Firms Cram for Passing Grade on Sarbanes

Updated from 4:14 p.m. EST

Hundreds of public companies soon may get a failing grade on a key Sarbanes-Oxley-related report. As disturbing as that may sound, some observers are more worried about how investors will react to such news.

Many observers consider the reports, which were intended to prevent the next Enron-type debacle, to be the key provision of the Sarbanes-Oxley Act. But some accounting experts and regulators are warning investors that just because a company turns in an imperfect report doesn't mean it's a corporate scandal in the making.

"It's important that investors have an understanding of what the material weakness is," added Erica Sulkowski, special adviser to the chief accountant of the Securities and Exchange Commission.

But Grace Hinchman, senior vice president of Financial Executives International, warned, "The public at large may not understand that. That's a real concern."

However, some corporate watchdogs think companies have little excuse for the poor reports, which concern a company's so-called internal controls.

That so many companies may get a failing grade on their internal controls reports is "really fascinating," said Nell Minow, founder of the Corporate Library, a watchdog and research group. "They were supposed to have these controls in place for 30 years, and only now are figuring out that there's a problem."

Internal controls are essentially a system of checks and balances designed to prevent corporate fraud. An example of such a control might be a provision that the person in charge of approving expense reports not be the same person who is in charge of cutting checks.

While federal law has long required public companies to have such systems, Sarbanes-Oxley mandated companies for the first time to assess annually the state of their controls, and required auditors to scrutinize them as well.