Sarbanes-Oxley - Can We Stand The Cost?

"You can't legislate intelligence and common sense into people"
Will Rogers

The stories keep rolling out on what to do for small companies (under $75mm market cap) that will come under the requirements of the internal control provisions of the Sarbanes-Oxley Act. Almost 700 companies self reported weaknesses last year before the first outside audit of controls was performed. The first reports with management and auditor reports on internal controls are due later this month although the smaller companies in this group ( $75MM - $750MM market cap) have been granted an extention of 45 days. Thus a number of Form 10-K's will be filed without these reports and amended later.

The SEC continues to mull over all types of actions. They have asked COSO, the group which drafted the framework for implementing internal controls back in the early 1990's, to rework their framework for smaller companies. Right now COSO is scheduled to meet in April with the hopes of of drafting a new framework by late summer. Some of the members of COSO are now talking about adding elements to the framework to dictate how companies will conduct their internal communications. So now not only will we totally eliminate all mistakes and fraud in the accounting process, but we will now perfect all communications in the workplace. The best part is this age old problem will be resolved in a mere five months.

The head of the SEC is now reportedly asking the Commision's staff to review the situation of implementation of internal control policies and propose an extention. What comfort should be taken from this. A small filer with a December 31, 2005 year-end needs to have their controls reviewed, implemented and staff trained by the end of June to have a chance of success in this process. This would leave the filer six months to start internal auditing, remediate weaknesses, implement changes and audit further. Why is the Commission waiting to pick a new deadline, when small filers needed an answer months ago?

While the SEC sits on its hands, the quality companies will have wasted time, effort and precious capital trying to reach a higher standard than what is attainable. Another problem is looming over the heads of our regulators. Last year almost 200 companies voluntarily delisted and took themselves out from under the requirements of Sarbanes - Oxley. They are basically refusing to comply. The real rush toward this movement is yet to come. As I attend the seminars and network with others like myself, I find there are many who have not started the work. Their companies simply do not intend to comply.

How does this fit in with the SEC's mission? Their whole existence is based on protecting the investors in public companies. The Commission failed investors in the 1990's. Our large public accounting firms failed us at the same time. The Finacial Accounting Standards Board worried about how to take stock options away from executives by trying to change the nature of equity to expense, while a small group of company's executives changed the nature of debt to revenue to enrich themselves. Did Congress investigate this group and their failures? Not really. We saw the parade of corrupt executives before Congressional Committees where nothing was said to protect the guilty. Then Congress passed legislation to punish the innocent in hopes of catching the few. They created a new bureaucracy to watchdog the public accounting industry, but our real culprit, Arthur Andersen, is long gone.

Where does this leave the SEC. They are enforcing a law that is taking billions of dollars out of corporate profits and investor's pockets every year. Their mission of reestablishing investor confidence, is being undermined by hundreds of companies reporting material weaknesses with probably thousands more to come. Small public companies who face compliance or being turned into perpetual money losing machines have their eyes on the exit. This is also true of the larger foreign companies that flocked to the US markets for cheaper capital. If they leave our markets, they can go back to the sane rules of their own local markets.

Will Congress self evaluate what they have done? Evaluate the costs and rewards? Will the SEC go back to the Congress and look for changes? Given the manner in which these people are currently acting, the damage will have to be done first. How many companies will have to close their doors, delist or report to the public that they just can't comply? How far does the market have to go down before a Congressperson looks at their own broker statement and asks how did this happen? My guess is it will need to be a deep drop before our Congress can look at itself and say, I made a mistake.

Note: Today, as expected, the SEC has announced that the implementation dates for non-accelerated filers to implement Section 404 Internal Control Proceedures has been extended by 12 months.