Sarbanes-Oxley: Insurmountable Hurdle for Small Business?

All executives of public companies know of the Sarbanes-Oxley Act (SOX), which was signed into law on July 30, 2002. Many owners of small businesses planning an IPO certainly are aware of it, and some dread it.

In fact, there are owners of small-cap companies who have withdrawn their IPO applications because of their fear of SOX. Is this fear justified? In a word, no.

First some background. When Congress was wrestling with the accounting scandals several years ago — you remember Enron, don’t you? — it decided that something must be done. That “something” was SOX.

President Bush stated at the time that the Act was intended to “…deter and punish corporate and accounting fraud and corruption, insure justice for wrongdoers, and protect the interests of workers and shareholders.”

SOX is organized into eleven titles. But insofar as compliance is concerned, make sure you pay special attention to Sections 302, 401, 404, 409, 802 and 906 as you read through the Act. Among these, the section that seems to cause the most worries for accountants and those responsible for the implementation of the Act is section 404. I’ll talk more about 404 later in this column.

When we examine the process that the government took to implement the Act, we’ll see that more needs to be done to make it more user friendly.

What Motivated Congress?

If we think back to the heat of the accounting scandal, we’ll realize that Congress was under a great deal of pressure to fix the system of accounting reporting that appeared to fail the public so profoundly.

Many people had their pensions wiped out when the company for which they had worked for so many years went bust. Congress was deluged with angry letters, e-mails and phone calls.

The politicians dutifully and wisely — from a political point of view — expressed righteous indignation, even though some had reaped substantial benefits from these flawed corporations in the form of political donations.

What else could we expect from such turmoil except a law with some pretty sharp teeth in it?

Remember the movie Wall Street? How about the character in it called Gordon Gekko and his philosophy that greed is good? This attitude seems to have infected the upper ranks of the companies that got into trouble.

In fact, the greed virus apparently spread beyond the upper ranks of corporate America to the higher echelon of major accounting firms — thus the demise of Arthur Andersen, a previously high-profile, high-quality accounting firm.

Government Overkill and Compliance

In its inimitable fashion, Congress did go overboard in writing SOX. Why is this? First, the white-collar crime provisions in the Act were already on the books. They only had to be enforced. Second, Congress left the public companies in the lurch as far as compliance was concerned.

Section 404 clearly lacks specific standards for compliance. When these standards are written, accounting costs will begin to subside. The final 404 procedures are what audit firms need. In the meantime, accountants are well served if they work closely with the SEC and the Public Company Accounting Oversight Board (PCAOB) when they are uncertain of how to deal with certain key issues.

How can a small-cap company focus on managing its business yet still be in compliance with SOX? The answer is to have a management team that is committed to fostering an ethical environment and culture. This alone, of course, is not enough.

Management must assure itself that adequate internal controls are implemented and maintained regularly. Mere oversight is not sufficient. Management must be certain that, first, adequate (not necessarily elaborate) standards and procedures have been developed and implemented to assure compliance and, second, that these standards and procedures are periodically reviewed.

Implementing SOX

Let’s get specific as to how SOX can be implemented. What is usually the largest item in your statement of income? That item is revenue.

How do you make sure that your revenue figures will not bring you afoul of the provisions of the act? Well, for one thing, make sure that top management knows exactly what procedures are in place for the booking of income.

In other words, income should not be booked on a promise. It should result from a completed business transaction. Be sure that you’re aware of the controls in place to recognize income according to sound principles of accounting.

You don’t want to have maverick salespeople or sales supervisors fixing the books to let them look good. The day-to-day oversight of revenue recognition falls to the CFO. But, not surprisingly, the buck stops with you, the CEO.

This is a small example of the philosophy that should pervade management. It’s not rocket science, just plain common sense.

The Small-Cap Company?

Some of the above might sound daunting, but it really isn’t. Don’t have the attitude of Chicken Little that the sky is falling. It isn’t. So often in our country’s history, laws have been enacted as a reaction that may, at first blush, appear to be overkill.

This is usually the result of congress wanting to show its constituents that it means business. Congress was right to enact a law to correct the wrongdoings of a small, but financially significant, number of corporations and accountants.

There is no doubt in my mind that the law will be modified, not so much to give it loopholes, but to make it more easily subject to rational implementation.

Public companies, IPOs and small businesses are integral parts of our economy. There’s just no way that the government will make things so hard for public corporations that many will have to revert to private status.

Also, remember that the small business is the backbone of our economy. There always will be IPOs and there always will be small-cap IPOs.

In a previous article [Theodore F. di Stefano, “Finding Dollars for Small-Cap Companies,” June 28, 2004], I wrote about the IPO process and how it can be user friendly. The government can’t and won’t put the small-cap company out of business. Stay the course and, if you have plans for an IPO, don’t let Sarbanes-Oxley stop you. And, as always, good luck!

Theodore F. di Stefano is a managing partner at Capital Source Partners and can be contacted at [email protected].

1 Comment

  • I would really love to know if any of you out there have withdrawn IPOs because of SOX. I’m an investment banker as well as the author of the article, so this information would really be welcome. Thanks, Ted di Stefano

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