Sarbanes-Oxley impact extends far beyond public companies

When the Sarbanes-Oxley Act was enacted into law in 2002, the focus primarily was on oversight of publicly traded companies and accounting. The legislation, while it did have some application to not-for-profits, was seen essentially as a way to clean up corporate America.

It is now apparent, however, that Sarbanes-Oxley's impact has been far broader than its supporters intended or envisioned. Not-for-profits and private companies quickly began to feel SOX' impact and now some are calling for similar regulation at the state and local government level.

To review, here are some highlights of Sarbanes-Oxley:

• Created the Public Company Accounting Oversight Board, an independent entity to oversee the profession of accounting.

• Limited narrowly the types of services that accounting firms can provide their public company clients.

• Increased disclosure requirements for public companies.

• Required top executives of public companies to take personal responsibility for the content of financial statements.

• Required analysts to disclose potential conflicts of interest.

• Added rigorous penalties for fraud and other misdeeds.

Interestingly, while most of SOX' attention focused on public companies, it did impose two little-noted provisions on all corporations, whether nonprofit or for profit (public or private). The two requirements are:

• Destruction of documents: SOX makes it illegal to destroy or alter a document to prevent its use in a legal action, such as a federal investigation.

• Protection for whistle-blowers: Sox makes it illegal for corporations to retaliate against an employee who reports a suspected illegal action by the employer.

In a farther development, in 2004 the U.S. Senate's Finance Committee held hearings on charitable giving problems and best practices, the newspaper On Philanthropy reported.

IRS Commissioner Mark W. Everson told the commission, "There are abuses of charity that principally rely on the tax advantages conferred by the deductibility of contributions to those organizations. If these abuses are left unchecked, I believe that there is the risk that Americans not only will lose faith in and reduce support for charitable organizations, but that the integrity of our tax system will also be compromised."

The hearings resulted in a series of recommendations that included:

•  IRS would review tax-exempt status every five years.

•  Scope and quality of form 990 and financial statements should be improved.

•  Availability of financial records should be improved to create greater transparency.

Today it is not unusual to find that not-for-profits, especially those with sizable budgets, have implemented a number of practices that mirror those used by public companies. Some examples are:

•  The organization has created an audit committee, which may be fully "independent" in keeping with SOX, which means no members of the committee are part of management and no one receives compensation. In smaller organizations, the finance committee may operate as the audit committee.

•  The CEO and CFO publicly attest to the accuracy, completeness and fairness of the financial statements, including Form 990, which is the annual report for not-for-profits. The also attest to the adequacy of internal controls.

•  The organization's financial statements are more easily accessible by the public and may be posed on the not-for-profit's website.

•  The organization has adopted and publicizes a code of ethics.

•  The organization has adopted rules regarding transactions with any "insider," which includes executive compensation and fringe benefits.

Over the past four years, BlueCross BlueShield of Kansas City has implemented many SOX requirements. The Missouri not-for-profit made the changes to "live up to the best practices in the industry," said Bryan Camerlinck, BCBSKC's president of audit and compliance, who played a lead role in designing the plan.

Camerlinck said one major benefit of the governance changes is that they "provide a clarification of roles and responsibilities, especially for board members. Board governance requires active participation by the board of directors, with special requirements for the Audit Committee. Active participation results in better transparency and ultimately better communication between management and the board."

The accounting firm BDO Seidman reported that not-for-profits were making the changes in response to pressures from a variety of constituencies, including funders, organizational associations, governing boards and members of the media.

Another driving force behind the changes has been state regulators. New York Attorney General Eliot Spitzer has proposed regulations that are similar to Sarbanes-Oxley and California has enacted a "Nonprofit Integrity Act" covering nonprofits with budgets of more than $2 million. It requires nonprofits to be audited by an independent auditor and to make the results available to the public.

Private corporations also are making changes. In addition to provisions protecting whistle blowers and prohibiting document destruction, many private companies encounter SOX when they raise capital by offering public debt.

Cargill, the U.S.' largest privately held company, according to Forbes' 2005 rankings, was an early leader. In 2003, the international provider of food, agricultural and risk management products, took several actions including describing off-balance-sheet activities and reducing the length of time the lead audit partner can serve to five years from seven. CFO Robert Lumpkins told CFO.com that Cargill's governance practices are "a hybrid between public and private."

In a 2005 survey of private companies by the law firm Foley & Lardner, reported by the Milwaukee Journal Sentinel, almost 80 percent of the respondents "have self-imposed corporate governance reforms." Almost all of the respondents said they required or planned to require audited financial statements, about 95 percent reported having an ethics code and almost 80 percent had or planned to have independent directors.

The Journal Sentinel also reported that several reasons for private companies to adopt Sarbanes-Oxley provisions were presented at a meeting of the National Directors Institute. Some of the reasons are:

•  Some banks and insurers are requiring companies to embrace SOX before doing business with the firms.

•  If owners of a private company want to sell to a public company, they will have to do extensive work to bring the seller into compliance.

•  Private equity funds seem to be more willing to invest in companies following SOX because they think their investment would be safer and that it might be easier to sell to a public company.

•  Talented outside directors will be easier to bring on board.

The Foley study noted that many of the governance measures being adopted were things that were comparatively inexpensive to enact.

Another area feeling the impact of Sarbanes-Oxley is state and local government. Some accounting firms have been warning government entities that special interest groups and oversight agencies can be expected to take a closer look at their practices in the current environment.

In addition, some academics have suggested that SOX should be applied to state and local governments. Richard E. Brown, professor of accounting at Kent State University, in an article in Public Budgeting & Finance, pointed out a number of similarities between the issues that led to the Enron crises and practices in public sector accounting. In his piece entitled "Enron/Anderson: Crisis in U.S. Accounting and Lessons for Government," Brown warned that government financial officials need to ask themselves some hard questions in the wake of scandals at Enron, Adelphia, WorldCom and others.

Some academic research indicates that failure to adopt SOX-like oversight can be costly to taxpayers. A recent research paper by Justin Marlowe and David Matkin at the University of Kansas finds that the cost of issuing debt is higher for governmental units with internal control problems than those without such problems.

As research findings like these become widely known, how long will it be before taxpayer groups and other activists demand tighter review of local and state government?

The impact of Sarbanes-Oxley on organizations such as nonprofits, private companies and governments has received very little attention from the business press. Numerous stories are sitting there, waiting to be written.

James K. Gentry is a professor and former dean of the School of Journalism and Mass Communications at the University of Kansas.

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Copyright © 2008 Donald W. Reynolds National Center for Business Journalism