"Honesty requires a lot of paperwork," The Baltimore Sun, March 16, 2005 <p>Copyright (c) 2005, The Baltimore Sun <p>Honesty requires a lot of paperwork <br>Sarbanes-Oxley: A provision of the law intended to prevent business mischief such as WorldCom's elicits growing corporate complaint. <p>By Laura Smitherman <p>Sun Staff <p>March 16, 2005 <p>When President Bush signed the Sarbanes-Oxley Act into law in July 2002, the problems at WorldCom Inc. were fresh on everyone's mind because the telecommunications giant had sought bankruptcy protection just nine days earlier. <p>Nearly three years later, WorldCom's former chief executive has been found guilty of fraud and could face a maximum prison term of 85 years, potentially one of the stiffest sentences yet in a parade of white-collar criminals. <p>But many businesses remain disgruntled about the government's remedy to corporate corruption. Companies have grumbled about the impact of Sarbanes-Oxley on their bottom line since the law was enacted. Lately, the grousing has reached a fever pitch as the costs to meet one requirement under the law have skyrocketed beyond expectations. And that has caught the attention of federal regulators. <p>Executives and auditors are required to attest to the strength of internal controls at publicly traded companies, or the ability to detect fraud and accounting errors. The provision, considered by many to be the most effective tool for heading off corporate mischief, accounted for two paragraphs in the 66-page law. <p>Things got more complicated - and the paperwork and manpower escalated - as an alphabet soup of federal and self-regulatory agencies imposed rules and guidelines. <p>Internal controls <p>U.S. Sen. Paul S. Sarbanes, the Maryland Democrat who co-wrote the legislation with Ohio Republican Rep. Michael G. Oxley, said the law is working. He pointed out that hundreds of companies have disclosed that they found shortcomings in their internal controls and were able to correct them, possibly preventing a fraud and thereby protecting investors. <p>"The question is, 'Do you think a public company listed on an exchange that any investor can buy worldwide should have a system of internal controls?'" said Sarbanes in an interview last month. Last week, Sarbanes announced he will not seek re-election in 2006 after a 30-year career in the Senate. "I haven't run into anyone yet who says 'no' in answer to that question." <p>"Then the question becomes how is this thing being implemented," he said. "How much double-checking is being done, how much paperwork is being required that may not be absolutely necessary? Well, that's always worth looking at." <p>Securities and Exchange Commission Chairman William H. Donaldson has responded by giving foreign and smaller companies more time to comply and by scheduling a public forum next month for companies to air their concerns. Donaldson told a congressional committee last week that the agency needs "to ensure that the benefits are achieved in the most sensible way." <p>An initial rough estimate from the SEC put the annual cost for a company to fulfill the law's internal control provision, called Section 404, at $91,000. But in a survey by Financial Executives International, a professional group, companies estimated that the cost is more than $3 million on average. <p>"The amounts of money being spent on it are staggering. It's almost like being taxed for being a public company," said Geoffrey F. Feidelberg, chief financial officer of CompuDyne Corp., an Annapolis maker of security systems. It put eight full-time workers on the compliance effort and was still unable to file its latest financial results on time. <p>Investor advocates are warning the SEC not to weaken the Sarbanes-Oxley law by allowing "shortcuts" that would reduce costs. Companies have been relying on outdated or ineffective internal controls for decades, said Laurie F. Hacking, executive director for the Ohio Public Employees Retirement System, a $64.5 billion pension fund. <p>"Leave Sarbanes-Oxley intact, and reject any proposal by its critics to weaken this important investor protection legislation," Hacking wrote in a letter to SEC officials. "Investors are just starting to realize the benefits." <p>Outside auditors <p>Companies actually have been required to have a system of internal controls since 1977, when Congress enacted legislation to prohibit bribery of foreign officials for government work. That law compelled companies to implement accounting systems to control and accurately record company assets, in part to prevent "slush funds," or accounts used to make illegal payments. <p>Sarbanes-Oxley reiterated that companies must have internal controls and also required that an accounting firm vouch for the