by John Covaleski
Forget about the “cascade effect.” Privately held companies may be leaning toward voluntarily adopting their own rules for working with auditors similar to ones in the Sarbanes-Oxley law covering public companies.
Thirty-eight percent of 1,356 chief financial officers at privately held companies agreed that privately companies should implement “the same type of governance and control practices” required by Sarbanes-Oxley, while another 38 percent were undecided and just 24 percent disagreed in a survey completed this summer by staffing and consulting company Robert Half International Inc. A separate Robert Half survey of 1,400 private company CFOs found that 58 percent were already adopting some of the measures required by SOX.
Practice leaders at CPA firms with private company audit clients agree that privately held companies are adding some elements of SOX into their policies, but they doubt that the movement is as widespread as the Robert Half findings suggest. Half’s most recent survey canvassed approximately 225 companies in each of the following employee size ranges: 20 to 49 employees; 50 to 99; 100 to 249; 250 to 500; 500 to 999; and 1,000 and above.
“There are aspects of Sarbanes-Oxley that are causing people in small businesses to ask if they are doing the right things in corporate governance,” said Rick Julien, co-leader of corporate governance and risk management services with national CPA firm Crowe Chizek and Co., in Indianapolis. “But I don’t think there’s a groundswell of private companies trying to comply with this law right now.”
However, Julien and his counterparts at other firms all concur that the stage is set for private companies to significantly expand their corporate governance and financial reporting requirements.
“This is an era of general skepticism about the quality of all financial reporting - from both public and private companies,” said Trent Gazzaway, national director of corporate governance for Grant Thornton, in Chicago. Adopting SOX-like rules voluntarily is an opportunity for these companies to “stand above board and above the rest in the eyes of their lenders, partners and employees,” he added.
Should privately held companies adopt SOX-like regulations, it would undercut the widely held theory that individual state legislatures, which set rules for private companies in their jurisdictions, would force the issue by individually passing laws that emulate the federal act. The American Institute of CPAs, which dubbed that state activity “cascading,” has been conducting a major anti-cascading effort that includes the Web site www.aicpa.org/statelegis/index.asp.
The movement could also profoundly affect accountants and the economy in general, because privately held companies far outnumber public companies. The AICPA reports that there are from 15,000 to 17,000 CPA firms that audit privately held companies, and that its SEC Practice Section has just 7,832 member firms that audit public companies. Also, just 17,000 of the nation’s 4.9 million corporations are registered with the Securities and Exchange Commission.
Julien, Gazzaway and others familiar with governance issues all say that the high cost of Sarbanes-Oxley is among the factors thwarting a widespread movement by private companies. “If anything, we are seeing public companies go private because of the costs of Sarbanes-Oxley,” said Wayne Kolins, national director of assurance services for BDO Seidman, in Chicago.
High costs are the biggest issue facing public companies already trying to comply with the law, reports Protiviti Inc., a national internal audit and risk consulting firm and Robert Half affiliate. Its recent survey of public companies found that they estimated that SOX compliance costs range from $10,000 to over $ 1 million, and that 12 percent could not estimate the total costs.
“If the public companies cannot figure out what it will cost them, then the private companies will not be able to know,” said a Protiviti spokesman.
High costs could mean that private businesses will first adopt the less costly aspects of the law. The Robert Half survey regarding SOX measures already in place at private companies cited the following as the most common activities: reviewing or altering accounting procedures, expanding internal audit functions, and hiring outside consultants for internal audit work.
The Robert Half findings did not show private businesses moving toward the SOX element with the potentially largest negative impact on many accounting firms - the prohibition against firms providing non-audit services to their audit clients.
Just the same, there’s growing fear that private companies will adopt tougher reporting requirements en masse. “Sarbanes-Oxley has ratcheted the bar up to a new standard,” said David Hardesty, a partner in Wilson Markle Stuckey Hardesty & Bott CPAs, in Larkspur, Calif., and author of “Corporate Governance and Accounting Under the Sarbanes-Oxley Act of 2002,” published by RIA/Warren, Gorham & Lamont, a Thomson business.
Hardesty noted that incorporating SOX-like standards might ultimately be necessary for small businesses to fend off litigation alleging fraud. Specifically, a court could rule that if the company did not have SOX-like standards, it was negligent by not doing all it could to prevent fraud.
“Private companies are seeing Sarbanes-Oxley as a ‘best practices’ thing, and may start adopting it to take the high road,” said Allan Koltin, president of PDI Global, a leading practice management consultancy for accounting and law firms.
The lingering effects of the Enron and Worldcom scandals that prompted last year’s passage of Sarbanes-Oxley may also be motivating private companies today.
“We are hearing private companies starting to say, ‘There’s all this bad stuff [financial scandals] going on that, even though we don’t think we have problems, we want you to look at our controls,” said Julien.
Paul MacDonald, executive director of Robert Half Management Resources, said that private companies’ actions today are in the “wake of corporate scandals.” He also noted that private companies expecting to go public would have to be SOX-compliant eventually, so they are opting to do so early on.
Kolins said that while BDO has been consulting for public companies going private, it has also seen attendance increase at its initial public offering training. “This is really becoming a schizophrenic business environment,” he said.
Private companies would also have to adopt SOX measures should they enter into long-term arrangements with, or become acquired by, a public company, MacDonald said.
There’s also a growing sense that third parties, including regulators or banks dealing with loan clients, could ultimately mandate SOX-like standards of their constituencies.
The most prominent example thus far has been the General Accounting Office’s restrictions on government entities, subject to nonprofits receiving at least $250,000 in federal funds per year.
The rules say that auditors of these organizations:
● “Should not perform management functions or make management decisions” in addition to the audit services provided to these clients.
● Should not audit their own work or provide non-audit services in which the amounts involved are “significant” or the work is “material to the audit.”
The accounting professionals all said that nonprofits will likely lead the private sector’s expansion to SOX-like rules. Besides the GAO rules, they note that nonprofits share several key characteristics with public companies.
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