Smaller Firms Are Paying Big To Comply
Monday, May 8, 2006
Smaller companies face disproportionately higher costs than bigger firms to comply with new, post-Enron investor-protection rules, but much of the added burden comes from one-time start-up expenses and confusion over how to begin compliance, a congressional study concludes.
The effect on small and mid-size public companies has been debated since the new rules were adopted by Congress as part of the Sarbanes-Oxley Act of 2002.
The report by the Government Accountability Office, the research arm of Congress, says the full cost and other effects of the new rules won't be known for years because the Securities and Exchange Commission has extended the deadline for small firms' compliance until next year. Even so, the report says, "regulators, public companies, audit firms and investors generally agree" that the law has had "a positive and significant impact on investor protection and confidence."
The report concludes that the SEC -- the federal agency that polices public companies -- must take care to craft regulations that are specific enough to help smaller firms create and strengthen the internal controls mandated by the act at the lowest possible cost. But the SEC must balance that goal with the essential purpose of the new rules, namely protecting shareholders from the fraudulent practices that cost investors billions of dollars in accounting scandals at Enron Corp., WorldCom Inc. and other once-highflying companies.
SEC Chairman Christopher Cox has said the rules implementing the act should not be the same for small and large companies. Small firms have said they want more specific regulatory guidance so they do not waste money on unnecessary procedures. Big companies, by contrast, have requested more general rules so that executives have more flexibility in tailoring them to fit their industry. Sen. Paul S. Sarbanes (D-Md.), the chief architect of the act, also has said he thinks the law can accommodate special rules for smaller companies.
Some executives and members of Congress have called for small businesses to be exempt from parts of the law altogether. In particular, they want an exemption from a provision requiring executives to document -- and an outside auditor to confirm -- that a company has adequate internal controls to prevent employees from abusing company resources or using misleading accounting. Cox, a majority of his fellow SEC commissioners and Sarbanes in recent weeks have rejected those calls.
The study, which is scheduled to be released today, reaches conclusions that appear to bolster arguments of both critics and supporters of the Sarbanes-Oxley Act. The GAO says it found that smaller firms bear a higher compliance cost as a percentage of revenue and that some smaller companies may remain private to avoid having to comply with the law -- two arguments often cited by critics.
However, the report finds that many of the costs are one-time expenses incurred as companies put in place internal accounting controls that should have been implemented long ago under requirements by another, decades-old law. And, while the number of public companies that went private jumped to 245 in 2004 from 143 in 2001, the report says that other factors beyond the new law contributed to the trend and that the proportion of firms opting out of public markets was just 2 percent of public companies in 2004.
The report also found that Sarbanes-Oxley benefited the accounting industry by spurring more companies to hire mid-size and smaller accounting firms, a healthy trend in a business where four big accounting firms dominate.
The study was requested by Sens. Olympia J. Snowe (R-Maine) and Michael B. Enzi (R-Wyo.).