MATT OLBERDING/Lincoln Journal Star | Posted: Saturday, January 7, 2006 6:00 pm
When it was signed into law in July of 2002, the Sarbanes-Oxley Act was touted as the most extensive crackdown on corporate fraud since the Great Depression.
“No more easy money for corporate criminals, just hard time,” President Bush said at the time.
But while the law has seemed to work as it was intended restoring investors’ confidence in publicly traded companies and preventing another corporate fraud like those at Enron or MCI Worldcom it has done so at a cost literally.
There is a debate going on from corporate offices to the halls of government over whether the benefits of the law outweigh the financial costs, especially for smaller publicly traded companies.
In a survey of its members that the Nasdaq stock exchange did in April of 2005, 90 percent of the respondents said they thought the cost of complying with Sarbanes-Oxley was too high.
Various studies, including one done by the University of Nebraska at Omaha, have shown the average costs of compliance to be in the seven-figure range.
Even the government has acknowledged that the costs of compliance may be too high for some companies.
At issue is Section 404 of the law, which requires publicly traded companies to assess the internal controls they have in place to prevent accounting fraud and to have an outside auditor vouch for those controls.
Internal controls are policies or measures a company has in place to make sure laws and regulations are being followed and financial information is being accurately reported.
Last month the Securities and Exchange Commission’s Advisory Committee on Smaller Public Companies voted in favor of reforms that would, among other things, exempt companies of a small enough size from having to use outside auditors to attest to their internal controls and to exempt the smallest public companies from the rule altogether.
If the proposed reforms become law, it would suit Pat Beans, chief financial officer of National Research Corp., just fine.
National Research, a Lincoln company in the health-care performance measurement business, has a market capitalization of about $100 million, small enough that it would be exempt from Sarbanes-Oxley rules if the SEC advisory committee’s recommendations are adopted.
In September the SEC gave those companies an extra year to comply with Sarbanes-Oxley, and Beans said an all-out exemption would be another plus.
“For a company our size, (the government) has probably gone overboard on the compliance,” said Beans, who oversees the company’s compliance efforts.
Beans said National Research has already spent an extra $100,000 working toward meeting the requirements of Sarbanes-Oxley and plans to spend about $350,000 to $500,000 before all is said and done.
That includes a plan to add one or two positions in the coming year to its staff of around 200 to help deal with Sarbanes-Oxley compliance.
“Our current staff can’t do their normal work plus the compliance work,” Beans said.
But National Research’s estimated costs actually are a little less than similar-sized public companies are spending to comply with Sarbanes-Oxley, according to the Nasdaq study.
The study showed publicly traded companies with less than $100 million in revenue spent an average of $535,000 to comply with Section 404 of the law.
TierOne is another publicly traded Lincoln company that could benefit if the SEC committee’s recommendations are adopted.
With a market cap of about $500 million, the banking company would still have to comply with Sarbanes-Oxley, but would be small enough that it would not have to hire outside auditors to doublecheck its efforts.
That could be of great benefit to TierOne.
While the company declined to disclose what it has spent on Sarbanes-Oxley compliance thus far, Vice President Ed Swotek offered a peek into its expenses related to the law, noting that the company’s auditing fees increased substantially in 2004 compared with 2003.
According to company filings with the SEC, TierOne’s audit and audit-related fees more than tripled, from a little more than $150,000 in 2003 to nearly $550,000 in 2004.
Swotek said Sarbanes-Oxley is a good thing, but compliance is a burden, especially on smaller companies.
“What you’re seeing in this latest reform is a message getting through to the SEC that Sarbanes-Oxley is burdensome,” he said.
Lincoln’s largest publicly traded company, Nelnet, is too large to benefit from any of the proposed reforms.
But even for a company with a market cap around $2 billion, the costs of Sarbanes-Oxley compliance are an issue.
Chief Financial Officer Terry Heimes said Nelnet’s costs to comply with the law have been “in the high six figures,” and the company has had to substantially increase the resources focused on compliance.
“Most companies would say the cost of compliance would not be what they would call a good investment from a pure economic standpoint,” he said.
And Heimes said he understands the burden small companies face in meeting the requirements of compliance.
“A portion of that cost of compliance is going to be fixed, no matter what size of company you are,” he said. “That’s why it’s going to put a strain on smaller caps.”
