Financial Restatement Due to Lease Misclassification Not Actionable

A recent decision by the District Court for the District of Arizona, In re Hypercom Corp. Securities Litigation, No. CV-05-0455-PHX-NVW (July 5), may prove to be instructive in this regard.

A publicly traded technology company, Hypercom, announced that it was restating its financial statements for the first three quarters of 2004 because 3200 leases entered into by its UK subsidiary had been improperly accounted for as sales-type leases, rather than operating leases. This misclassification resulted in a premature recognition of $3.2 million in revenue and $2.1 million in net income. The company later filed a Form 8-K with the SEC, attaching a copy of its press release for that day, which stated, 'As previously disclosed, the significant internal control deficiency that caused the recent accounting reclassification of certain leases from sales-type to operating leases and gave rise to a restatement of 2004 interim period financial statements, represents a material weakness in internal controls over financial reporting as defined by PCAOB's Auditing Standard No. 2.' The same press release also stated that Hypercom expected its independent auditors to issue an adverse opinion with respect to Hypercom's internal controls over financial reporting. Shortly afterward, the company's stock fell by $1 per share, or 18.32%. This led to the resignation of the CFO and a lawsuit against both the company and CFO for alleged violations of '10(b) of the Securities Exchange Act of 1934, Rule 10b-5, and in the CFO's case allegations that he violated '20(a) of the Exchange Act.