Firms Feel the Sarbanes Slam

For many companies, complying with a key provision of the Sarbanes-Oxley law is proving to be a tough task. But who's to blame and whether the chore was worth the effort are up for debate.

The provision calls on companies to assess and -- for the first time -- report on the state of their internal controls, a system of checks and balances over financial accounting that are designed to prevent corporate fraud. In recent weeks, hundreds of public companies have warned investors either that they have significant problems with their controls or that they won't be able to finish their reports in time to meet a mandated deadline. Meanwhile, estimates of the cost of complying with the provision keep growing.

"We're now in the final stages, and it is just a freaking mess," says Jeff Brotman, a professor of accounting at the University of Pennsylvania's law school and the managing partner of Philadelphia-based Ledgewood Law Firm.

After delaying implementing the provision several times, the Securities and Exchange Commission required that the larger public companies -- those with market capitalizations of $75 million or greater -- include their internal controls reports on annual reports filed beginning last month. The SEC gave smaller companies an extra 45 days to file their reports.

With many companies' reports due by last week, the data indicate that quite a few are having problems with compliance:

Of the more than 2,600 companies that had filed their annual reports by March 16, some 289 of them -- or 11% -- had warned of material weaknesses, according to data compiled by the Corporate Executive Board (CEB). Among the companies disclosing weaknesses: OfficeMax (OMX), Chiron (CHIR) and MCI (MCIP).

Another 291 companies with market caps over $75 million have warned investors this year that they will be late in filing their annual reports, according to the CEB. That's up from just 65 companies last year. While not all of those are related to complying with the internal controls provision, "roughly half" are, says Eisha Tierney Armstrong, managing director of the CFO Executive Board division of the CEB. Among those asking for more time to deal with the compliance provision: Cray (CRAY), PC Mall (MALL) and Carrizo Oil & Gas (CRZO).

The actual cost of complying with the internal controls provision was about 39% higher than companies were expecting to spend, according to a survey by Financial Executives International. For the 217 companies surveyed, which had an average of $5 billion in revenue, the average cost of compliance was $4.36 million, according to FEI. That was in addition to regular auditing fees, which have also been on the rise, FEI said.

Analysts have blamed compliance problems on a number of factors. Worried about their financial liability, accountants seem to have taken a hard line on internal controls, dubbing even minor problems a "material weakness," some analysts complained.

Brotman, for instance, who advises a number of corporate clients, has heard of companies being cited for "material weaknesses" for reporting information in the wrong footnote in their financial reports or because the minutes of a board meeting weren't signed by the secretary until the next meeting.