U.S. Sen. Paul S. Sarbanes calls the corporate governance law that bears his name, the Sarbanes-Oxley Act, the “most far-reaching improvements in the protections for American investors since the Securities and Exchange Commission was established 70 years ago.”
A little more than two years after its enactment, some Maryland business leaders have other — perhaps less complimentary — opinions of the law.
“It’s very costly,” said Robert W. Kurtz, president and CFO of First United Corp. of Oakland, the financial holding company of First United Bank & Trust, which has branches in Frederick and other Maryland counties.
Kurtz estimated that his bank, which has assets of $1.2 billion, has spent about $500,000 on additional accounting, auditing and support staff, fees and other services to comply with the law.
First United is by no means alone. Nationwide, businesses’ average cost of complying with Sarbanes-Oxley has been almost $2 million, according to a recent survey of 321 companies by Financial Executives International, a trade organization in Florham Park, N.J. That includes about 12,000 additional hours of internal work and 3,000 hours of external work, with average auditor fees of $590,000, an increase of 38 percent over the previous year.
MedImmune, a Gaithersburg biotech company, is spending more than the average to comply — “at least in the mid-single-digit millions,” said Jamie Lacey, a MedImmune spokeswoman.
Estimates for the total tab paid by U.S. companies this year are as high as $5.5 billion, a survey of CEOs by AMR Research of Boston found.
The law is designed to help end the accounting fraud and other corporate scandals that caused bankruptcies at Enron, WorldCom and similar public companies in 2001 and 2002, resulting in thousands of lost jobs, billions in lost investment savings and dozens of corporate indictments and convictions.
The measure strengthens accountability standards and criminal penalties for wrongdoing, creates a private regulatory board and prohibits companies from lending money to their top executives.
Some of Sarbanes-Oxley is already in effect, including a requirement that chief executive and chief financial officers vouch for all financial statements.
Businesses scramble to comply with Sarbanes-Oxley Act
One particularly expensive provision, Section 404, requires companies to establish internal auditing controls, warn shareholders of any problems and get independent auditors to verify the changes. Most large public businesses face a Nov. 15 deadline to comply with that section. An SEC official recently said some other portions, such as counting stock options as expenses, may be delayed.
Not surprisingly, officials at accounting firms, which are getting plenty of new work because of the law, are generally enthusiastic about Sarbanes-Oxley.
James H. Quigley, CEO of New York accounting firm Deloitte & Touche, which has offices in Maryland, praised the law when he testified last month before the House Committee on Financial Services, chaired by Rep. Michael G. Oxley (R-Ohio), the legislation’s other main sponsor.
The law’s internal control requirements may be costing companies more money, Quigley said, but those costs represent a small percentage of the companies’ invested capital and can help eliminate redundant systems to boost investment returns.
Also, companies’ audit committees meet more frequently and for longer periods, and thus are more involved in making sure businesses’ figures are accurate, Quigley said.
“The need for increased financial reporting oversight and enhanced safeguards for investors has been recognized, and companies are responding,” he said.
The law has also been good for workers whose retirement pensions are often invested in capital markets, said Richard L. Trumka, secretary-treasurer of the AFL-CIO. He estimated that union members lost $35 billion from the Enron and WorldCom debacles alone.
Kurtz said he recognizes such positive parts, but the series of checks gets to be redundant and can’t always be considered foolproof.
“Just because we have auditors signing off on internal controls, that won’t necessarily stop anyone from being crooked,” he said.
Some companies go private
When Sarbanes-Oxley was passed, some observers predicted that many public companies would simply go private to avoid its additional expenses and scrutiny.
A few more public companies did make the switch last year — 85, compared with 80 in 2002 and 49 in 2001, according to New York business information company Thomson Financial.
Aronson & Co., a Rockville accounting and consulting firm that has numerous public company clients, has recently helped public companies go private, said Lisa J. Cines, a certified public accountant and managing officer.
“Some might be better off being private,” she said. “Each one is different.”
Aronson employees are busy these days, though the pace is not as frantic as one might expect, Cines said. “We’re not working a lot of overtime,” she said. “But employees who can work overtime are asked to do so.”
