Revisiting the Ripple Effects of the Sarbanes-Oxley Act

By Jo Lynne Koehn and Stephen C. DelVecchio

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Negative Influence on Corporate Mergers and Acquisitions
Merger and acquisition activity in the immediate wake of SOX did not show a decline. The number of deals consummated actually rose, from 7,702 in 2003 to 8,313 in 2004. The dollar value of those deals rose from $570 billion in 2003 to $833 billion in 2004. A portion of the increased activity is likely due to foreign buyers capitalizing on the weaker dollar (R. Weisman, “Merger Activity at Full Tilt, Even Before Gillette,” Boston Globe, February 7, 2005).

Some believe that the reason the M&A activity has been the opposite of expectations is that mergers can result in combined entities that can more easily absorb the significant compliance costs associated with SOX. And, while the number of deals after SOX has not declined, SOX has still affected M&A activity by impacting the due diligence required to support merger transactions. Acquiring companies must carefully review financial records, vendors, and key customers of target companies and assume accountability after the merger for those records and relationships. Such increased time and scope for due diligence has increased the transaction costs associated with mergers and acquisitions (R. Ouellette, “Sarbanes-Oxley Sure to Affect Variety of Transactions,” Due Diligence, September 26, 2005).

Increased Efforts by Audit Committees

In 1999, the New York Stock Exchange and the National Association of Securities Dealers created the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. The committee established recommendations that audit committee charters require meetings at least four times per year. A survey following the committee’s report (W. Read and K. Raghunandan, “The State of Audit Committees,” Journal of Accountancy, May 2001) found that, on average, audit committees met less than the recommended four times per year. Since SOX, as anticipated, audit committees are meeting more frequently. The annual Spencer Stuart Board Index study of corporate governance in S&P 500 corporations found that audit committees met, on average, five times per year in 2002. In 2003, the frequency of meetings increased to seven. An alternate survey of governance practices in 200 corporations by Pearl Meyer & Partners reported an average frequency of nine meetings for audit committees in 2005.

Contraction of the Audit Market/Decreased Competitiveness of the Audit Market

In July 2003, the General Accounting Office (GAO, which became the Government Accountability Office in 2004) published a report titled “Public Accounting Firms: Mandated Study on Consolidation and Competition.” The SOX-mandated report did not find impaired competition in the audit market for public companies, nor did it find the conditions favorable for any second-tier firms joining the Big Four. The GAO stated: “[L]ack of staff, industry and technical expertise, capital formation, global reach, and reputation” comprise some of the market forces that make it unlikely that any firms will be able to join the Big Four (S. Taub, “Too Few Auditors to Go Around?,” cfo.com, July 31, 2003). Size disparity between the top-tier and second-tier firms may just be too large to overcome. If all the revenues of the second-tier firms are added together, they fall short of the revenue of KPMG, the smallest of the top-tier firms (“Report from a General in the SEC’s War on Fraud,” BusinessWeek, September 26, 2005).

Even though the audit market has not expanded in the sense that second-tier firms have moved to the first tier, nonetheless shifts are occurring in the market. When hiring auditors, many public companies are now considering second-tier firms as viable options. Because the typical audit requires more hours to complete since SOX, the Big Four have shed some clients due to a lack of manpower. Other companies have switched to second-tier firms based on the service they expect to receive if they are among the second-tier firm’s highest-profile clients. In 2004, the second-tier firm of BDO Seidman, LLP, gained 109 clients and lost 38. Another firm in the second tier, Grant Thornton, LLP, gained 80 and lost 63 (N. Byrnes, “The Little Guys Doing Large Audits,” BusinessWeek Online, August 22, 2005). The next year, the 2005 revenues of BDO Seidman showed growth of 13% to $3.3 billion. Comparatively, Ernst & Young’s revenues increased 16% to $16.9 billion (J. Ciesielski, “Happy Holidays: Big Revenue Growth at Accounting Firms,” www.accountingobserver.com/blog/2005/12/bdo-revenues-up-13/, December 21, 2005).

One constraint to companies changing from the first-tier audit firms to the second tier is geographical dispersion of operations. The Big Four, with their worldwide coverage and other attributes noted above by the GAO, remain the best audit firm candidates for companies with significant size and global operations.

