Source: TKTK
nies will be required to fi le their quarterly reports thirty-fi ve days after the end of a quarter, rather than forty-fi ve days. Annual reports on Form 10-K or 10-KSB for these companies will be fi led sixty days after the end of the year rather than ninety days. Insider reports of changes in holdings by of- fi cers, directors, and 10 percent shareholders of all public companies now must be completed within two days of the change. In the past, these fi lings could sometimes be delayed by as much as fi ve or six weeks.
SOX created a new cause of action: securities fraud. The U.S. Securities and Exchange Commission and private parties can now bring charges of securities fraud against alleged bad actors in public companies. At one time, cases were brought for wire fraud, mail fraud, and the like. This is no longer necessary. Statutes of limitations on these cases also were broadened.
SOX prohibits public companies from loaning money or extending credit to their senior offi cers. Apparently, many companies loaned money to senior executives, then forgave the loan as a way to hide compensation.
SOX also changed accounting and auditing practices.
Companies on larger exchanges (not including the OTC Bulletin Board and Pink Sheets) are required to have audit committees on their board that are totally independent of management. Those committees are required to hire, fi re, and set compensation for auditors without manage- ment involvement. Theoretically, this will make auditors less subject to bullying by management.
In addition, all accounting fi rms that wish to audit public companies now must register with a new organization known as the Public Company Accounting Oversight Board, or PCAOB. If an auditor has more than one hundred public clients, the PCAOB will send in its own auditors to audit the auditing fi rm at least once a year. All other accounting fi rms are subject to random audits. This scrutiny has made auditors more conserva- tive in their approach, to the point where many in public companies now consider auditors to be their adversaries.
According to Section 404 of the bill, companies must hire a separate accounting fi rm to establish fi nancial controls, which their auditors must then monitor and update every year.
This is probably the most diffi cult and costly change SOX requires because it involves hiring a second accounting fi rm. As of this writing, the SEC has delayed the day on which these rules will apply to smaller com- panies (also known as “nonaccelerated fi lers”), but the day is expected to come. The SEC Advisory Committee on Smaller Public Companies has recommended all but eliminating Section 404 obligations on compa- nies with less than approximately $125 million in market capitalization (though this number would adjust), and reducing them for companies with less than approximately $700 million in market capitalization. It is
not clear what the full SEC will do about this recommendation.
SOX defi nes nonaccelerated fi lers as those with a market capitalization of less than $75 million (market capitalization is determined by multiply- ing the number of shares outstanding by the per share stock price). As of this writing, these companies have until the fi rst fi scal year ending after July 15, 2007 to implement the fi nancial controls described above. They are also currently exempt from the new rules regarding accelerated fi lings.
As mentioned throughout this book, this sweeping set of changes has had a disparate impact on smaller public companies. If the small business lobby had had a chance to be heard before SOX was passed, there might have been changes to the fi nal legislation. That said, the law is what it is and small companies continue to deal with it. FIGURE 10.1 illustrates the extraordinary burden small companies must shoulder when it comes to compliance with SOX as measured by compliance costs as a percentage of revenues.
After more than three years of experience with SOX, in general we have found that compliance has been less of a burden on smaller compa- nies than most people had expected. The main reason for this has been the fact that 404 compliance has not yet been mandated. The rest of SOX, while somewhat annoying, has simply become “the new normal” and, in fact, is pretty manageable for most companies.
In the end, SOX largely provides a positive set of changes that will reduce the opportunity for shenanigans in both big public companies and
FIGURE 10.1 Burden of SOX on Smaller Public Companies
Source: American Electronics Association
0.0 0.5 1.0 1.5 2.0 2.5 3.0
<$100m
$100m–$499m
$500m–$999m
$1bn–$4bn
>$5bn
Firm’s total revenues
Section 404 compliance costs as % of revenues
Source: TKTK
small. The fact that the pendulum had to swing farther in the direction of regulation than I feel was probably necessary is sometimes the cost of reacting to a real problem. Between the SEC Advisory Committee and at- tention it receives in Congress, it is hoped that some of the more extreme provisions in the Act can be altered or revisited to reduce the impact on smaller companies.