As a private company, Aronson doesn’t have to comply with the overall act. But because it audits public companies, it has to register with the new Public Company Accounting Oversight Board, another creation of Sarbanes-Oxley, and be audited by that organization every three years.
Earlier this year, the SEC barred Ernst & Young, a New York Big Four accounting firm with an office in Baltimore, from adding new public clients for six months because it violated rules governing auditor independence when it formed a joint business with client PeopleSoft, a software provider in Pleasanton, Calif.
Public companies are having more difficulty finding independent auditors, Cines said. A company’s internal auditors can work on many of the new requirements, but an outside auditor has to be hired to test internal controls to guard against conflicts of interest.
“The Big Four accounting firms are being more selective in choosing clients,” she said.
Still, most of Aronson’s clients are trying to look on the bright side, Cines said. “Most companies are saying there is some good to Sarbanes-Oxley,” she said.
Tax and consulting firm RSM McGladrey of Bloomington, Minn., has worked with an affiliate accounting firm, McGladrey & Pullen LLP, to develop an internal control process for clients complying with Sarbanes-Oxley, said Dara Castle, a managing director with the Bethesda offices of RSM McGladrey.
“RSM McGladrey has worked successfully with McGladrey & Pullen through an alternative practice structure to develop a strong internal control process that helps our clients avoid risk, and properly assess and mitigate risk when the situation dictates,” Castle said.
Most clients have good internal controls but lack the formal documentation, assessment and testing of those controls, Castle said.
The compliance costs are among the top concerns for companies, especially smaller and mid-sized ones, said Imtiaz Hussain, manager of risk management services with the Bethesda offices of RSM McGladrey.
“After the initial year, those costs will decline for companies,” he said.
Banks and other financial institutions already face a good deal of regulation, so the additional steps taken to comply with Sarbanes-Oxley are not overly burdensome, said John Bond Jr., chairman and CEO of Columbia Bancorp, parent company of Columbia Bank. Many of Columbia’s 24 branches are in Montgomery and Prince George’s counties.
“It hasn’t been a big problem, but the act does make us do more to get ready for outside auditors,” Bond said. “We were already ahead of much of that in Section 404.”
Some companies have hired a chief compliance officer or at least designated a senior manager to track the complex set of changes under Sarbanes-Oxley. In many cases, the compliance officer reports directly to a company’s audit committee, rather than the chief executive, to provide more independence.
Others have purchased specific software to help them comply. Lockheed Martin Corp., the Bethesda aerospace and defense giant, employs a package from Longview Solutions, a Canadian software provider, that consolidates the company’s tax and accounting systems. Bresler & Reiner, a Rockville real estate investment trust, uses Web-based software from Axena, an Orlando, Fla., technology company, that documents and tests controls and assesses risk. Bresler has also developed a 10-year compliance plan.
Signs of effectiveness
The new law has been effective in helping investors “better understand a company’s true financial picture when they make a determination whether to invest in that company,” Sarbanes (D) of Baltimore said in a statement to mark the law’s second anniversary in late July.
“We are seeing more active involvement by independent directors — as the law requires — better internal controls and more robust disclosure,” he said. “We have also succeeded in nearly doubling the budget of the SEC to hire more staff and investigators. The SEC has moved quickly to issue the rules required to implement the legislation and to review new rules issued” by the accounting oversight board.
One key measure of the law’s efficiency is the lower ratio of accruals to revenues. The ratio declined by about half in the two years under Sarbanes-Oxley when compared with the previous two years, according to a study of more than 6,000 public companies by the Kellogg School of Management at Northwestern University.
Accruals is the practice of overestimating sales to inflate a company’s financial picture; even before Sarbanes-Oxley, accruals could result in steep fines.
The SEC has also stepped up enforcement, enacting 679 actions against companies or business officials in fiscal 2003, about 14 percent more than the previous year. While the pace for 2004 so far is behind last year’s, the SEC is imposing larger fines, most reached after negotiating settlements.
For example, nine of the 12 settlements of at least $50 million since 1986 have come in the past year.
Courtesy of The Gazette