The audit market has changed since SOX, and the initial concerns regarding contraction and decreased competitiveness now seem less worrisome. The increased audit demands attributable to SOX have been satisfied by some shifts from first- to second-tier firms. However, the SEC remains mindful that some corporations can be viably served only by the Big Four, and the loss of another firm from the first tier could resurrect concerns of market contraction and decreased competitiveness.

Increase in Accounting Costs

A survey by Financial Executives International reported that small companies anticipate spending $824,000 to comply with SOX and that the average cost for all companies is $4.3 million (D. Solomon, “Small Firms to Get another Extension on Sarbanes Rule,” The Wall Street Journal, September 13, 2005). AMR Research in Boston estimates that, collectively, U.S. public companies will spend $6.1 billion in SOX-related compliance costs (D. Gullapalli, “Living with Sarbanes-Oxley,” The Wall Street Journal, October 17, 2005).

One component of compliance costs is related to corporate governance. Pearl Meyer & Partners’ 2005 Study of Director Compensation finds that median total board remuneration rose 10% in 2005, to $183,204. In 2004, the comparative increase was 13%.

These consultants maintain that three board committees—audit, compensation, and governance/nominating—are the committees that are generally most impacted by issues related to regulatory changes, shareholder activism, and the public’s scrutiny of financial controls, executive compensation, and board performance.

One way that companies are adapting board pay to the new governance environment is by differentiating committee chair pay by the effort demanded of the committee. Exhibit 1 shows the median combined meeting fees and retainers for audit, compensation, and governance/nominating chairs. The chairs’ combined compensation rose 22% to $22,500 for audit chairs, 12% to $14,000 for compensation chairs, and 14% to $12,000 for governance/nominating chairs. Audit committee members are paid 96% more than compensation members and 122% more than governance/nominating members. Interestingly, the pay for committee members on these committees was reported to be flat or down. The compensation report notes that corporations are relying less on meeting fees, in response to criticism that board members should not be rewarded for fulfilling a mandatory responsibility.

Increased Records-Management Requirements

SOX has focused increased attention on the records-management area. Since 2002, many companies have implemented e-mail archiving systems to allow efficient retrieval of e-mail in the event it is subpoenaed for cases related to regulatory or private litigation. The software systems archive e-mail, usually on backup servers, according to company-specified indexing systems. Key items, like the date and the name of the sender and the receiver, can be indexed. Later searches by the key items will allow the entire message to be retrieved for review (P. Loftus, “Send and Save,” The Wall Street Journal, August 19, 2005).

Salary Increases

The Lucas Group, a professional recruiting firm, in its 2005 report indicated strong hiring growth in positions needed to meet Sarbanes-Oxley compliance. This growth in demand has impacted salaries for accounting and finance professionals. Robert Half International’s 2005 Salary Guide forecasts that starting salaries for accounting and finance professionals will increase an average of 2.4% next year. However, the guide reported double-digit average increases for certain areas of accounting:

• Internal auditors at large corporations: 12.5%
• Internal auditors at mid-size corporations: 16.8%
• Managers at large public accounting firms: 10.2%
• Senior accountants at large public accounting firms: 11.7%
• Entry-level professionals at small public accounting firms: 11.4%.

Increase in Audit Fees

Respondents to a survey by the Financial Executives Institute in 2003 anticipated audit fees increasing by 30%. In 2004, the FEI respondents anticipated fees would increase by 50%. The large increases correlate positively with the increased time that auditors report spending on audits. Deloitte & Touche, LLP, estimates spending 40% to 60% more time on audits since SOX’s implementation (“Online Extra: ‘Huge Progress’ in Auditing,” BusinessWeek Online, January 10, 2005).

Influence on SEC Sanctions

The SEC must be mindful of the oligopoly conditions among the Big Four in the audit market when deciding upon sanctions for accounting firms. In 2004, a court action by the SEC forbade one of the Big Four from accepting new public company audits for six months, due to the firm’s violations of audit independence rules (Initial Decision Release 249, April 6, 2004). The duration of the suspension period may stem from consideration of the limited competition currently existing in the audit industry. Each firm possesses various industry specializations, so there may be only one or two firms that offer expertise in a specific industry.

Impact on Private Companies

Private companies with no intention of going public, and those without pressure from outside parties, such as lenders or auditors, are not, by statute, impacted by SOX, but may choose to selectively comply with its provisions.

