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Monday, January 31, 2005

Sarbanes-Oxley's costs more than anticipated

The recent rash of corporate scandals has created both attitudinal changes among skeptical consumers and stockholders, and legislative changes that have forced public companies to radically alter the way they keep tabs on their accounting practices.

The 2-year-old Public Company Acc-ounting Reform and Investor Protection Act (more commonly known as Sarbanes-Oxley) requires companies to have more independent oversight of their accounting functions. These requirements have some companies spending more or altering schedules to abide federal regulators.

Michael Dollins of Birmingham-based accounting firm Dent Baker & Co. LLP says well-publicized scandals such as Enron Corp. and WorldCom Corp. "shook the confidence of investors."

Sarbanes-Oxley "is supposed to create corporate accountability and restore the investor confidence," he says.

Richard Turpen, associate professor and director of the University of Alabama at Birmingham's Accounting Graduate Pro-gram, says that the scandals created a need for dramatic changes.

"While accounting abuse is nothing new, the sheer number and magnitude of these deceptions outraged the public, and Congress felt compelled to do something about them," Turpen says.

Honesty, accuracy
The law requires public companies to follow a number of steps to ensure honesty in its accounting practices. The four primary steps, according to Dollins, are:
(1) The establishment of the Public Company Accounting Oversight Board that will oversee the audits of all public companies;
(2) Certification of each annual or quarterly report by the principal executive officer or officers and the principal financial officer or officers;
(3) Protection for employees (otherwise known as whistleblowers) who provide evidence of fraud against the publicly traded company that employs them; and
(4) Repayment by the executive officers of companies of any incentive pay they receive if the company has to restate financial statements due to fraud.

"The most significant steps are those requiring senior management to certify reports filed with the Securities and Exchange Commission," Turpen says.

"Corporate CEOs and (chief financial officers) must now provide certifications covering a wide range of reporting aspects such as the accuracy of report contents, the fair presentation of financial statements, disclosure controls and procedures, and controls over financial reporting."

The most eyebrow-raising part of the act has been Section 404, which requires written documentation of the internal controls.

According to Anthony Joseph, a partner at the law firm Johnston Barton Proctor and Powell LLP, it requires public companies to "establish and maintain internal controls over financial reporting, assess the effectiveness of such controls and then be able to show this effectiveness on paper."

Turpen says the documentation, which is to be included in a company's annual report to the SEC, must be attested to by the corporation's external auditing firm.

Added costs, duties
These new requirements are quite substantial for corporations because they create the need for additional manpower and financial investment.

"To develop support for these certifications, companies have had to hire additional staff, especially in accounting and information systems since much of the work involves studying and documenting internal controls and reporting processes," Turpen says. "Compliance also means greater involvement of the corporate attorneys and, of course, the external auditors."

The financial investment required of Sarbanes-Oxley is perhaps the biggest change for public companies under its umbrella - and the investment is more than most anticipated.

"The SEC predicted that the cost would average around $91,000 per company. Costs have far exceeded that estimate," Dollins says.

"Company estimates are into the millions of dollars. In addition to cost, employees are being taken off their normal duties to assist with the documentation, which is causing reduced productivity," he adds.

Impossible to stop
Opinions are mixed on the success of Sarbanes-Oxley.
Some say the law has reasserted many controls that have been in place for years but have not been practiced. "Most of the basic conceptual points were expected already," Joseph says of Sarbanes-Oxley.

Turpen says Sarbanes-Oxley has forced companies to take a critical look at key accounting processes and controls, and to implement improvements. In that sense, he says, the act can be seen as a success.

Dollins says some companies are reaping secondary benefits from Sarbanes-Oxley. One example of this, he says, would be a company finding more efficient ways of processing invoices after documenting how shipping invoices are entered into accounts payable systems.

There are other sides to the story, however, and many experts question the fairness and effectiveness of the new law.

The reality, many say, is that fraud is not always easily detectable and no law can completely rid public companies of some level of dishonesty.

"Section 404 does not guarantee or protect the company from fraud at every level. No one will ever be able to guarantee that fraud will not happen," he says.

"The major criticisms focus on the costs to comply - which are clearly huge - and the time that compliance efforts take away from core operations," Turpen adds.

"Some critics would also argue that the act has resulted in too much attention being devoted to detailed procedures and very little directed toward the more serious threat of fraud perpetrated at high levels of management."

The Scrushy trial
In Birmingham, special attention will be paid to the law because of the Richard Scrushy trial. Some say that the trial also will be a test of the new law.

"No matter the outcome (of the trial), I believe that Sarbanes-Oxley will survive because holding executives accountable for the financial information is long overdue," Dollins says.

Turpen agrees, adding that the law is a step in the right direction. Its merits will continue to be debated, he says, because there will be no way in the future to tell how many frauds or questionable financial reporting practices it prevented.

"It was designed to restore investor confidence in investor corporations," Joseph says. "If it does that, then it's a success."

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