system. <p>Under the law, most of the nation's largest companies had to have outside auditors assess their internal controls within 75 days of the new year - today. Already, more than 600 companies have announced that they discovered problems, including difficulties with reconciling accounts or tracking inventory, according to Compliance Week, a newsletter on corporate governance. <p>Investors might never have known about those problems had it not been for the auditors, said Lynn E. Turner, a former chief accountant at the SEC and a managing director at Glass Lewis & Co., a financial research firm. <p>Chief executives and chief financial officers had been personally certifying their financial results under another Sarbanes-Oxley provision since August 2002, and Turner said most didn't alert shareholders to trouble with internal controls until auditors had to report on it. <p>"There have been a lot of CEOs and CFOs who quite frankly misled their investors," he said. "And the reason we know that is not because the executives bellied up and admitted their mistakes but because the auditors found problems and forced that to become public." <p>The Sarbanes-Oxley law has spawned a cottage industry of consultants and accountants specializing in helping companies get up to speed with its provisions. <p>"The Enron problem killed one accounting firm but ended up benefiting all of them," CompuDyne's Feidelberg said, referring to Arthur Andersen, the firm brought down in the Enron Corp. scandal. <p>Companies complain that auditors who face the risk of lawsuits for their mistakes are applying a standard that's too stringent and that many of the problems that have been uncovered are trivial. That "abundance of caution" has added to costs that are becoming a drag on the economy, especially for smaller businesses, said David Hirschmann, senior vice president at the U.S. Chamber of Commerce. <p>"What's at stake is ability of innovative small companies to grow and prosper and create jobs, and their success in doing so shouldn't hinge on one regulation," Hirschmann said. <p>The number of companies that delisted their stock from exchanges, or went private, reached nearly 200 in 2003, three times the number from the previous year, according to a study by the University of Pennsylvania's Wharton School and the University of Maryland's business school. Many companies cited the burden of conforming to Sarbanes-Oxley. <p>Sherwood Brands Inc., which makes chocolate, lollipops and gift baskets, took its shares off the American Stock Exchange this month. Chief Financial Officer Christopher J. Willi said the Rockville company did so because it would have had to pay $200,000 for an audit of its internal controls, on top of other legal and accounting bills that had ballooned as the company struggled to meet other Sarbanes-Oxley requirements. <p>"We wanted to bring back shareholder value, which was diminished by being public," Willi said. "Every time you get government involved, you get more regulations." <p>Provident Bankshares Corp. said it would have met Wall Street's expectations for its earnings last quarter if the Baltimore bank hadn't spent so much checking and re-checking its accounting. <p>2 cents a share <p>Gary N. Geisel, Provident's chairman and chief executive, said the bank underestimated how much it would cost, as its bill for auditing and consulting services rose $184,000 in the fourth quarter alone. That translated into 2 cents a share just to meet Section 404, bringing down its earnings per share to 56 cents, or one penny short of Wall Street estimates. <p>Geisel said he broke out the cost for analysts and investors in the bank's most recent earnings statement to draw attention to the problem, although he said he doesn't expect any relief, not anytime soon at least. <p>"People are more open to listening to concerns, but it's too early or premature to presume that that listening will result in any changes right away," he said. <p>Many executives are resigned to the new regulatory environment and concede it was time for a major overhaul. <p>Joseph Streppel, chief financial officer at Aegon NV, the Dutch insurance company whose U.S. operations are based in Baltimore, said, "People with integrity will admit that it was about time for new regulation." Aegon has spent more than $35 million on its compliance effort, he said. <p>"We had to do a lot of changes that will not immediately result in an improvement," Streppel added, "but that's life." <p>Sarbanes points out that stock markets have risen since the law was enacted. The Standard and Poor's 500 Index has gained about 50 percent. <p>"Investors can have a greater sense that the information they've been given is accurate and transparent and comprehensive," he said.