A recent PricewaterhouseCoopers survey of 340 CEOs of private companies found that slightly more than one quarter have adopted SOX “best practices.” Data shows that the companies most interested in adopting best practices tend to be larger private businesses (averaging $74.2 million in revenues) and that these companies choose to apply SOX provisions chiefly in the areas of governance and transparency (J. Jusko, “Sarbanes-Oxley: Private Opportunity in Public Regulation,” www.barometersurveys.com, February 1, 2006).

Phillip Toomey, the managing partner of the law firm Artiano, Guzman & Toomey, notes in “Advising Private Cos.: What You Need to Know About SOX” (Accounting Today, September 26–October 9, 2005) certain specific best practices that private companies have adopted:

• CEO/CFO certifications of financial statements;
• Developing an internal code of ethics;
• Appointing independent board members and an audit committee;
• Creating processes for reporting concerns; and
• Splitting audit and nonaudit services between separate accounting firms.

Reluctance of Foreign Companies to Comply

Charlie McCreevey, the European Union’s internal-markets chief, has been working closely with the SEC to achieve accounting equivalence. In September 2005, top officials of the EU Commission and the SEC worked out a “roadmap” outlining steps that will eliminate the requirement that European companies using International Financial Reporting Standards (IFRS) reconcile their financial reports to U.S. Generally Accepted Accounting Principles (U.S. GAAP). The agreement may be effective as soon as 2007, but not later than 2009.

On December 1, 2005, in a speech to the Federation of European Accountants in Brussels, Ethiopis Tafara, director, office of international affairs at the SEC, stressed that a permanent elimination of the reconciliation requirement is highly dependent on the expectation that IFRS–U.S. GAAP convergence efforts will continue to make good progress.

The elimination of the reconciliation requirement will ease regulatory burdens for European companies that are publicly traded in the United States. However, many foreign companies may nonetheless still choose to delist from the U.S. stock exchanges rather than comply with SOX. Many foreign issuers not only see SOX’s new governance rules as too costly to implement but also view managers and directors as more vulnerable to personal liability (D. Hilken, “New York Shy,” Weekend Standard, April 30–May 1, 2005). Currently, McCreevey has also entered into discussions with SEC officials seeking easier delisting procedures from U.S. exchanges for foreign companies (“SOX and Stocks,” The Wall Street Journal, April 19, 2005).

For foreign companies, the London Stock Exchange, with fewer regulatory requirements, is an attractive alternative to U.S. exchanges. More foreign companies are listed on the London Stock Exchange than on any other exchange, including the New York Stock Exchange and NASDAQ combined (L. Jenkins, “The Ultimate City Take-Over,” Bruges Group International Conference, November 2, 2002).

Increased Volume of Corporate Disclosure

One of the primary goals of SOX is to increase investor confidence and the assurance of the integrity of the U.S. capital markets. To this end, SOX requires increased corporate disclosures to improve the quality of financial reporting. The SEC has recommended that companies consider the formation of disclosure committees to be charged with judging the materiality of information and disclosure obligations on a timely basis (L.J. Bevilacqua, “Disclosure Under Sarbanes Oxley: An Assessment and a Look Forward,” Directorship, December 2003). The volume of disclosure since SOX has increased, not only due to such increased corporate diligence with respect to disclosure, but also because actual additional reporting is required by SOX. New SOX disclosure requirements include the following:

• Management certifications (section 302);
• Reconciliations of publicly disclosed non-GAAP financial measures, such as pro forma measures with GAAP [section 401(b)];
• Off–balance-sheet transactions, arrangements, and obligations in quarterly and annual reports filed with the SEC [section 401(c)]; and
• The internal control report (section 404) stating management’s responsibility for establishing and maintaining internal controls, as well as management’s assessment of the effectiveness of controls, including any material weaknesses.

Trickle-down Accountability

SOX section 302 requires CEOs and CFOs to certify quarterly and annual filings with the SEC. A survey of company leaders conducted by Pricewater-houseCoopers (P. Collins, “Management Barometer,” July 23, 2003) shows that, on average, 22.5 executives, other than the CEO and CFO, will be required to submit subcertifications. This number is an increase from the 18.6 that was initially expected.

The AIPCA reports hearing from its membership that many companies require subcertification statements from others within the finance division of the companies. Visit www.aicpa.org/sarbanes/ceo_cfo_sub-certifications.asp for the certification requirements and sample documents that various organizations are using to support subcertification at lower levels.

