Lobby efforts under way to change Sarbanes-Oxley Act

Published by: Silicon Valley/San Jose Business Journal
Written by: Becky Bergman
Date Published: January 5, 2007

Fed up with sweeping laws that have threatened smaller public companies' profits and tangled business leaders up in bureaucratic knots, corporate America is waging an all-out battle for governance reforms.

Business leaders and financial experts say that Section 404 of the Sarbanes-Oxley Act of 2002, addressing internal-controls assessment requirements, has made companies and accounting firms more prone to shareholder and government lawsuits.

"The regulations have put many companies out of business or pushed them out of the U.S. as a reporting vehicle," says Rick Brounstein, director of CFO Network and executive vice president for Calypte Biomedical Corporation.

Brounstein, a local business expert who has spent the past 34 years advising financial firms around the valley, also serves as a leader for the Sarbanes-Oxley Section 404 risk assessment sub-group for the Securities and Exchange Commission (SEC) on Smaller Public Companies.

He says relief may be coming for U.S. public firms, starting from the SEC, which deferred Section 404 implementation for small companies -- non-accelerated issuers with less than $75 million in market capitalization -- until at least December 2007 for management assessment and a year later for auditor attestation.

Section 404 requires public companies to include an assessment of the internal control procedures it has over its financial reporting.

The annual statement must also include an independent auditor's report on that internal process.

The idea behind Section 404 was to reduce the market impact from accounting "errors," whether from fraud, inadvertent misstatements or omissions, but assure the investors that public companies maintained effective control over financial reporting.

Although Sarbanes-Oxley has helped to restore investor confidence, the corporate governance regulations have also served a blow to the bottom line of U.S. public companies, show some studies, particularly at smaller firms which argue they pay a higher proportion of their profits to comply with the strict anti-fraud laws.

Some small companies say they can't keep up with the expenses and they are worried about complying with the law and staying in business.

An annual study by law firm Foley & Lardner LLP said that Sarbanes-Oxley Section 404 has driven up audit fee costs for small companies.

Audit fee increases from 2003 to 2005 represented a 141 percent increase for S&P small-cap companies and a 104 percent increase for S&P mid-cap companies.

Companies that once paid out a few hundred thousand in various accounting-related services are growing accustomed to million dollar tabs, Brounstein says.

Small cap firms can expect to pay about $4 million annually and private companies looking to launch an initial public offering will spend at least $1 million just to establish accountability procedures, Brounstein says.

"Not all companies are created equal," Brounstein says. "The one-size-fits-all in the regulations doesn't work."

Responding to the outcry, the SEC and Public Company Accounting Oversight Board (PCAOB) announced in December that it was working to revise Section 404 standards to make reviews more risk-based and cost-effective.

The SEC's recommendations included requiring only one report from auditors compared to the two the PCAOB currently requires.

"Smaller companies are busy running a company instead of using their time to assess the company," says Glen Sato, a partner with the life sciences and public securities division of Cooley Godward Kronish in Palo Alto.

Katy Yeager, a certified public accountant at Horn Murdock Cole in Silicon Valley, agrees and believes it's a start in the right direction.

"Small companies struggle more by nature," says Ms. Yeager. "They typically have a thin accounting staff and don't have revenues to segregate duties like big companies can."

The SEC also suggested that it allow management to determine the appropriate level of documentation, using risk assessment tools to focus the audit on areas of greatest concern and testing only those controls that have a reasonable possibility of resulting in a material misstatement of the financial statements.

The SEC will spend the next few months studying data and hearing feedback from industry experts, including a newly formed bipartisan group of 22 corporate and financial leaders who are spearheading an effort to loosen the choke hold on public companies.

The Committee on Capital Markets Regulation warned the SEC and the PCAOB that "excessive regulation, problematic implementation and unwarranted litigation, particularly when occurring simultaneously, make U.S. capital markets less attractive and therefore, less competitive with other financial centers around the world."

In its first study, released early December, the committee recommended making it more difficult for the government to indict companies. The committee also told policy makers it wants to make it harder for private lawyers to sue and encouraged the SEC to perform cost-benefit analysis on all rules before they are adopted.