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Sarbanes Oxley : Law : Thought Leader
Will Sarbanes-Oxley Force Small Companies to Privatize?
It is clear that SOX should be modified to better address the needs of small companies
By
Megan Penick
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Megan Penick
General Counsel
Global Holding and Investment Co., LLC
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More than two years into the Sarbanes-Oxley Act of 2002, it is becoming increasingly clear that small and mid-sized publicly traded companies are having difficulty to complying with SOX. SOX makes no distinction between large companies and small companies in its compliance requirements. As such, trying to achieve SOX compliance is placing a much larger burden on small public companies, companies with substantially fewer resources and personnel than their larger competitors.
Where a large cap company is expending 3-5% of its gross revenue in setting up and orchestrating its compliance program, small cap companies may be facing even greater hurdles and expense due to their comparatively smaller size. For instance, where large companies generally have an in-house accounting department that can be arranged to bear much of the burden, small companies often don?t have such resources and are required to set up an entirely new department, hiring new staff and facing significant investment.
Furthermore, according to a survey recently conducted by Financial Executives International, companies have had to expend large sums to meet the requirements set out in Section 404. The survey found that companies with market capitalization of $5 billion or more are spending on average .03 percent of overall revenue to comply, while small cap companies, those with market capitalization of $100 million or less in revenue, are spending an average of 1.3% of revenue to meet compliance requirements.
The Sarbanes-Oxley Act of 2002 was designed to improve corporate governance and remedy the accounting fraud revealed in the rash of scandals involving Enron, WorldCom and other large companies. These scandals were devastating for those invested in these companies and revealed that the current system of financial controls were too weak to properly protect investors from corporate corruption. Furthermore, as accounting firms were serving as both advisor and accountant, it seemed there was too great an opportunity or incentive for collusion and cover-up.
But SOX was designed as one-size-fits-all answer to the corporate accounting scandals, and many are arguing that a one-size-fits-all solution isn?t the answer as small companies are unduly burdened by SOX?s compliance and reporting requirements. To adhere to SOX?s requirements, companies have to invest a significantly larger proportion of their capital into SOX compliance.
This has left many small public companies crying foul. Critics say that small companies with smaller staffs and where managers often wear numerous hats are unable to dedicate the amount of time and resources required (estimated at as many as 1,000 or more additional staff hours) to adhere to SOX. Large public companies (those with capitalization of $1 billion or more), on the other hand, are reporting having to dedicate between 3-5 percent of revenue to comply SOX ? quite a large output but in many ways a drop in the bucket considering their size.
While the estimates for small public companies have varied widely, and as small public companies are not yet required to comply with SOX?s most expensive component?Sec. 404, which will not be enforced against small-cap companies until July 2007?many small companies complain that the burden of compliance will be so great that they will be forced to de-list and go private. Already, in the year ended July 2003, the year after the Sarbanes-Oxley Act came into effect, the number of companies de-listing increased by 30% compared with 2002.
This trend could continue should Congress not opt to modify SOX to create a different standard for small companies and thus ease the burden placed on small and mid-sized companies.
So what is causing this great increase in costs? Due to the complexity of SOX compliance, the cost of hiring auditors has increased, some would even say that SOX has created a windfall for auditors. Also, costs for director and officer liability insurance has also increased due to the greater risk a director faces should he or she be found liable for the company?s inaccuracies in their financial statements. In addition, due to the record-keeping requirements, new computer programs and storage programs must be put in place and continually monitored, bringing in costs of the installation and implementation of these new devices.
Small companies, for instances, have reported expending an additional 1,000 or more staff hours just for SOX compliance, and that is in addition to the extra money expended for SOX auditing, lawyers, etc.
And what does this all mean for the future? Companies generally go public when they are seeking growth and infusion of capital. If smaller companies find the burden of Sarbanes-Oxley compliance untenable, then fewer companies are going to make the leap from private company to public. Furthermore, reports have shown that an increasing number of companies are de-listing and are citing SOX compliance as the primary factor in their decision to do so. If going public is not an option, innovation would be harmed as companies generally go public with the purpose of raising additional capital to allow them to pursue growth and expansion in ways that would not be possible without the infusion of additional capital. If small companies find themselves unable to adhere to the requirements of SOX, larger companies will be allowed to dominate the marketplace and gain an even greater hold against the competition.
In response to these concerns, the Chairman of the Securities and Exchange Commission, Christopher Cox, extended the filing deadline for small public companies to comply with SOX until July of 2007. While this was a reaction to complaints made by small businesses, Mr. Cox indicated he is not leaning toward loosening the regulations for small companies, but said he and the SEC will continue to monitor the impact of SOX on companies. The Securities and Exchange Commission?s Advisory Committee on Smaller Public Companies also met two weeks ago and is considering recommendations that compliance requirements be modified for microcap (companies with market capitalization of $25 million or less) and small cap companies
While not all deem the Sarbanes-Oxley Act of 2002 to be a negative ? and many see the greater transparency and director responsibility created by SOX as a positive ? it is clear that SOX should be modified to better address the needs of small companies. But should Congress fail to do so, the future of competition, growth and innovation in this country will likely be damaged for the worse.
Megan Penick
General Counsel
Global Holding and Investment Co., LLC
Megan Penick is General Counsel at Global Holding and Investment Co., LLC, a sales finance company located in Fairfield, NJ. Megan has long had an interest in China's development issues, having lived and worked in Beijing as a journalist, and later as a Summer Associate at the law firm Holman Fenwick & Willan in Shanghai. Megan is a graduate of New York Law School and the University of Iowa School of Journalism and Mass Communication, where she studied print journalism. Megan is fluent in Mandarin Chinese.
She is licensed to practice law in New York, New Jersey and Washington, D.C..
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