Trickle-down Power to Shareholders

Shareholders of some publicly traded companies have gained the right to nominate candidates to the board of directors that appear on proxy ballots alongside board-nominated candidates. Many companies, however, are reluctant to give shareholders this power. A rule has been proposed by the SEC to allow shareholders more power to nominate directors to corporate boards (E. Iwata, “Businesses Say Corporate Governance Can Go Too Far,” USA Today, October 4, 2005).

While awaiting a final rule from the SEC on this issue, it is interesting to note that some governance reforms are occurring as settlement terms in shareholder lawsuits. The following is a selection of governance changes (see P. Plitch, “Governance at Gunpoint,” The Wall Street Journal, October 17, 2005) specified as settlement terms in recent class-action shareholder lawsuits:

• Term limits for directors
• Shareholder nominations of directors
• Required rotation of outside audit firm
• Restrictions on insider sale of stock
• Required independence of two-thirds of the board.

Impact on D&O Insurance

Directors and officers (D&O) insurance underwriting has been significantly impacted by SOX. Many D&O policy applications now consider any filings with the SEC to be part of the insurance application. If filings are later amended or restated, underwriters may attempt to rescind D&O policies. Some companies are finding that underwriters are not willing to insure at the same coverage levels as before SOX. Adequate D&O coverage can sometimes be obtained only by purchasing from several insurers. Directors are perhaps most troubled by policies’ narrower coverage. Formerly, most policies excluded coverage for fraudulent conduct only upon an ultimate finding of liability. Currently, some insurers are attempting to deny coverage for even alleged fraudulent acts (G.H. Weisdorn, L. McCord, and M.S. Williams, “D & O Policies: Greater Risks—Less Coverage,” Graziadio Business Report, 2005, Volume 8, Issue 3).

Companies considering going public must realize that underwriting for public-company D&O insurance is quite different from underwriting for private companies. D&O underwriters for public companies must assess SOX compliance in areas such as audit committee quality and composition, accounting controls, accounting policies, and the existence of a code of ethics (C. Waterfall, “Sarbanes-Oxley and the Private Company: D & O Insurance,” Mercator Monitor, September 20, 2003).

D&O policy premiums rose 11% in 2000, 29% in 2001 and 2002, and even more sharply, 33%, in 2003. In 2004, some leveling of premiums occurred as more insurers entered the market (Plitch, “Governance at Gunpoint”).

Consulting Is Booming

“The Global Consulting Marketplace 2005–2007,” a report published by Kennedy Information, Inc., projects growth rates for consulting sectors. In the operations management sector (where consultants suggest changes for efficiency, cost cutting, and business process improvement) mid to high single-digit growth is anticipated.

Many links to company news releases disclosing increased consulting and compliance costs related to SOX can easily be found through an Internet search. An excerpt from Inovio’s second-quarter 2005 news release (www.innovio.com) is fairly typical:

The increase in general and administrative expenses for the six months ended June 30, 2005, as compared to the same period in 2004, was mainly due to increased consulting and legal expenses and increased personnel costs to support our administrative infrastructure, which includes our finance, investor relations and information technology departments, and ongoing business development efforts. The increase in general and administrative expenses was also due to accounting-related expenses incurred during the six months ended June 30, 2005, related mainly to the implementation of and ongoing compliance with internal control over financial reporting requirements under Section 404 of the Sarbanes-Oxley Act of 2002 [emphasis added].

New Compliance-Software Production

Unquestionably, SOX has been a boon for software vendors. Large companies are spending at least $500,000 on compliance software. Such software must assist in the documentation and testing of internal controls, as well as adequately report compliance progress to executives. Software must also easily allow for auditor review. A company could meet SOX requirements without investing in new software; however, consultants acknowledge that attempting systematic documentation with spreadsheets and word-processing documentation would likely require considerable human resources.

Many software vendors have shifted business models to focus on the growing SOX-compliance software market. Certain packages focus on section 404 requirements, while others may be narrower. For example, software can now be purchased to comply with section 301, to allow employees to anonymously file complaints, or to allow section 409 reporting of 8-K events (P. Loftus, “Software for Sarbanes,” The Wall Street Journal, April 25, 2005).

