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Maybe March 16 won’t be such a nightmare after all. That’s the date when the nation’s biggest companies have to complete an audit of their internal controls—yet another new chore courtesy of the Sarbanes-Oxley Act. Businesses have to disclose their findings to the Securities and Exchange Commission (SEC). They feared that if they have problems to report, they’ll be punished by stockholders, bond rating agencies and plaintiffs’ lawyers. A funny thing happened on the way to doomsday, though. Many companies decided to report their problems early, rather than wait for the March 16 deadline. And so far, the reaction to the bulk of these disclosures has been decidedly ho-hum. According to Compliance Week, a corporate governance newsletter, more than 200 companies reported problems with their internal controls in the last three months of 2004. (An SEC spokesman said that the agency doesn’t keep count of these filings, but has no reason to doubt the Compliance Week figure.) Among the early birds, Visteon Corp.-an auto parts manufacturer based in Dearborn, Mich.-admitted in November that there were flaws in the accounts receivable for sales to Ford Motor Co., from which it was spun off in 2000. Also in November, the Seattle-based bank Washington Mutual Inc. said in a preliminary filing that “certain areas” of its internal controls “required improvement.” (A more detailed disclosure will come in March.) Only 6% sued-so far Visteon and Washington Mutual, like most of the early reporters, haven’t seen their stock price drop-indeed, their share price has risen since their filings. Plus, none of last year’s early birds have seen their bond ratings lowered. As Neri Bukspan, the chief accountant at New York-based Standard & Poor’s, said, “We haven’t seen the need to cut any ratings yet.” Finally, only 6% of companies that have reported material weaknesses so far have been hit with securities lawsuits, according to a recent study by Big 4 accountant Deloitte & Touche and Dallas law firm Haynes and Boone. The mild reaction has been a happy and unexpected development for corporate executives. “It’s surprising,” said Michael Roster, the general counsel at Oakland, Calif.-based Golden West Financial Corp. As Roster prepares to submit Golden West’s disclosure statement on March 16, he said that the deadline “just might wind up being not all that important after all.” Referring to the mistaken prediction that computers would crash on Jan. 1, 2000, Roster said that the internal audit report deadline “could go down as a sort of mini-Y2K.” Although Sarbanes-Oxley was enacted in the summer of 2002, executives didn’t pay attention to its Section 404-which requires the internal-controls audit-until about a year later. That’s when the SEC established the March 16, 2005, deadline for the completion of the audits at public corporations with a market capitalization of more than $700 million. (The due dates for smaller businesses come later.) The assessment of internal controls is a demanding one. Companies must ensure the reliability of their accounting systems by documenting nearly everything about their assets, from the way they manage their inventories, to how they bill their customers, to how they handle payroll. Problems-deemed “material weaknesses” or “significant deficiencies”-must be reported to the SEC. 26,000 hours on compliance Compliance is costly and time-consuming, according to a survey released last July by Financial Executives International, a Florham Park, N.J.-based professional association. Companies with more than $5 billion in annual revenue have spent an average of nearly 26,000 hours and $8 million in auditing and consulting fees. Though the audit is usually run by the chief financial officer, in-house lawyers have played a leading role in preparing the disclosure statements for the SEC. “[Section 404] has kept the lawyers here quite busy,” said Bart Schwartz, deputy GC at Marsh & McLennan Cos., the New York-based insurance broker. “You really want to make sure the [reports] are well prepared and well executed.” Why haven’t the early-bird reporters taken more of a hit for revealing their problems? For one thing, last fall SEC officials started telling the investment community not to panic if Section 404 resulted in a wave of negative disclosures. According to Michael Young, a securities litigator at New York’s Willkie Farr & Gallagher, the SEC is “trying hard to pull the sting out of this. They’re telling the public that if a company reports it has, say, a segregation of duties problem in its payroll department, it’s not like it’s filing for Chapter 11.” Perhaps more importantly, most of the businesses that have already disclosed problems have also presented detailed remediation plans to cure their ills. These proposals have mollified shareholders and bond rating agencies. “So far, we’ve been satisfied with all of the remediation plans,” said Bukspan of Standard & Poor’s. Music publisher WMG Acquisition Corp., for example, made sure to include a remediation plan in its latest S-4 filing, submitted last November. The company reported several material weaknesses related to its spin-off from Time Warner Inc. last spring. Among other issues, WMG said that it lacked an inside audit department, an internal tax group and a formal code of conduct. But the company included a letter stating that it had recently hired a chief accounting officer and chief financial officer, set up an internal audit committee and hired a new director of taxation. To date, the company’s bond ratings hadn’t been affected by the news. (It hasn’t yet issued stock.) Buying time With a remediation plan, a company can buy some time to fix its faults. But if it hasn’t cured its ills by the time its 2005 report is due, it could be in for some real pain, most notably from the plaintiffs’ bar. Covington & Burling partner David Martin Jr. noted, “If you haven’t ironed out your issues by [next year], I’d imagine it’s going to signal to a lot of people that you’ve got much larger problems.” Joel Bernstein, a securities litigator at New York’s Goodkind Labaton Rudoff & Sucharow who represents plaintiffs, agrees. Bernstein said he’ll start looking at companies’ disclosure statements after March 16, but the lawsuits may not get filed right away. “It might take a while to show that the current disclosures don’t match up with reality,” he said. As a result, some businesses might get stung. But compliance with Section 404 might lead to an unexpected payoff, Bernstein said. “If corporate America follows this law, there’s going to be less fraud and fewer securities class actions,” he said. “And that will benefit everyone. Except, of course, the lawyers.”

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