The Nasdaq study bears that out.
While actual costs are lower for smaller companies, when expressed as a percentage of revenue, they are much higher.
For instance, according to the study, the smallest Nasdaq companies spent an average of 1.27 percent of their revenues on Sarbanes-Oxley compliance, while the largest companies spent only 0.03 percent.
A study done for the Big Four accounting firms Deloitte & Touche LLP, Ernst & Young LLP, KMPG LLP, and PricewaterhouseCoopers LLP also shows that audit fees are proportionately higher for smaller companies.
According to that study, audit fees account for about a third of small companies’ Sarbanes-Oxley costs. They are only about a quarter of larger companies’ costs.
But the study also said those costs should fall for companies in their second year of compliance by 42 percent on average for large companies and 39 percent for small companies.
Law’s private’ side
While many companies, large and small, deal with the costs of complying with Sarbanes-Oxley, there is evidence that some companies are saying “no thanks” and staying in private hands.
Initial public offerings of venture-capital backed companies were down 40 percent in 2005, according to figures released last week by the National Venture Capital Association.
The association’s president attributed that drop in part to Sarbanes-Oxley.
“For the IPO market to improve, we need relief from certain hurdles associated with the Sarbanes-Oxley Act,” said Mark Heesen.
Overall, 194 companies went public in 2005, down from 216 in 2004.
Denny Wood, executive director of the Midlands Venture Forum in Omaha, said he didn’t know of any local companies putting off an initial public offering because of Sarbanes-Oxley concerns.
“I really don’t see a lot of that in Lincoln or Omaha,” he said.
Wood said most companies that go public are fairly large and have already weighed all the factors, including Sarbanes-Oxley.
“It probably isn’t a huge deterrent,” he said. “It’s all part of the process.”
The law also appears to be a factor in some public companies choosing to go private.
A study by accounting firm Grant Thornton LLP found that the number of companies going private in 16 months after the enactment of Sarbanes-Oxley rose 30 percent over the 16-month period immediately preceding enactment of the law.
It’s likely most of those companies had other reasons for going private, but at least a few companies have publicly blamed the law for their decisions to go private.
A company with Lincoln ties named Sarbanes-Oxley as a reason for going private.
John Q. Hammons Hotels, which owns the Embassy Suites in dowtown Lincoln and has expressed interest in building other hotels here, went private last year when founder John Q. Hammons bought out other shareholders.
Hammons said at the time that Sarbanes-Oxley played a role in the decision, telling the Springfield (Mo.) News-Leader, “We left Sarbanes-Oxley by the side of the road.”
Local companies say the issue has come up, but it has not affected their plans.
Nelnet went public in December 2003, long after Sarbanes-Oxley came into being.
Heimes, the CFO, said the law was definitely a consideration for the company.
“It was something our board of directors took very seriously,” he said.
But he said the company viewed it as simply a “byproduct of going public.”
National Research, sizewise, would be the most likely of Lincoln’s public companies to consider going private, and CFO Beans said people have asked about the possibility.
“The topic comes up,” he said, “but I don’t think we will.”
While companies are quick to point out the flaws in Sarbanes-Oxley and its high costs, most people agree it has been beneficial, especially in restoring investors’ confidence.
“I think it’s been good,” said TierOne’s Swotek. “I think it’s brought some more trust back to the investing public.”
And while that trust may come with some increased costs, so be it.
“The biggest issue from an investor standpoint is noncompliance,” said Nelnet’s Heimes. “The cost of compliance is high, the cost of noncompliance is higher.”
Reach Matt Olberding at 473-2647 or molberding@journalstar.com.
Proposed reforms
The Securities and Exchange Commission’s Advisory Committee on Smaller Public Companies has proposed these reforms to the Sarbanes-Oxley Act:
* Companies with a market capitalization up to $125 million and annual revenue less than $125 million would be exempt altogether from the rule requiring management to attest that the company has adequate internal control over its financial reporting, and has tested those controls and found them to be effective. Market capitalization is a measure of value calculated by multiplying the price of a company’s stock per share by the number of shares outstanding.
* Companies with a market cap of up to $750 million and revenues less than $250 million would be exempt from the rule requiring external auditors to attest to the strength of their internal controls.