WASHINGTON, May 6 (UPI) -- It's been nearly two years since passage of the Sarbanes-Oxley Act, aimed at mitigating investor fears after the Enron and WorldCom corporate collapses. While the act is meant to better inform stockholders of what publicly-traded companies are doing, some secondary consequences include extra regulatory costs, not necessarily better management, and diverting staff away from running the business, discussion participants noted at the American Enterprise Institute on Wednesday.
Sarbanes-Oxley is wide-ranging in its scope. In addition to creating stiff new penalties, it establishes a new Public Accounting Oversight Board, restricts the various services an audit firm can offer to its clients, and limits the time audit firm partners can serve a single client. For corporations, the greater effect is on complying with stringent new compliance and disclosure rules.
For the 12,000 public companies that file financial reports with the Securities and Exchange Commission, compliance dates for Sarbanes-Oxley (SOX) are fast approaching. Companies with market caps of $75 million or more have to file "section 404-compliant" reports along with their annual reports for the fiscal year that ends on or after Nov. 15, 2004. For those companies with market caps of less than $75 million, the compliance date is April 15, 2005. Section 404 of SOX requires detailed examination of a company's financial and information control policies and practices -- which translates into extra expenses for public companies or those which aspire to go public.
A January 2004 survey of 321 public companies by Financial Executives International showed that of 321 companies surveyed, on average they expected to expend 12,000 hours of internal work, 3,000 hours of external work, spend an additional $590,000 in auditor's fees (an average increase of 38 percent), and an additional $700,000 in software and IT consulting, for a total of $1.9 million in first-year compliance costs. For the largest companies, the time and expense was two to three times these averages.
The costs are daunting for private companies with plans to go public, and are causing some public companies to delist, and some private companies to try and sell the company so as to not have to pay the extra costs to become SOX compliant, according to accounting firm Grant Thornton. The firm reported that since the enactment of SOX, the number of companies seeking to go private has increased by 30 percent and the number of proposed management buyouts has increased 80 percent.
Greg Bentley, co-owner of software company Bentley Systems, noted that SOX will cause public companies to be responsible for the compliance of companies they acquire after SOX goes fully into effect, which means that companies that haven't taken steps to be 404 compliant will be considered untouchable for buyout by a public company.
"We cannot afford to be public with 120 percent increases in costs," said one respondent to a survey by law firm Foley and Lardner on the costs of being a public company. The poll of 450 publicly-traded companies showed that on average, the costs of being public increased 90.4 percent to $2,481,000 -- nearly twice what they were before SOX. And while the largest companies will see the largest cost increases, they will be best able to absorb them, the survey said, while small and mid-cap companies may face "crippling" cost increases to go or stay public.
Bentley, who co-owns Bentley Systems with his four siblings, described how the company withdrew its IPO bid in spring of 2002 after SOX was passed, mostly because of the SOX requirement for a majority independent board.
Some say that on the one hand, having more independent boards and directors doesn't necessarily result in better management -- but on the other hand, it forces companies to make better choices about who's leading them.
SOX "will lead members to question the competency of other board members which they should do," said Stuart McFarland, co-founder and managing partner of Federal City Capital Advisers.
Julie Daum, practice leader for North American Board Services at Spencer Stuart, said that now, "boards are trying to be more thoughtful" and are willing to "cast a wider net" for directors.
Being led by an outsider means being led by someone who is a good manager, but may not know anything about that company's business, Daum said. "Just as you have an increase in the demand for independent directors you have a decrease in the traditional supply of candidates," she said, with the result that boards are looking at younger and older people than normal, including retired CEOs, or younger people who may be running a company division.
Daum also noted an increase in "professional directors" or people who for a living serve on a board. "The experience they're bringing is governing experience ... what the processes are of governance rather than someone who might be really good at understanding the business that this company's in," she said. Corporations "need to bring people on who are actively engaged in the market as it is now," she said.
Also, companies fearful of the more vigorous audits mandated by SOX are hiring second and even third financial experts for boards, she said. As a consequence, "there are more financial people on the board and maybe less people who are strategic or understand the business."
With all the hubbub over SOX, KPMG LLP, the audit, tax and advisory firm, has created the 404 Institute, an open forum where companies trying to become 404-compliant can share war stories and ideas about their efforts. Less than three weeks after it was launched, it already has over 1,200 members.
"These new open forums offer a platform for organizations and shareholders to learn about the 404 journey, share leading practices, and candidly discuss ways to address the evolution of effective internal controls," said Timothy Flynn, vice chair of KPMG's Audit and Risk Advisory Services.
AEI resident fellow Peter Wallison said there was no basis for the act to be adopted in the first place. Wallison challenged claims that corporate scandals had caused a "dramatic loss of confidence in investors" based on how the stock market reacted to the Enron collapse and the WorldCom scandal. "If Enron and WorldCom had indeed caused a crisis in investor confidence it should show up as a sharp and sustained decline," Wallison said, adding, "Instead what we see is a choppiness with the Dow rising and falling." The long decline that started in March 2002 and ended in March 2003 was directly related to the potential of war with Iraq, he said, and ended with the U.S. invasion of Iraq.
