Sarbanes Sensibility Seeps In

Despite complaints of legal oppression, corporate transparency seems to be improving.
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Could Sarbanes-Oxley be working?

Four years after the financial scandals rocking

Enron

and other large companies prompted Congress to toughen disclosure and governance laws, defenders and detractors of the legislation remain as divided as ever over whether the high costs of compliance are worth whatever benefits it's bringing about.

To date, defenders have had a hard time making their case, if simply because the law wasn't crafted as a quick fix but as a solution that would gradually yield benefits over time. Critics of the law had plenty of ammunition as auditing fees shot up into the millions for most companies.

And there have been many critics. Last year, Financial Executives International said that 94% of companies it surveyed felt the costs were outweighing the benefits. In February, the executive recruiting firm Korn/Ferry found that 58% of corporate board directors felt the law "should be repealed or overhauled."

However, another, less-publicized survey from Deloitte showed that companies do expect benefits to kick in over the next few years: 71% said Section 404 -- the most contested provision, which requires complex internal controls -- would help them better understand and mitigate risks, while 67% said it reduced material misstatements. Other benefits included a stronger corporate culture and more confidence in their financial reports. Only 6% were expecting no benefits at all.

"None of us likes more regulation, but I actually think SOX 404 is helpful,"

General Electric

(GE) - Get Report

CEO Jeffrey Immelt said in a letter to shareholders, noting that GE had spent $33 million on compliance in a single year. "It takes the process control discipline we use in our factories and applies it to our financial statements."

Granted, CEOs penning shareholder letters try to put a sunny light on all expenditures, but Immelt's point suggests something many investors are waking up to: The best-run companies would be taking controls seriously even without the law. And if a company's financial controls are in disorder, you have to wonder: What else isn't working?

It's not just companies such as GE (as well as

Dow Chemical

(DOW) - Get Report

and

Eli Lilly

(LLY) - Get Report

) whose executives have said compliance helps them. Many entities that aren't required to comply are doing so anyway. The law firm of Foley & Lardner found that 80% of nonprofits and 64% of private companies are making changes to meet Sarbanes-Oxley standards, even though the law doesn't apply to them.

Still, many companies are quietly fighting Sarbanes-Oxley. The onerous costs and obligations demanded by the fledgling law are driving more than a few smaller companies away from

raising capital in the U.S. public markets. And the perception is that larger companies forced to bite this governance bullet are doing so with great reluctance.

Consider: Companies have spent a total of $14 billion on Sarbanes-Oxley compliance since the act was signed into law, says Korn/Ferry. AMR Research estimates that the corporate world will spend another $6 billion this year -- which seems like quite a cost.

But look at those costs from another perspective. CEOs of the 500 largest companies in the U.S. were paid $5.1 billion in 2004 alone. That figure doesn't include other highly paid executives at those 500 companies, or any executives at the thousands of other companies facing Sarbanes-Oxley compliance.

Investors also seem less than thrilled with the new rules. Many are left with the impression that the law, for all its best efforts, isn't working so well. A Harris Interactive poll showed that 55% of U.S. investors felt the laws were too lenient, with only a quarter of those surveyed believing they made financials more transparent, while 11% felt they made things cloudier.

That impression isn't helped when companies see their stock prices crater after having to restate earnings. In February,

Travelzoo

(TZOO) - Get Report

missed its earnings, citing a $571,000 bill for Sarbanes-Oxley compliance. The

stock fell 11% on the news. Earlier,

Learning Tree

(LTRE)

warned of a fourth-quarter loss caused in part by $1.7 million in compliance costs,

pushing its stock down 12%.

But evidence is beginning to emerge that Sarbanes-Oxley is starting to give investors the kind of transparency it promised. Of course, it's impossible to count the number of financial scandals that won't arise, if any, because of the new laws. But earlier this month the research firm Glass Lewis produced a report arguing that the wave of painful restatements hurting some stocks is exactly the cure that the market needs.

U.S. companies filed 1,295 financial restatements in 2005, the report said, nearly double the 2004 figure and about one restatement for every 12 public companies. Those numbers suggest that there were troublesome numbers that needed fixing and that investors in some cases weren't getting the right financial information.

Lynn Turner, formerly the

Securities and Exchange Commission's

chief accountant and now a managing director at Glass Lewis, says the most frustrating and costly aspects of Sarbanes-Oxley are precisely what are needed. "Given the number of errors that auditors found in financial statements last year, it's clear that this is only going to work if auditors are involved."

Turner says it's no coincidence that the wave of restatements is being followed by a healthy stock market. "The market is near a five-year high," he says. "If you didn't have some event that gave people the confidence to get back into the market, the market wouldn't be where it is. Sarbanes-Oxley gave them that confidence."

So, while the law's most vocal critics may not want to admit it, evidence is emerging that Sarbanes-Oxley is yielding benefits -- perhaps even enough to eventually outweigh the costs. The big losers, though, will remain financial officers: Half of the CFOs recently queried by

CFO Magazine

said the tougher compliance "has made my job less satisfying."

But then again, no one ever became an accountant because it was fun.