More Work for Lawyers

Consultants and attorneys have found new opportunities working for companies that seek to comply with SOX. One likely unforeseen effect of SOX is that it has motivated certain companies to completely privatize. Another unforeseen effect is that of companies seeking to “go dark” to cut SOX compliance costs and required financial disclosures. Going dark entails deregistering company shares with the SEC, a step short of privatization in that shares can still be publicly traded via listings on “pink sheets” at the National Quotation Bureau. Assisting companies with deregistration has provided attorneys with sizable fees, as much as 10% to 25% of a company’s first-year savings on audit and compliance after delistment (J. Norman, “Companies ‘Go Dark’ to Cut Compliance Costs,” Orange County Register, April 10, 2005).

Educational Impact

SOX’s passage in 2002 is partially responsible for the increased demand for accounting graduates. Bea Sanders, the AICPA’s vice president of academic and career development, states that SOX has led private companies to increase their hiring of new accountants. Tom Rogowski, director of university recruiting for Grant Thornton LLP, concurs by noting that “Sarbanes-Oxley has created an additional layer of reporting or diligence required by certain companies and that has had an impact on the number of resources needed” (A. Giegerich, “Enron Gives Boost to Accounting Field,” Portland Business Journal, July 29, 2005). The economy’s overall health, in conjunction with the demands placed by SOX, has strengthened the demand for accountants.

The supply of accounting graduates is rising to meet this increased demand. The 2004 edition of the AICPA’s “The Supply of Accounting Graduates and the Demand for Public Accounting Recruits Survey” reported that in 2002/03, 37,000 students were awarded bachelor’s degrees in accounting and close to 13,000 were awarded master’s degrees. Compared to 2001/02, the number of bachelor’s degree recipients increased 6% and the number of master’s degrees awarded increased 30%. In the same year, the number of candidates for the CPA exam rose by 1%. Some students are likely entering accounting due to the notoriety caused by heightened media coverage of high-profile audit failures and fraud. Others are responding to the increased demand, and resulting job opportunities, caused by SOX.

Company Loans to Executives Prohibited

A key provision of SOX prohibits company loans to executives. Nonetheless, new strategies are evolving that allow companies to direct money to CEOs. Michelle Leder, in an article in Slate (“Outfoxing SOX,” January 24, 2005), identifies three of the more-popular strategies:

• Special signing bonus: upfront money for joining a company
• Retention bonus: money upon renewal of employment contracts
• Death retention bonus: money payable to executive’s beneficiaries upon proof of death of the executive.

Change in the Audit Process

SOX, with its requirement that management and the external auditors attest to effective controls over financial reporting, has reshaped the audit processes used to evaluate internal control. The graphic in Exhibit 3, which the consulting firm Complyant labels a “SOX Wheel,” is a representation of the typical phases that a company and external auditors might use in evaluating internal controls.

Two Tiers of Compliance?

As initially passed, SOX made no distinction in regulation between large-capitalization and small-capitalization companies. As costs of compliance have been large and extremely burdensome for small companies, the SEC has revisited the requirements placed on small publicly traded companies.

After SOX became law, the SEC began a series of changes to the reporting deadlines for 10-K and 10-Q filings. In September 2002, the SEC established new periodic reporting rules that shortened the deadline for filing both the 10-K and the 10-Q reports; created a new class of reporting entities, known as accelerated filers; and allowed a three-year phase-in period. Accelerated filers are companies that—

• have $75 million or more of public float (defined as an Exchange Act reporting company with aggregate market value of voting and nonvoting common equity held by nonaffiliates as of the last business day of the issuer’s most recently completed second fiscal quarter);
• are subject to reporting rule 13(a) or 15(d) of the Exchange Act for a period of 12 calendar months; and
  n have filed at least one previous annual report, and are not eligible to use 10-KSB or 10-QSB.

The three-year phase-in period stipulated that for years ending on or after December 15, 2003, and before December 15, 2004, the deadlines were 75 days for the 10-K and 40 days for the 10-Q. Beginning with annual reports filed for fiscal years ending after December 15, 2004, the 10-K deadline became 60 days and the 10-Q deadline became 35 days. For companies not meeting the definition of an accelerated filer, the deadlines remained 90 days for the 10-K and 45 days for the 10-Q.

After receiving and considering the comments made by companies and their auditors concerning these deadline changes, the SEC in February 2004 extended the deadline for SOX section 404 reports, which accompany the 10-K filings, to the first fiscal year ending on or after November 15, 2004, from June 15, 2004.

