Compliance: Is Sarbanes-Oxley Working? - ' The Real Problem with '
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The Real Problem with SOX
At last, an unchallenged fact: SOX implementation is a lot more expensive than the regulators promised it would be. The initial estimates were about $91,000 per company for Section 404 compliance. Not even close: the CRA study showed that the average direct cost of complying with Section 404 at large companies (defined by a market cap of $700 million or more) was $8.5 million in 2004, while companies in the $75 million-to-$700 million range spent an average of $1.2 million. Smaller companies are not yet required to comply with Section 404.

Bell says those costs declined by as much as 44 percent for 2005. "It would not surprise us to see costs continue to decline," he says. "Maybe not as much as between year one and year two, but given the learning curve and the one-time costs, it should become more of a maintenance issue."

None of which changes the fact that SOX compliance is very hard on smaller companies. It not only costs them a relative fortune, but it may solve some problems that don't exist for investors, who already know that smaller companies probably carry greater risks than their larger, more-established counterparts.

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Alan Musso is the chief financial officer of Targacept Inc., a development-stage biopharmaceutical firm in Winston-Salem, N.C., that went public on the Nasdaq exchange earlier this year. Obviously, his company wasn't deterred by the regulatory costs—Targacept won't be required to comply until the end of 2007, a year after issuing its first annual report as a public company—but they are a big deal, nonetheless, for a young company with limited revenues to date. "We're not excited about the compliance costs, but it didn't change our plans," he says. "We would have to spend maybe $250,000 to $400,000 in the first year, and then there's the ongoing cost. That's hard to digest, because we don't see it adding value." He calls the regulations a "distraction that takes money away from developing our products."

It's not that small companies don't need or have strong financial controls, says Musso. Targacept has robust financial and accounting systems from Microsoft Corp.Great Plains (now Dynamics), he says, but it has not had to spend on the auditing processes. Still, Musso believes that SOX may push some businesses in the right direction. "Companies may be building themselves in a higher quality way around the SOX standards," he says. "But the challenge for companies like ours is the one-size-fits-all solution. We're not as complex as a large company. A lot of what SOX is trying to accomplish at a company our size is done just by having the CEO and CFO certify results, because at a company our size they actually know what's going on."

Relief may be on the way for smaller companies. An SEC advisory committee recommended in late April that companies with revenue of less than $125 million, and a market cap of under $128 million, be exempted from Section 404, and midsize firms exempted in part.

Senator Paul Sarbanes has challenged the recommendations, saying they exempt too many companies, that the committee included too few investor advocates, and that there may not be a statutory basis for the exemptions. "Fortunately, vigorous opponents of the recommendation have stepped forward," he told the Consumer Federation gathering in March.

Sarbanes may be correct that the SEC is suggesting too much of a revision to his namesake law, but it seems a move in the right direction. Such massive regulation is an uncertain science, and even if it is beneficial in general, there is certainly room for improvement.

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