The Future of Sarbanes-Oxley

This week we have a post by a guest author:

Scott A. McPherson, CPA, CFE, CVA

Ah, Sarbanes-Oxley. It’s that albatross that has hung around so many business owners’ necks since it was unfurled in 2002. No wonder one of the top questions I’m asked is, “Scott… what do you think the future of SOX will be?”

Since I’m not gifted with the powers of 100% accurate prognostication, I can only speculate as to where the Sarbanes-Oxley Act will head in the coming years. However, based on the current economic climate, the intense debate surrounding the regulations and the media it’s been getting, I’ve put together a few predictions:

1. Small Businesses Will Continue to “Rage against the Machine”

For small businesses that are publicly owned, Sarbanes-Oxley has brought larger financial ramifications than it has for monolithic corporations. Thanks to the fixed costs associated with SOX compliance, those smaller businesses are forced to spend a larger percentage of their revenues on SOX-related measures.

Of course, the SEC has granted several SOX extensions to small public companies, namely those dealing with Section 404. The next is scheduled for June 15, 2010. However, no one is jumping for joy at the news. This constant pushing back of SOX deadlines is akin to being on death row and receiving a stay of execution. Sure, you’re glad that you’re not going to the electric chair right away, but you’re still on death row.

Fortunately, unlike a prisoner, small businesses are free to fight back politically and legally. I think you’re going to see plenty of that as the next Sarbanes-Oxley deadline for small businesses closes in.

2. SOX Will Undergo Revisions

The Enron scandal that created Sarbanes-Oxley is coming up on its 10-year anniversary, and the memory of the problems that precipitated SOX are waning in the minds of the up-and-coming generation of entrepreneurs and execs. Consequently, I think you’re going to see some minor – and perhaps even major – revisions when it comes to the way that Sarbanes-Oxley will shape the future of the business world.

Currently, many politicians and business leaders have set their sights on reshaping SOX. Truly, not a day goes by that financial bloggers around the world aren’t discussing Sarbanes-Oxley. Some find it praiseworthy, others find it loathsome. But all find it highly interesting and relevant, and that keeps SOX in the public’s eyes and minds.

Though this may sound like great news, it’s important to be realistic… so I have to say that…

3. SOX Is Probably Not Going to Significantly Change for Many Years

Given the fact that laws are tough to change, the chances of SOX going away tomorrow are nil. That means that all businesses – especially public small businesses – need to be prepared.

Last year we notified small public clients of procedures that should be taken. Most said “Let’s wait and see before incurring unnecessary costs given the economic climate.” The SOX audits loom over these businesses again this year and most are expecting another reprieve. Again we will reiterate last year’s notification of procedures that should be taken, and again we will probably wait on the enforcement ruling.

So will my Sarbanes-Oxley forecasts come true? I don’t know. But I do know that it’s absolutely critical for any publicly-owned business (or business that’s considering going IPO) to stay up to speed on the direction of SOX today and tomorrow.

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Sarbanes-Oxley: Could it be Eliminated?

The world continues to change, and not always in the same direction. Just as we are moving to an environment of more regulation in the wake of the crises of the last two year, someone is trying to yank the wheel of the regulatory machine and pull it in the other direction, toward less regulation.

 Michael Carvin and Noel Francisco are two Washington lawyers attempting to topple the mighty Sarbanes-Oxley Act, also known as Sarbox, or SOX. For an explanation of Sarbox, see my previous post.

Why attempt such a thing?

They are representing Brad Beckstead, a CPA in Nevada, who is not happy with the Pubic Company Accounting Oversight Board (PCAOB). The PCAOB was created under Sarbox to regulate auditors. The intent was to not have a rerun of the Enron scandal, when auditor Arthur Andersen performed a less than rigorous audit of Enron.

One of the intentions of Sarbanes-Oxley is to audit the auditors. Makes a lot of sense in theory. What Brad Beckstead says is that the Sarbanes-Oxley act was written for the big four accounting firms and Fortune 500 companies, and for smaller public companies the cost of audit and compliance is prohibitive.