In November 2004, the SEC postponed the final phase-in deadline for the accelerated filers to 2006. Then, in September 2005, the SEC proposed changes to both the reporting rules and the definition of accelerated filers. The SEC proposed a three-tier report-filing deadline for companies, and refined the definition of accelerated filers to include a new class of companies known as large accelerated filers. The large accelerated filers are companies with public float of $700 million or more. The SEC proposed that only the large accelerated filers would have a 60-day deadline for the 10-K and a 35-day deadline for the 10-Q.

After further consideration and deliberation, on December 27, 2005, the SEC issued Release 33-8644, which established the current version of the rules covering reporting deadlines and the classes of reporting filers. Release 33-8644 maintains the three tiers of reporting filers (large accelerated filers, accelerated filers, and nonaccelerated filers) and establishes the reporting deadlines for each class. Exhibit 2 provides a summary of the current rules.

Release 33-8644 also provides a mechanism for companies to move to a different filer class based on the value of the public float the company has as of the last business day of its most recently completed second quarter. The reporting guidelines established by Release 33-8644 are effective for fiscal years ending on or after December 15, 2005.

Neal L. Wolkoff, chairman and CEO of the American Stock Exchange, highlights several reasons different rules for different-size companies make sense (“Sarbanes-Oxley Is a Curse for Small-Cap Companies,” The Wall Street Journal, August 15, 2005). First, large companies often have more-complex business models and, hence, more-complex accounting. Small companies, with less-complicated financial transactions and statements, may require less-rigid internal controls. According to Wolkoff, small and mid-size companies in the early stages of growth merit different regulations, because it is hard for start-up companies to afford heavy compliance costs.

‘Auditing’ the Auditors

In May 2005, the Public Company Accounting Oversight Board (PCAOB) took its first disciplinary action. The PCAOB banned the managing partner of a small New York City CPA firm from auditing public companies and revoked the firm’s registration. The PCAOB administered the discipline upon finding that the firm concealed information from inspectors and submitted false documents related to the inspection (S. Hughes and D. Gullapalli, “U.S. Accounting-Oversight Board Takes First Disciplinary Action,” The Wall Street Journal, May 25, 2005).

The PCAOB inspects registered accounting firms to gauge their compliance with PCAOB rules, SEC regulations, professional standards, and the individual firm’s quality-control policies. Annual inspections are required for registered accounting firms that conduct more than 100 audits per year. Firms completing fewer audits must be inspected at least once every three years. Registered accounting firms are closely monitoring the PCAOB’s initial inspections for signals regarding how it will approach findings, deficiencies, and discipline.

The initial implementation of inspections has been challenging. In October 2005, the PCAOB issued reports to some of the Big Four firms citing deficiencies in obtaining sufficient and competent evidential matter to support opinions on several issuers’ financial statements (J. Weil, “Board Is Critical of Deloitte Audits,” The Wall Street Journal, October 7, 2005). The PCAOB and the SEC are also already on record rebuking auditors for being “overly cautious” and “mechanical” in their efforts to comply with SOX. Some corporations believe that SOX-related compliance costs are higher than necessary, while some auditors have been criticized for conducting large-scale reviews that are not tailored to a company’s specific risks (D. Solomon and D. Gullapalli, “Auditors Get Sarbanes-Oxley Rebuke,” The Wall Street Journal, May 27, 2005). The next few years will be instructive, as accounting firms become more familiar with the PCAOB’s expectations and work continuously to improve the quality of financial statement audits.

Changes in Attorneys’ Legal Conduct

SOX section 307 mandated that the SEC issue a rule to govern the conduct of attorneys representing public companies. SEC Rule 205 requires attorneys who become aware of material wrongdoing to report the incident “up the ladder” to the highest company authority (G.T. Stromberg and A. Popov, “Lawyer Conduct Rules Under Sarbanes-Oxley and State Bars: Conflicts to Navigate?” Critical Legal Issues: Working Paper Series, No. 132, July 2005).

