Companies Feel Impact of Sarbanes-Oxley

By James Gentry
January 31, 2005 04:24 PM

If you cover a public company, you can be sure that the words Sarbanes-Oxley have been ricocheting off its walls on a daily basis.

Most public companies worked overtime to comply with the "internal controls" requirements of the Sarbanes-Oxley Act of 2002 by the end of 2004.

One indicator of the focus on internal controls is the large number of recent filings by public companies pointing out their own shortfalls under Sections 302 and 404 of the law, and how they are dealing with them.

Section 302 says that each audit must be accompanied by a statement signed by the CEO and CFO certifying the "appropriateness of the financial statements and disclosures" and that they "fairly present, in all material respects, the operations and financial condition" of the company.

Section 404 goes into even more detail. It requires that each annual report contain an "internal control report" assessing the company's internal control structures and procedures. The company's auditor must report on management's assessment of its controls. In addition, companies must report to the SEC if they have adopted an ethics code for senior financial officials. And they must file an 8-K if there is any change in the company code of ethics.

According to the newsletter Compliance Week , in November 119 companies made filings that revealed "material weaknesses or significant deficiencies in internal controls, or provided material updates on the status of their control-improvement processes." The newsletter reported that the number of companies reporting "new material weaknesses, significant deficiencies or reportable conditions" had nearly doubled from October and almost quadrupled from July.

Compliance Week reported that "the increase was largely due to the volume of companies filing quarterly reports, which -- for many companies -- are their final 10-Qs before Sarbanes-Oxley 404 assessments are due as part of their next 10-K. " Under Sarbanes-Oxley's internal control requirements, management must "assess the effectiveness of the company's internal control over financial reporting."

Companies are typically reporting problems such as poor procedures, problems with inventory processes and account reconciliation, unqualified or inadequate finance staffs and weaknesses in the area of information technology. For example, CFO.com reported that Advanced Materials Group Inc. flagged itself for operating without a full-time CFO and being short on staff expertise.

Because companies and their auditors must come to agreement on what are "material weaknesses," a number of auditors were terminated over the summer. And, as CFO.com reported, "when auditors and management disagree, however, auditors usually prevail…dismissal triggers a requirement to disclose (in an 8-K) any differences the two have had…And companies that maintain their relationships with the audit firm are usually bound to make the suggested changes."

In addition to pointing out the deficiencies in filings, some companies are even delaying filing their annual reports. For example, Adecco SA reported in its Form 6-K (report of foreign firm) that it didn't expect to complete its audit for FY 2003 to be completed by the originally announced date for Sarbanes-Oxley. Reasons for the delay included identifying "material weaknesses in internal controls" and problems with "possible accounting, control and compliance issues."

And in its 10-K filed in June, Bristol-Myers Squibb said that its auditors had identified two "material weaknesses" for 2002, including "lack of adequate resources and processes to ensure timely identification and recognition" in its accounting systems and "lack of processes" to ensure management review of "certain accounting matters." The 10-K does, however, go on to describe corrective measures the company is taking.

Interestingly, deficiencies are being reported in a variety of SEC filings, including the 10-K, 8-K, 10-Q, 6-K and 20-F.

Sarbanes-Oxley also requires a number of other actions that have received little attention. Several examples include:

• The lead audit partner must rotate off the audit every five years
• The GAO is studying the possible impact of requiring a rotation of audit firms
• Company audit committees have the authority to hire independent counsel or other advisors to help with its duties
• Company and accounting firm employees have "whistleblower protection"

If a company must make a restatement because of "material noncompliance" with reporting requirements, the CEO and CFO must reimburse the company for any "bonus or other incentive-based or equity-based compensation received" during the year following the filing of the document containing the misstatement

Expanded list of 8-K filings

The SEC has almost doubled the number of items requiring an 8-K filing. The new list is:

• Entry into an agreement that is "material" in nature
• Termination of an agreement that is "material" in nature
• Filing for bankruptcy or receivership
• Completion of acquisition or disposition of assets
• Announcing results of operations and financial condition
• Taking on debt or creating an off-balance sheet arrangement
• Triggering events that accelerate or increase a direct financial obligation under an off-balance sheet arrangement
• Costs associated with exiting a business or disposal of assets
• Material impairments
• Notice of delisting or failure to satisfy a continued listing rule or standard; transfer of listing
• Unregistered sales of stock
• Material modifications to rights of stockholders
• Changes in auditor
• Restatement of financial results
• Changes in company control  
• Changes in directors or principal officers
• Amendments to articles of incorporation or bylaws; change in fiscal year  
• Temporary suspension of trading under employee benefit plans  
• Amendments to company code of ethics, or waiver of a provision of the code of ethics  
• Regulation FD disclosure

In addition, companies now have only four business days to file 8-Ks and the SEC is posting them almost upon receipt.

SEC comment letters going public

Several months ago, the SEC announced that it would start posting to Edgar copies of all correspondence between the commission and filing companies regarding filings received after Aug. 1, 2004. Details of the process are:

• After a filing, the SEC typically takes 25-30 days to conduct a review. After the review is completed and a notification letter is sent to the filer, the filer and the commission often engage in a series of correspondence about the review. Once the parties come to an agreement, the commission hopes to have all of the correspondence posted no later than 45 days after that agreement.
• The SEC says it is difficult to know when postings will begin occurring because of the uncertainties associated with correspondence between filers and the commission, and with "technical issues" associated with getting the Edgar system set up to accommodate the correspondence.  
• The SEC is expected to issue a press release when it is ready to implement this process. Correspondence possibly could start appearing this winter.

Accountants' profitability increases

It was good to be employed by the nation's largest accounting firms last year. Inside Public Accounting newsletter reports that net income at the 100 largest firms grew by 11.5 percent in 2003. And per hour fees were up 9.8 percent from 2002. In addition, an unprecedented number of firms changed auditors in '02.

The newsletter reports that the changes are attributable to the Sarbanes-Oxley Act of 2002. "My clients are having a field day," consultant Jay Nisbeg of Ridgefield , Conn. , told the newsletter. "The 90 non-national firms … have truly become an alternative to the Big Four. It's driven by SOX (Sarbanes-Oxley) work."

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