Sarbanes' Pain Getting Sharp for Some

The deadline to comply with a key provision of the Sarbanes-Oxley Act is fast approaching, and already companies are warning they may not meet the target date -- or will only do so after incurring huge costs.

The controversy focuses on a section of the landmark law that requires companies to document their so-called internal controls for preparing financial reports. The law mandates that companies' auditors evaluate their assessment. Companies with fiscal years ending on Nov. 15 will be the first to have to comply with the provision when they prepare their annual reports.

Some companies and business groups are calling the internal controls rule overkill, part of an overreaction by policymakers to Enron, WorldCom and other corporate scandals.

"I don't think drafters in the [Securities and Exchange Commission] and Congress anticipated the extent of the cost and management time that this is taking," said David Hirshman, senior vice president at the U.S. Chamber of Commerce. "The concept of stronger controls may be sound. But at some point you have to say, 'Is there a smarter way to do it?'"

But corporate critics counter that the provision is simply a cost of doing business, one that wouldn't take much time or effort if companies had been doing things properly all along.

"This is another situation where corporate America is looking for another excuse not to do the right thing," said Nell Minow, founder of the Corporate Library, a watchdog and research group.

Whether legitimate or not, the complaints are starting to pour in:

• Last week, wireless-networking company UTStarcom(UTSI Quote) warned that it might not meet the deadline for complying with the internal controls rule. The warning followed a delay in the company's quarterly report and an admission by the company that its controls on revenue recognition had "deficiencies."
• In recent weeks, Homestore (HOMS Quote) and Media General (MEG Quote) missed analysts' quarterly earnings expectations. Both companies attributed their disappointing results in part to rising administrative costs related to complying with Sarbanes-Oxley.
• While not necessarily missing estimates, companies such as Audible (ADBL Quote), Hot Topic (HOTT Quote), Sharper Image (SHRP Quote), La Quinta (LQI Quote) and others all have warned that conforming with the internal controls rule already has resulted in increased costs, and that those costs will weigh on their bottom lines in coming quarters.

Internal controls are essentially a system of checks and balances designed to prevent and detect fraud and errors. Such a system might require, for instance, that an employee who mails invoices is different from the person who counts the checks that come in from customers.