The original Rule 205 included a provision that would require an attorney to make a “noisy withdrawal” (a written notification of withdrawal to the SEC) when the attorney had reported up the ladder and the board of directors had not provided an “appropriate response.” The SEC’s proposed noisy withdrawal has received much interest and critique from the legal profession. Attorneys have expressed concern regarding the rule’s possible impact on confidential attorney-client relationships. Given such concern, on January 29, 2003, the SEC withdrew the noisy withdrawal portion before finalizing Rule 205. The SEC also proposed a revision to the noisy withdrawal provision that would require the issuer, as opposed to the attorney, to report the attorney’s withdrawal to the SEC and would require additional reports by the issuer to the public via forms 8-K, 20-F, or 40-F. To date, no decision has been finalized by the SEC to require noisy withdrawal reports by attorneys or issuers.

New Metrics

The disclosure of more non-GAAP performance metrics to increase the transparency of companies’ reported results does not seem to be coming to pass in the SOX era. FASB has, however, proposed establishing an investors’ task force to facilitate input from the investment community on proposed changes to GAAP (D. Gullapalli, “FASB to Create Investor Task Force,” The Wall Street Journal, September 29, 2005). The input that FASB would receive from stock-research analysts and portfolio managers via this task force could provide better insight into what information.

New Effects: The Urge to Privatize

SOX compliance has made it more time-consuming and expensive to function as a public company. If one also factors in the personal risk to managers for failure to adequately comply, the idea of simply avoiding these costs and risks by going private is appealing to some. A main deterrent to operating as a private company is the difficulty of raising capital; however, if private equity firms show the ability to buy even the largest of companies, this deterrent to privatization may be less significant (S. Rosenbush, “The Allure of Going Private,” BusinessWeek Online, March 29, 2005).

Collins Industries Inc. is one small company where directors recently decided to take the company private. Director Don S. Peters estimated the cost of complying with Sarbanes-Oxley at $1 million. Peters questioned whether being publicly listed justified the cost, stating, “It’s a heck of a mess for companies our size” (M. Davis, “Vehicle Maker Restates Earnings,” The Kansas City Star, August 9, 2005).

Impact on Management Style

Dominic D’Alessandro, the Manulife CEO, told those in attendance at his company’s annual meeting that he worries that compliance with SOX section 404 may stifle managers’ creativity and entrepreneurship. Such curtailment of managers’ style could negatively impact company performance (M. Gutschi, “Manulife CEO: New Governance Rules May Stifle Creativity,” The Wall Street Journal, May 5, 2005).

Repeal or Rollback?

Several recent surveys of corporate executives provide some sense of CEOs’ perceptions of SOX. A 2005 Christian & Timbers survey of 186 U.S. executives reported that 34% thought SOX should be repealed. In Bain & Co.’s 2005 Management Tools & Trends survey, 63% of North American executives maintain that SOX raises costs without actually improving governance. International perception varied, as only 53% of Europeans and 42% of Asians and Latin American executives concurred.

On February 7, 2006, the Free Enterprise Fund, a pro-business conservative group, along with a small Nevada-based accounting firm, filed a suit in federal court against the PCAOB and its board. The plaintiffs are seeking to overturn SOX on grounds that the PCAOB violates the appointments clause and the Constitution’s separation of powers among the three branches of government (K. Scannel, and B. Mullins, “Suit Seeks to Overturn Sarbanes-Oxley Law,” The Wall Street Journal, February 8, 2006).

Despite the negative opinions of SOX, the pending lawsuit, and the considerable costs to comply with the auditing-disclosure requirements, hundreds of companies say that accounting problems have been uncovered. Efficiencies gained by eliminating redundancies are a positive outcome of SOX (D. Henry, A. Borrus, L. Lavelle, D. Brady, M. Arndt, and J. Weber, “Death, Taxes and Sarbanes-Oxley?” BusinessWeek, January 17, 2005).

While many CEOs would undoubtedly support a rollback of SOX, if better audits and increased investor confidence prove to be continuing effects from SOX, fine-tuning, not wholesale repeal—barring no findings of unconstitutionality of the Act—could be the more likely scenario going forward. As Federal Reserve Bank of Atlanta President Jack Guynn so aptly stated when commenting recently on the costs associated with laws aimed at improving corporate business practices: “I don’t think it’s possible to tally up the cost of not having credibility.”

The authors wish to thank two anonymous reviewers for their insightful comments and suggestions. They reference numerous reports and sources in this article. All sources for this article are available from the authors by contacting Jo Lynne Koehn at Koehn@cmsu.edu.