Corporations such as Intel with a highprofile presence in the East Valley are spending millions of dollars and devoting hundreds of thousands of people hours to comply with it.
Many smaller, public corporations could go private because the cost of compliance is too high.
And while most everybody agrees it’s a good thing, they are still concerned about how it will affect corporations and their ability to prosper in the coming years.
It’s the Sarbanes-Oxley Act of 2002, a far-reaching set of laws aimed at corporate reform. Public companies already struggled to comply with Section 302, which requires chief executive officers and chief financial officers to review all quarterly and annual financial statements, and certify that all statements are accurate.
Now, public companies are facing an even tougher deadline of Nov. 15 to comply with Section 404, which requires chief executive officers and chief financial officers to publish information on an annual basis concerning the scope and adequacy of their internal control systems with evidence that the systems can catch anything that could cause a misstatement.
Congress quickly passed Sarbanes-Oxley to crack down on corporate fraud in the aftermath of Enron, WorldCom and others that rocked the corporate world and severely damaged investors’ trust. It also addresses such issues as board composition and duties, and director compensation.
"It was absolutely necessary, and it’s too bad because most companies were pretty much playing the game in a very fair manner," said Herb Baum, CEO of Scottsdalebased Dial Corp. "I think they’ve tightened up things a whole lot and put an accountability measure into the whole process."
Baum also serves on several boards of directors, including those of America West Holdings, PepsiAmericas, Meredith Corp. and Action Performance, and other, smaller companies.
Whether the reforms can prevent future unethical and unlawful behavior remains to be seen, said Amy Hillman, an associate professor in the W.P. Carey School of Business at Arizona State University.
"But I think we’re definitely headed in the right direction," she said. "We know that there are changes being made in boardrooms across the United States, and we can assume that those changes are going to make for better boardroom decision-making."
RACE TO COMPLIANCE
Evan Burks is senior vice president of ComForce Corp. and runs the company’s technical services division, which is based in Mesa. The national staffing company provides information technology, auditors and other types of professionals to companies, and is experiencing a jump in demand for professionals with knowledge of Sarbanes-Oxley.
"I don’t think that companies, at least as recently as six months ago, truly had their arms around the process," Burks said. "So that’s why we’re getting called. They’re finally starting to realize that we have some serious potential issues here and we need to get personnel on board to help us tackle these issues, these potential problems."
The last thing a company wants to do is have to make a public disclosure in January that they are not in compliance with Section 404 and list the reasons why, he said.
"If you’re not in compliance, I’m wondering what that does to shareholder lawsuits or shareholders who might have a problem with a particular company," Burks said. "There’s a lot of far-reaching implications of not being in compliance with this."
Public companies are scrambling to get their accounting processes documented, and that takes a lot of extra employee hours, he said.
"It’s going to take a lot of internal review, a lot of assessing of their policies and changing of policies that aren’t quite up to muster with regards to the requirements," Burks said. "Since there hasn’t been a lot of case law out there, companies were unsure how to proceed. This isn’t going to be an easy process. It’s not going to be a matter of having two folks in a back room working on compliance."
In addition, corporations are going to have a tough time complying with Section 409, which will require rapid disclosure of information on material changes in a company’s financial condition or operations, he said.
Despite the headache, Sarbanes-Oxley is a good thing for corporate America because it will provide shareholders with an added sense of security, he said.
"It’s designed for the long term, that even if the economy does take a hit, it’s because of the underlying economic situations, not because companies aren’t properly reporting their financial conditions and inflating their values," Burks said.
Intel spent millions of dollars last year on Sarbanes-Oxley compliance and will spend twice as much this year, said Cary Klafter, the hightech giant’s vice president of legal and governmental affairs, and corporate secretary.
"It’s a combination of both employee time and also the necessity of acquiring new software or otherwise getting support from third-party service providers," he said.
Intel is in the process of documenting all internal accounting controls, Klafter said. After that, it will create a process for management assessment of those controls, he said.
"And then we have to have all of this work audited by the independent accountants because they are now responsible both to give an opinion about management’s review of internal control and also give their own opinion," he said. "That requires a lot of additional work on the part of the external accountants. That’s clearly the most expensive single prov ision in Sarbanes-Oxley."
Intel can afford to spend millions on compliance without skimping on other areas, such as research and development, Klafter said. But smaller public companies aren’t that lucky, he said.
"What it has done is raise the bar with respect to the amount of revenue and profit necessary . . . to be able to effectively afford that status and at the same time at the end of the day wind up with a sufficient return for investors," he said.
The cost to comply is onerous for companies of all sizes, but it’s "disproportionately onerous on the smaller public companies," said Jack Henry, president of the Arizona Chapter of the National Association of Corporate Directors. He retired in 2000 after working 34 years with defunct accounting giant Arthur Andersen. He spent the last 18 of those 34 years as managing partner of the firm’s Arizona practice.
Henry serves on the boards of directors of several public companies, including Tempebased Vodavi Technology and Phoenix-based White Electronic Designs Corp., and on the subsidiary board of Harris Bank Arizona.
He also sits on two private company boards.
"I would say anyone under $500 million in revenue will at least have to consider whether or not they want to stay public," he said. "It might even be positive if these companies go private."
In addition, the bigger accounting firms with large public company client lists are saying they don’t have enough people to get all of the work done for compliance, Henry said.
"I don’t think anybody intended (Sarbanes-Oxley) to be that onerous," he said. "If it’s costing a lot of companies much more than the benefits that are derived, then you would hope over time it would be adjusted and there would be more reason in the process."
Compliance is costing most companies "a couple of pennies a share" so in the long run the shareholders are paying for it, Baum said.
"But it’s absolutely necessary," he said. "Corporate America had gone astray, and this put everything on the straight and narrow."
WON’T STOP ALL CROOKS
Tying top management compensation to stock and stock options without increasing audit standards helped create the unethical and illegal behavior that resulted in corporate scandals, said Jeffrey Coles, chairman and professor of the W.P. Carey School of Business department of finance.
"The idea was let’s align CEO and top management incentives with those of shareholders by making their payoffs a little bit like shareholder payoffs," he said. "The things that (resulted) involve fraud and off-balance sheets, funny business, special-purpose entities and related-party transactions. These are things that were meant to sort of pump up shareholder wealth artificially in order to enrich top managers."
As for increased regulation, it’s not going to stop unethical people from continuing to do whatever it takes to further their own interest regardless of the law, Coles said. It could, however, unduly constrain companies from performing to the best of their ability, he said.
History tells us that no matter what laws are passed, unethical people will find ways to remain unethical, Henry said.
"If I were on the other side and I wanted to pull one off, I think I could do it," he said. "I don’t know how long I could keep it hidden, but I could keep it hidden long enough to create damage. This might reduce the likelihood of it, but bad guys are going to find a way to do it."