Detractors still see holes in SOX

Six years in, CEOs of many public companies say Sarbanes-Oxley compliance costs too much, study finds

‘‘The company’s board of directors decided to take this action because it believes the burdens associated with operating as a registered public company currently outweigh any advantage to the company and its stockholders,” CEO and president Sidney M. Bresler said in a statement.

‘‘Among the factors that the board considered were the costs of preparing and filing periodic reports with the Securities and Exchange Commission [and] the elimination of the substantial legal, audit and other costs associated with being a reporting company, including the substantial increase in costs associated with the requirements of the Sarbanes-Oxley Act of 2002 ... Many small public companies are choosing to deregister because of these same concerns.”

SOX, as it’s known, was designed to curb corporate accounting abuses, such as Enron Corp.’s, and ensure better accountability for shareholders. Sarbanes, who retired last year and has joined the speaking circuit before groups such as the Institute of Internal Auditors, defended the law in recent published reports. He said he had heard from executives who acknowledged that the stricter financial controls made their companies stronger.

In addition, corporate audit committee members surveyed by the Center for Audit Quality in Washington gave SOX high marks this year. Some 58 percent of members surveyed agreed changes resulting from SOX had a positive impact due to factors such as more audit committee oversight, stronger internal financial controls and better communication within audit committees.

The law has generally worked, but there are still some areas that need ‘‘fine tuning,” said Kayla Gillan, chief administrative officer of RiskMetrics Group, in a recent webcast interview provided by the company’s Governance Exchange online community. The New York risk management and corporate governance company bought Institutional Shareholder Services of Rockville in 2007, reportedly for about $550 million.

Gillan said she was heartened that boards of directors have provided more vigorous oversight of companies and that independent auditors can do their jobs more effectively with the additional information.

But the controversy over the relatively high cost of complying with Section 404 requirements, which require independent auditors to ensure that companies’ internal financial controls are working, has not been helpful, she said.

More time to comply

Earlier this year, the SEC agreed to give smaller public companies with less than $75 million in market capitalization — the stock’s price per share times the number of outstanding shares — another year to comply with Section 404, which followed other delays of that provision for smaller businesses whose executives have complained about the costs. Those companies will now have until at least Dec. 15, 2009.

‘‘I think it has been a success,” said Gillan, a former board member of the Public Company Accounting Oversight Board, a private corporation created by the law that regulates auditors of public companies.

But recent surveys of executives of public companies that the law targets did not rate SOX so highly. Only 29 percent of financial executives surveyed by Atlanta software provider Oversight Systems said they had confidence that SOX reduced accounting fraud, down from 40 percent in 2005.

Business groups such as the Competitive Enterprise Institute of Washington blame the law for everything from hurting companies’ ability to raise capital to significantly increasing costs by duplicating accounting tasks.

And some executives have issued strong condemnations. John A. Allison, CEO of BB&T Corp., the Winston-Salem, N.C., parent of BB&T Bank, which is the seventh largest bank in Maryland with $6.1 billion in deposits, said during the company’s annual shareholders meeting this year that the bank had spent at least $100 million trying to comply with SOX in an effort that ‘‘amounted to nothing.”

‘‘The whole obsession with Sarbanes-Oxley misdirected huge amounts of resources in the risk management area,” Allison said. ‘‘It did no benefit.”

Spending on SOXrose last year

Companies are still spending significant sums to comply with SOX. The average spent on total audit fees by larger businesses with at least $75 million in market capitalization was $3.6 million last year, up 2 percent from 2006, according to a survey of 185 companies by Financial Executives International of Florham Park, N.J.

For smaller companies, total audit fees averaged about $500,000 last year, up 5.4 percent.

However, some companies have reported spending less this year. Carrollton Bancorp, the Baltimore parent of Carrollton Bank, reported that non-interest expenses declined by 5 percent in the 2008 second quarter to $4.2 million from a year ago due largely to reduced consultants’ and auditors’ fees to comply with SOX.

Companies such as Bresler & Reiner that no longer want to deal with such costs can deregister from stock exchanges if they have fewer than 300 shareholders or meet other requirements. While Bresler will no longer have to file annual and quarterly reports with the SEC or abide by SOX, the company will still post financial reports on its Internet site, elect board of directors and conduct shareholder meetings, executives said.

Bresler & Reiner has been losing money recently. In the first quarter of 2008, the company reported a $5 million net loss, compared with net income of $3.8 million a year earlier. For all of 2007, Bresler saw a net loss of $9.3 million, compared with net earnings of $15.7 million in 2006.

Executives with other companies that have delisted in recent years have also cited the high costs of SEC reporting and SOX compliance, according to a study published in the August issue of the Journal of Accounting and Economics. Authors of the study included Alexander Triantis, a finance professor at the Robert H. Smith School of Business at the University of Maryland, College Park.

‘‘The passage of SOX is associated with an increase in the number of firms that go dark,” the study says. ‘‘SOX does not account for the entire, but a large, part of the jump in deregistrations. Our results provide some indication that higher scrutiny associated with SOX, and not just increased compliance costs, play a significant role in the decision to go dark.”

Some companies, such as accounting firms, have increased their revenues due to additional work spurred by the law. And software companies such as Chesapeake System Solutions of Owings Mills have developed products to help businesses meet SOX requirements.

Venture capital groupseeks changes

The National Venture Capital Association, an Arlington, Va., industry organization, blamed SOX partly for a significant reduction in venture-backed initial public stock offerings by companies this year. In the first half of 2008, the number of businesses going public across the nation declined by 88 percent to only five from a year ago.

‘‘Venture-backed companies that successfully enter the public markets represent a critical job creation engine for the United States economy, and that engine has completely shut down,” Mark Heesen, president of the group, said in a statement. ‘‘We need to put regulators, legislators, presidential candidates and the private sector on notice that this situation represents a serious problem that will have long reaching economic implications if not addressed.”

SOX was cited as the third most common factor for the IPO drought by venture capitalists in a survey, behind skittish investors and the credit crunch crisis.

The group called for loosening SOX regulations, including exempting smaller companies from having to meet Section 404 requirements.

The SEC is conducting a cost-benefit study, focusing on the act’s impact on smaller businesses. That review is expected to be completed by this fall.

Beckstead and Watts, an accounting firm in Henderson, Nev., has filed a lawsuit challenging the constitutionality of the Public Company Accounting Oversight Board. The lawsuit, which questions whether the SEC and not the president should be appointing board members, is before the U.S. Court of Appeals for the District of Columbia Circuit.

To learn more

For more information on the Sarbanes-Oxley Act:

U.S. Securities and Exchange Commission, 202-942-8088, www.sec.gov⁄spotlight⁄soxcomp.htm

Maryland Association of Certified Public Accountants, 800-782-2036, www.macpa.org

Public Company Accounting Oversight Board, 202-207-9100, www.pcaobus.org