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Sarbanes Oxley : Technology : Internal Controls
Delivering SOX Compliance and Shareholder Value
By
David Bolton
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David Bolton
Counsel and Executive Leadership Team
Procuri
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Sarbanes-Oxley has created a new era of accountability for corporate officers by demanding greater transparency in controls, auditing, and reporting of financial information. By implementing best practices that deliver the transparency that SOX requires, many CEOs and CFOs are also discovering ways to make their organizations better-equipped to provide increased shareholder value over the long term.
One way executives can enhance compliance and help to offset its costs while increasing organizational efficiency is through effective contract management. A 2005 Aberdeen Group report estimates that year-over-year growth rates for the contract lifecycle management industry will exceed 20 percent through 2008. SOX compliance is one of the drivers fueling this growth.
Despite the recent increased emphasis on controls and reporting, many companies still don?t have a contract management system or process in place. According to the Aberdeen Group, nearly half of companies still store at least a portion of their contracts in paper formats. Finding hard copies of various contract terms amidst the clutter of someone?s desk can be a tremendous challenge for companies to provide quick, accurate reporting. Monitoring and managing SOX compliance in such a scenario, let alone trying to maximize organizational and process efficiencies, is nearly impossible and clearly unreliable.
Many companies, if they track contract compliance at all, do it manually with standalone Excel spreadsheets or in-house systems that are prone to inconsistent and unreliable reporting. They may even rely upon customers to police the performance or payment obligations in the contract, assuming that customers will alert them when they?re being undercharged for products and services or overpaid on incentives.
On the buy side, companies often have no idea if a supplier is charging the right fee or is in compliance with the terms of the agreement. Furthermore, many companies often have multiple contracts in force at the same time with the same supplier, making it difficult to determine which contract governs orders being negotiated by multiple departments or divisions within a corporation.
The resulting error-prone process is fraught with high costs, the inability to locate specific agreements, and exposure to penalties for non-performance or default ? all factors that can negatively impact a company?s financial results.
A contract management tool, coupled with an effective management process, can provide companies and its managers with:
? Improved contract compliance ? Companies are starting to view contract life cycles as commencing before the creation of the contract. They chart the process cycle from the generation of a requirement and the communication of the requirement to sourcing for its fulfillment. Consequently, the number of control points and departments involved in the cycle?s process flow are increasing ? and so is the need for more control over operations and process efficiency. By helping companies establish and document best practices in enterprise contract management, a contract management tool enables the alignment of internal policies and procedures with compliance requirements. This improves internal processes, streamlines the contract creation process, identifies and minimizes financial risk through the contract life cycle while boosting SOX compliance.
? Higher contract performance ? The ability to track multiple provisions and obligations is particularly important when managing special-purpose contracts that deviate from a company?s standard form or agreement, since these are often the ones that corporations lose track of. By providing the ability to monitor compliance by compiling and summarizing contractual obligations, a contract management tool can help companies understand how to continuously improve internal controls and contract performance and to take immediate corrective action as necessary. This enables managers to stay on top of contract terms, conditions, deadlines, and details of commitments to reduce the high costs of erroneous payments.
? Reduced risks ? In addition to implementing a contract management tool, it?s essential that companies establish processes that obligate those who manage contracts at risk to alert those responsible for reflecting risk in the financials. By allowing corporations to view contractual risks and material events ? and by providing immediate access to all relevant documents and communications related to the risk or contract ? a contract management tool can help companies analyze and quantify contractual risk of any type across their entire enterprise.
? Enhanced contract visibility ? More and more companies are electing to purchase contract and supplier management software, and hosting of their contracts repository, as a service as opposed to operating licensed applications within their IT environment. Having a centralized, searchable, enterprise-wide repository for contracts eliminates paper-based contracts and ensures fast and efficient access from any computer. It enables companies and their auditors to quickly compile relevant information to demonstrate SOX compliance and impacts to their financial reports without having to ask, ?Who has the latest version??
Implementing Internal Controls
One way companies manage risk is by establishing standard contractual terms, such as limitation of liability, within the organization. Having a contract management tool in place enables companies to control when their standard terms can be changed and who can change them during contract creation and negotiation. It manages this process to ensure that if a particular clause is being negotiated and there is a request to modify it, it is delivered to the proper corporate contact with the delegated authority to make the change. It eliminates the risk of ?maverick buying? by ensuring that the proper internal controls are in place during the contract negotiation process ? and by ensuring that only those delegated with the authority to make contractual commitments on behalf of the company are in fact the ones making them.
While a record of contractual obligations is not specifically required by SOX, a contract management suite can help companies accurately and quickly access information that is required. After all, the contract is the foundation for the financial statistics of a company, since the financial obligations of a company ? both when selling and buying ? start with a contract.
Take, for example, the process of determining the revenue-recognition rule to apply for a particular transaction. First, the terms of delivery, acceptance and payment described in the contract need to be determined. The determination today often involves multiple disciplines interpreting the terms of the contractual obligations. This makes it imperative that each discipline involved has access to the terms of the obligations and that the terms being reported are accurate, current and reliable.
SOX does reference contracts in the requirement that every annual and quarterly report filed with the SEC disclose all material off-balance sheet transactions, arrangements, and obligations (including contingent obligations) that may have a tangible current or future effect on the company. These arrangements can include certain types of leases, subsidiary guarantees, interest-rate swap instruments and foreign exchange contracts.
