Private companies: 4 lessons from Sarbanes-Oxley Act
Surprise, surprise. Many public companies subject to the provisions of Sarbanes-Oxley Act of 2002 aren't happy with the increased paperwork and the higher compliance costs that have come with the legislation.
But in the wake of the many business scandals in recent years, few companies and executives are trying to shoot down the U.S. law.
Moreover, the thrust and spirit of the Act is reaching beyond companies trading on Wall Street. Some Sarbanes-Oxley requirements also are serving as models that private companies — which are not forced to comply with the Act — are following to improve their own operations.
The difference is that private companies — small, medium and large — are able to take on parts of the Sarbanes-Oxley Act as their own initiatives, without the threat of legal action for noncompliance, and still achieve some benefits.
"Generically, anything that shows accountability and transparency and responsibility to the people who own the enterprise is a good principal to follow," says Lance Jon Kimmel, a veteran attorney with the SEC Law Firm in Los Angeles.
"I have not spoken to any executives who say the things that a company has to do under Sarbanes-Oxley are bad ideas; it's just that there is a one-size-fits-all mentality that translates to relatively high costs for small public companies. On the other hand, I think companies that don't have to follow Sarbanes-Oxley can benefit by picking and choosing parts of the corporate governance principals that apply to them and can help them."
Based on interviews with legal and accounting experts, here are four key areas where small businesses and other private companies can take some lessons from Sarbanes-Oxley.
1. Work with two accounting firms — not just one. This is maybe the best-known impact of the Enron and other accounting scandals: having just one firm handling all of the accounting-related needs for a big public company can now raise red flags. "The instances where you had these huge accounting firms that did everything for these major corporations, up to and including providing staff to go in and help run the company, helped lead to some of the provisions in Sarbanes-Oxley," notes Dave Ellrich, a certified public accountant with the accounting firm of Moore Ellrich & Neal in Palm Beach Gardens, Fla. Ellrich notes that CPA firms will typically provide a certified audit for a family business as well as handling or advising on family tax returns, succession planning, estate planning, business consulting, and other matters. "That's now being separated out, as more and more you'll probably see successful family businesses going to a separate outside auditor and then having a separate CPA for tax filing and consulting services," he says. "It's really sound common-sense reasoning. I have clients with whom I've worked for more than 20 years and I don't like to provide audit services to those clients because I don't feel that I am independent. I don't have a share of their companies, but I have become a friend over the years." "A private company doesn't have to hire one of the big firms to conduct the external audit," adds Melanie Damian, an attorney with the Miami-based law firm of Damian & Valori. "They can use a smaller firm. Even thought it's still an additional expense, it's less than the large public companies have to spend, and it helps the company to be sure it's operating efficiently and properly," she says.
2. Have an audit committee. A private business may or may not have the resources to hire experienced auditors, Kimmel says. But some system of internal checks and balances that includes interactions with management is a sound principal, and can be especially useful for growing companies that might someday go public, he says. "Whether or not the audit committee has to have someone sitting on it who is a former auditor himself is open to discussion, but just having an audit committee is a good start."
3. Institute whistleblower protections. A company's top managers and owners can become divorced from what's going on at the company on a daily basis. They may not even find out about a problem unless an employee within the company is willing to bring it to their attention." It makes sense to have provisions for people within the company to be able to make complaints about internal problems without being afraid of getting fired for making a complaint," Damian says. "If you were a business owner, wouldn't you want to know if something was happening that was wrong?" You also want to have a system in place for employees to make complaints anonymously," she says. "A system that lets employees know they can report problems without fear of being fired can really benefit a company."
4. Make your independent board truly independent. The idea of an outside board of advisers is that there should be people reporting to the chief executive officer who are not expressly loyal to or working directly under the CEO.Reports of companies with boards of advisers comprised of rubber-stamping friends of management have helped reinforce the idea of the importance of having a truly independent board. The Sarbanes-Oxley requirement that chief executive officers and chief financial officers personally certify the accuracy of public filings and audits highlights the importance of having an independent board that gets and can respond to accurate information to help management. Companies are looking to software and other solutions for help with tracking or investigating financial records, as well as with internal documentation requirements and other compliance issues." Board members are now under tremendous pressure to document that they are doing everything properly under Sarbanes-Oxley," says Ellrich. "If the audit committee gets a report from audit staff that there appears to be a possible financial problem, software can also provide basic guidance as to how to deal with the situation and what kinds of memos and reports you have to put out." Even if your company isn't subject to Sarbanes-Oxley, it still makes sense to maintain and support an independent board. Most independent businesses can benefit from having more rather than fewer trained and concerned eyes assisting management.