Small public companies yet to comply with the stringent accounting provisions of the Sarbanes-Oxley Act could receive a reprieve from federal regulators weighing a one-year extension.
Section 404 of the act requires public corporations to assess their internal accounting controls to ensure their financial reporting is accurate-and requires accounting firms to vouch for those controls.
To comply with the act, which was enacted in the wake of financial scandals at Enron Corp. and MCI WorldCom, public companies have devoted thousands of employee hours and millions of dollars to ensure annual reports are accurate.
But the most extensive provision of Sarbanes-Oxley has become the bane of small public companies. Critics argue the requirements are too costly and burdensome for many still unprepared to meet their 2007 deadline.
“Personally, I think it’s overkill,” bemoaned Jerry Engle, CEO of Lincoln Bancorp in Plainfield. “We’re heavily regulated, anyway, by the FDIC and the state, and this has just added to it.”
Help might be on the way, however. Senators John Kerry, D-Mass., and Olympia Snowe, R-Maine, asked regulators late in February to delay by one year compliance for companies with a market value of less than $75 million.
That would mean extending the compliance date for management assessments of internal controls until December 2008 and deferring an outside auditor’s attestation until December 2009. The SEC already has delayed by six months the date for which management reports were to be completed, from July of this year until December.
A recent Government Accountability Office report found that small public companies will take a relatively bigger financial hit to implement Sarbanes-Oxley requirements, particularly Section 404. It said firms with less than $75 million in market value were spending nearly 900 percent more than larger counterparts-$1.14 in audit fees per $100 of revenue, compared with just 13 cents for companies with more than $1 billion in market value.
Overall, compliance with audit requirements of Sarbanes Oxley has cost U.S. corporations $6 billion annually the past two years, according to surveys by Bostonbased advisory firm AMR Research-much higher than the original SEC projections of $1.2 billion.
Most large corporations reassigned much of the additional auditing work to existing employees. But for a lot of smaller public companies, that isn’t an option. Many have to hire new employees and contract part of the project to outside consultants.
If an SEC advisory committee develops reporting reforms for smaller companies, it’s doubtful firms will continue to expend significant funds on Section 404 under current rules.
“There’s the potential for so much change that it’s a good idea for everybody to sit back and take a look at this, and let everybody get on the same page,” said Michael Becher, managing partner at the Indianapolis office of New York-based Deloitte & Touche USA LLP.
Because it can take up to a year to establish the internal controls and become compliant, many smaller companies already have started the process, including Lincoln Bancorp. The Plainfield-based holding company operates 17 Lincoln Bank branches.
Its market value hovers around the $75 million threshold, prompting the decision by executives to delve in early. Compliance going forward annually will cost the bank about half the initial expense of $300,000, Engle said.
“When it’s pushed down to the levels it is now,” he said, “it becomes costprohibitive.”
Indeed, the pressure on companies to remain public is taking its toll. Last year, 129 public firms were taken private, according to Robert W. Baird & Co. Inc. in Milwaukee, nearly double the 68 in 2005. Many other companies that were considering an initial public offering have decided against it.
The U.S. Small Business Administration is pressing the SEC and the Public Company Accounting Oversight Board, a not-forprofit established by Sarbanes-Oxley to protect the interests of investors, to extend the deadline for small public companies.
The SBA’s Office of Advocacy is recommending further exemptions until less costly procedures for internal controls reporting can be developed. Absent the exemptions, the Office of Advocacy frets the requirements will continue to keep small companies from exploring an IPO.
In Indiana, only one company went public last year, and only 10 have done so since 2002, the year Sarbanes-Oxley was enacted. One lawyer told IBJ earlier this year that the law partly is to blame.
“That increased burden is going to make companies think twice about being public,” said David Millard, chairman of the Business Department at locally based law firm Barnes & Thornburg LLP. “If they’re able to get a premium sale price in the marketplace, then the decision is to sell.”
Yet there are signs Sarbanes-Oxley is working. Earnings restatements rose 13 percent last year, but declined at larger corporations already complying with Section 404, a recent report from research firm Glass Lewis & Co. found.
The report from the San Franciscobased firm said the findings show the rule is working well in rooting out financial error and fraud and shouldn’t be softened. U.S. public companies filed a record 1,420 restatements in 2006, the study said, up from 1,255 a year earlier, with nearly one in 10 restating.
“Overall, there have been a lot of positives to come out of this,” said Steve Moore, a partner at the local office of Springfield, Mo.-based BKD LLP. “Now we just have to find a balance between the costs and those positives.”