To be SOX-compliant in contract-related matters, public companies must:
? Summarize their contractual obligations in the Management?s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section of Securities and Exchange Commission reports;
? Report and track all volume purchase contracts for goods, service or manufacturing capacity;
? Disclose all vendor-managed inventory, which may be considered assets;
? Disclose all outsourced operations; and
? Ensure that all outsourcing service providers have adequate internal controls and safeguards.
In practice, the only effective way to maintain and track SOX-related trading relationships and ensure compliances is through the use of a dedicated and mandated contract management suite that automates the entire contract life cycle. While most ERP and CRM suites have contract management modules, they generally track only a limited amount of information. They lack the required analytic functionality, reporting capabilities, and the ability to manage risk and assess compliance. The need for these expanded capabilities is particularly necessary for companies that outsource services that are considered part of the company?s internal controls over financial reporting and for those entering into volume purchase agreements.
According to SOX, these off-balance sheet transactions need to be provided on a ?rapid and current? basis. In addition, the SEC has accelerated the filing date requirements for annual reports on Form 10-K and quarterly reports on Form 10-Q in addition to demanding more rigid 8-K reporting requirements in the case of a material event, forcing companies to access contract information and performance risks much quicker than in the past. A contract management tool can greatly aid companies in their efforts to effectively implement internal processes for the maintenance and disclosure of the off-balance sheet transactions, material events, and mitigate risks associated with them.
The Corporate Mandate
While the advantages of implementing a central contract management solution are clear, the reality is that a lack of internal communication often exists today when companies go to buy such a system. Since the CFO of a company, along with the CEO, is held responsible for establishing and maintaining a company?s internal controls according to Section 302 of SOX, it?s imperative that the CFO become involved in the selection and implementation of a contract management system ? something that rarely occurs in companies today. This is important because simply purchasing contract management software doesn?t provide a company with everything it needs to maintain accurate, reliable, and timely information. All the technology in the world cannot eliminate the human element from the process, or the need for employees to input updated information on a regular basis.
To be certain that a contract management suite provides a company with accurate contractual information, the CFO should designate it by corporate mandate as the standard, required repository of information regarding contractual obligations for the company across all of its organizations.
It Takes a Champion ? and Management Attention
Establishing such a mandate isn?t enough. To ensure that contractual information remains current, reliable and reportable, an individual within the corporation should be delegated as the caretaker, or ?champion,? of the contract management suite. A project team should also be assembled to manage the implementation of the application, the development of the contract creation and negotiation process, and the assignment of administration responsibilities. The team, generally including representatives from the legal, business and finance departments, should be tasked with placing the corporate controls in the process flow and for assigning responsibilities to the appropriate individuals. Without a champion who is held accountable for ensuring that the contract information is being interpreted correctly and processed regularly by all divisions within the company or the development of a process, the data can quickly become stale and unreliable.
Appointing such a champion and project team adds another level of accountability to the process ? a must for CEOs and CFOs who are themselves held accountable for their companies? internal controls by SOX.
SOX and Better Process Efficiency
When it comes to increasing corporate process efficiency and control over operations, a contract management tool is just one part of the process. Companies can increase their efficiency by managing fewer suppliers and by reducing the number of applications existing across the corporation. Standardizing on a contract management tool across the organization can help in this respect, since the 2005 Aberdeen Group research shows that half of companies either lack formal procedures for creating and managing contracts or use approaches that vary across the organization.
The choice to standardize on the use of tools companywide, from contract management to supplier management to strategic sourcing to spend analysis, is another way for companies to both measurably improve their business performance and ensure better recordkeeping and controls over operations across all aspects of the enterprise. Choosing a single supplier to provide these separate tools is a way that companies can increase their efficiency even further.
A contract management tool, although just one application within a company?s overall set of reporting tools, can, if maintained, produce accurate, reliable and timely information on the status of a company?s contractual obligations. The implementation of a contract management solution is one significant means by which CEOs and CFOs can demonstrate that they?ve established and maintained adequate internal controls.
Making these changes is a process that requires considerable time and effort at first. But in the end, the dividends that result are well worth the effort required, leaving companies better prepared to meet SOX requirements and achieve ?sustainable compliance.? In the process, by reducing cycle times and increasing process efficiency, contract management software can save companies time and money ? and increase shareholder value.
David Bolton
Counsel and Executive Leadership Team
Procuri
David Bolton is Counsel and Executive Leadership Team member for Procuri, Inc. He joined Procuri in March 2005 following Procuri?s purchase of Contract Management Solutions, Inc. (CMSI). Mr. Bolton has over 20 years of experience in high-tech industry corporate development, contract management, intellectual property matters, and business operations.
Prior to joining Procuri, Mr. Bolton was Vice President, General Counsel and a corporate officer for CMSI, and was responsible for legal, corporate, and business operations.
Prior to joining CMSI, Mr. Bolton was General Counsel and Secretary of Real 3D, Inc., a fabless semiconductor and high performance 3D graphics technology and intellectual property company whose primary shareholders were Lockheed Martin, Intel and SGI. He co-drove resetting the company IP strategy, resulting in achieving maximum IP portfolio value by implementing long-term technology development and licensing arrangements with key strategic partners.
He negotiated deals that raised over $25 million in equity, as well as a deal that closed a $48 million technology licensing agreement. Mr. Bolton was a key member of the team that successfully negotiated the sale of Real 3D to Intel. Before joining Real 3D, he spent thirteen years with Lockheed Martin Corporation progressing through increasingly responsible positions, and gaining experience with advanced information processing, delivery, retrieval and display technologies for government and commercial markets.
Mr. Bolton earned his Bachelor of Arts degree in political science and sociology from Eastern Michigan University, and received his law degree from Detroit College of Law. He is a member of the Florida Bar.
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