Smaller firms likely to get Sarbanes-Oxley exemption

Part of financial reform; but experts question wisdom of move

NORTH BAY – It is increasingly likely the Wall Street reform efforts in Congress will include a permanent exemption from Sarbanes-Oxley for public companies with less than $75 million in market capitalization, something small businesses have been hoping for since the inception of the law.

Sarbanes-Oxley was put in place in 2002 after the Enron, Adelphia and Worldcom accounting frauds. It requires public companies with more than $75 million in market capitalization to have their financials audited under supervision of the nonprofit Public Company Accounting Oversights Board.

The board was created by Sarbanes-Oxley to oversee the auditors of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, fair and independent audit reports.

The costs and time of complying with Sarbanes-Oxley's requirements are substantial, and public and private businesses below the $75 million threshold have been concerned the law could someday be modified to include them.

[caption id="attachment_22601" align="alignleft" width="108" caption="Clark Keeler"][/caption]

“In a normal world, Sarbanes-Oxley would be old news,” said Clark Keeler, director at Burr Pilger Mayer. “It has been in place for eight years.”

But now, by putting a permanent exemption in place, Congress will have sent the market back to the pre-Sarbanes-Oxley era, he said. He said that if the exemption becomes permanent, officers of many public companies will be providing investors assurances of effective internal controls without proof or verification.

While small companies are likely to be relieved that they will not be subject to the same scrutiny as their larger counterparts and subject to the same auditing costs, Mr. Keeler said they are missing out on the protection that added audit layer offers.

Mr. Keeler estimates that while it is only 6 percent to 7 percent of the companies are subject to SOX, they represent 80 percent of the market.

By excluding the vast majority of the businesses, whether or not they represent the same market share as large companies, “Congress is saying that they don’t really care about the welfare of those public companies.”

“We have got it backwards,” he said. “If you are a huge company, you have all the resources to insure you are reporting financials properly. We are letting off the hook the people who need it. Every time we go into a small company and audit what management thinks are good internal controls, they fall short.”

Section 302 of the act states that “the principal executive officer or officers" certify and sign off on financial reports. The officers signing this statement are personally responsible.

In a letter to congressional leaders including Sen. Christopher Dodd, chairman of the Committee on Banking, Housing and Urban Development, Heather Booth and Barbara Roper of Americans for Financial Reform and Consumer Federation of America claim the exemption would leave investors with fewer defenses against fraud, and the cost of capital would be raised for small companies by increasing the risk premium they must pay to investors wary of that fraud risk.

“That is because small companies have been shown to be more prone to both accounting fraud and to accounting errors. Where fraud does occur at these companies, it almost always involves top executives, making management’s assessment of fraud controls virtually meaningless without an independent auditor’s review,” they said.

They said that without an independent review, companies with strong and weak fraud controls alike would both be forced to pay a higher risk premium, since the markets would have no basis for distinguishing between them.

The point of having controls in place, said Mr. Keeler, is to watch the underpinnings of internal controls and to check to see how a company is managed.

“When coming in to check their internal controls,” he said, “the gift you are giving the small business is getting them to stop, think and plan.”

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