No less than Ken Starr, the U.S. Solicitor General under President George H.W. Bush, makes the argument that there are many problems with Sarbanes-Oxley as it stands now. This call for adjustment of Sarbanes-Oxley does not come only from the political right. Senator John Kerry, a Democrat, introduced a bill in 2006 to reduce the regulatory burden on companies with a market capitalization less than $75 million.

Back to the BusinessWeek article.

The impetus for Beckstead to challenge Sarbox happened in 2004, when in a “grueling” audit in 2004, the PCAOB “picked apart his business”. He had to close his auditing practice because of the cost of compliance. Fortunately, this situation was noticed by the Free Enterprise Fund, an advocacy group aiming to reduce government and promote economic growth.

Carvin and Francisco argue that the PCAOB, currently appointed by the SEC, should be appointed by the President. The main problem is that the PCAOB is not under the control of the President; it is appointed by the Securities and Exchange Commission (SEC). Why does this matter? Because of the great economic impact of the PCAOB. It does not even have congressional oversight. Defenders of the PCAOB say it is not as powerful an organization as its detractors suggest.

But – if Sarbox is overturned, what about the post-Enron regulating spirit? Will it all fall? Former chairman of the SEC Harvey Pitt said that the Sarbanes-Oxley act was part of a national response to the accounting scandals in the early 2000s. Some have pointed out that if Sarbox is reexamined, what about other appointments? Sure enough in recent weeks, we have seen interest in reexamining the whole situation regarding the Federal Reserve.

In the wake of the Enron and other accounting scandals, the hope was that another debacle happening at publicly owned companies and affecting innocent ordinary people would not happen again. Instead, we ended up with the housing boom and bust, the subprime mortgage mess and the subsequent financial crisis affecting all of us in the United States, and extending far beyond our country’s borders.

There are some who argue that in this time of great recession, Sarbox is functioning as a giant drag on the economy for mid-size to smaller public companies. The cost of compliance has multiplied from the days before Sarbox, many public companies have chosen to delist, private companies have chosen to finance with debt instead of equity, and worst of all, the act has not prevented further wrongdoing.

But former Senator Sarbanes, former Representative Oxley and former PCAOB chair Mark Olson all defended Sarbox and argued that internal controls have strengthened, fraud has been prevented and investors were given more confidence. (Whatever confidence investors had, I’m sure has evaporated during the recent financial events!) Brad Beckstead, who prompted the Free Enterprise Fund to action, calls the Sarbanes-Oxley act a barrier to entry for small and startup companies because audit and compliance costs are so high. Even the Government Accountability Office (GAO) reported that the costs of compliance have increased by approximately eight times. Eight! Common sense tells us smaller companies must be having a difficult time in this recession; consider the result if they could cut some costs.

Unrelated to Sarbox, in Fall of 2009 a Democrat, Senator Dodd, is calling for a reexamination of the financial regulatory system. Seems like they always find some way to jump into action after a crisis, but never before. However, in true Democrat fashion he wants to put into place something even bigger and more powerful. Regarding the Federal Reserve, BusinessWeek points out the Fed governors have fixed terms and the President has limited ability to remove them. Somehow the American people don't seem to be bothered by that fixed system.

Should small companies be exempt from Sarbox? Beckstead certainly thinks so. Even John Kerry, a Democrat, thinks so. Carvin and Francisco seem to have their work cut out for them, decreasing regulation in a regulation-happy administration. Stay tuned for more news on December 7.

Sarbanes – Oxley 101

Sarbanes – Oxley is a piece of compliance legislation that was enacted in 2002 after the accounting scandals at Enron, WorldCom, Adelphia, Tyco and Peregrine Systems. This act is intended to increase regulation of boards and management of publicly owned companies, and the accounting firms which audit those companies. The act is also known as the Public Company Accounting Reform and Investor Protection Act, and created the Public Company Accounting Oversight Board(PCAOB).

This act relates only to publicly owned companies.

There are 11 sections of the act, enforceable by the SEC. The sections cover corporate accountability and governance, and set in place stronger penalties for violations.

The act was designed to strengthen internal controls in publicly owned companies, improve transparency, bolster investor confidence.

Supporters say these controls have worked, and have been beneficial to cutting down on potential future scandals. Critics say the cost of compliance is too high and restrains economic growth.