg report by IPO reporter, Leslie Picker, points out that GrubHub, a food-delivery and pick-up website, disclosed in its prospectus that before merging with Seamless Holdings in 2013, the site had neglected to regularly document its review of journal entries. The company’s stock has surged 58% since its debut last April.

Frank Lopez, co-head of global capital markets at Proskauer, said: “If the auditors are saying there’s a material weakness, they’re saying you’re not set up like a public company should be yet.”

GrubHub’s IPO was one of the most-anticipated events last year, and the Chicago-based company raised the price range for its initial public offering from between $20 and $22 per share to between $23 and $25 per share.

GoPro, which makes video cameras used by adventure-seekers, disclosed in its IPO prospectus that it lacked accounting skills, monitoring activities and review processes prior to 2013. In September, the company’s shares soared by over 200% beyond its IPO price last June.

Material weaknesses in accounting systems: trend continues in 2015

Last year, Zoe’s Kitchen and Installed Building Products also disclosed weaknesses in their accounting systems. However, both stocks have gained more than 80% since their IPOs.

Interestingly, the trend continues in 2015. Etsy, the decade-old online marketplace for handmade and vintage goods, went public after disclosing two material weaknesses, including that it wasn’t able to account for some non-income tax related expenses. Highlighting a frothy market making new highs, Etsy’s share price soared in its IPO last month, up by over 100% in the first few hours of trading.

Last month, ValueWalk highlighted that CorMedix also filed an equity offering recently. We pointed out a material weakness as the company has had 3 CFOs since 2012. Moreover, in its SEC filings, the company has identified material weaknesses in its internal controls over financial reporting related to its limited finance staff and the resulting ineffective management review of its financial reporting.

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