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Hundreds of publicly traded companies finished their first, do-or-die year complying with tough new accounting and public disclosure requirements under the Sarbanes-Oxley Act of 2002. The response by big business to regulators has been akin to the Laurel & Hardy catch phrase: “Here’s another fine mess you’ve gotten us into.” It has been the kind of year that keeps corporate counsel awake at night. The growing corporate backlash over what they consider excessive cost, duplicative effort and wasted time has caused the Securities and Exchange Commission to take notice. The SEC called for a summit meeting of sorts on April 13 in Washington to air the grievances. A survey of 217 publicly traded companies by Financial Executives International found that the average cost for a company to comply was $4.4 million, and for the largest multinational companies it cost more than $10 million. Some 94% of those responding thought the costs outweighed the benefits. An ‘unreasonable burden’ The significant expenses and diversion of management resources to comply with Sarbanes-Oxley is “an unreasonable burden on publicly traded companies in the United States,” wrote Patrick Erlandson, chief financial officer of UnitedHealth Group Inc. to the SEC. But the new rules also have their champions among investor groups who say that last year 560 companies admitted discovering weaknesses in their internal controls. “Investors are just starting to realize the benefits of Sarbanes-Oxley,” said directors of the $142 billion Ohio Retirement Systems pension fund in a letter to the SEC. Although there has been a law on the books since 1977, the Foreign Corrupt Practices Act, that requires good financial controls, hundreds of companies still warned of problems under the new Sarbanes-Oxley disclosure requirements. “Under the 1977 law, the SEC could only take action if it knew the controls were missing and the SEC can’t know that unless something blows up,” said Lynn Turner, former chief accountant for the SEC and now managing director of research at Glass Lewis & Co. in Broomfield, Colo. The 1977 law required companies to maintain adequate internal controls and report accurate numbers. Sarbanes-Oxley goes farther, saying companies must explain publicly what internal controls it has and do an audit to assess them, Turner explained. The sweeping reforms imposed on corporate America by Sarbanes-Oxley came in response to investor outrage over the corporate frauds that led to the downfall of Enron Corp., WorldCom Inc., Adelphia Communications Corp. and others. Among the 20 major companies under investigation by the SEC, U.S. Department of Justice or Federal Energy Regulatory Commission, shareholder losses totaled $236 billion-Enron alone accounted for $25 billion of it, according to an estimate by private market technician Daniel Chesler. “Investors lost more in Enron alone than [companies] will pay for implementing this reporting at all public companies,” said Barbara Roper, director of investor protection for the Consumer Federation of America. “The potential benefits dramatically outweigh the cost.” Congress included provisions in Section 404 of the law that require companies to document each step of their internal financial reporting controls and hire outside auditors to test the practices, and corporate heads to vouch for the reliability of public financial reports. It is Section 404 that has stirred up all the fuss. Costs for documenting accounting procedures and hiring outside accountants to look over executives’ shoulders and test the accuracy of the procedures have run to millions of dollars more per company than originally predicted. Outside auditing firms, facing government scrutiny for the first time, demanded far more detail from clients than in the past to avoid claims of material weaknesses on financial procedures. That led to disputes over what “material” means in the new post-Sarbanes-Oxley world. Auditors face new liability if they fail to report any potential material misstatements, and that creates tension between top executives and their auditors, according to John Beccia, research director and chief regulatory counsel for the Financial Services Roundtable in Washington. Executives feared pointing out problems to auditors because it would then be publicly reported. Auditors, for their part, hesitated to issue opinions for clients on arcane accounting rules for fear of claims that they lacked independence. In addition, corporate counsel must confront the potential for claims of misstatements on financial reports if the money set aside for potential litigation losses misses the mark significantly, according to Linda Griggs of the Washington office of Morgan, Lewis & Bockius, a former chief counsel to the SEC’s top accountant. “It is so much easier to second-guess someone,” she said. She said that some lawyers have looked at “materiality” as a quantitative measure-a limited sample of transactions-while others see a much broader qualitative demand for information, and the two positions are irreconcilable. She’s not alone in calling for clarification. Griggs also said outside auditors should be allowed to rely on the work of a company’s internal auditors to reduce duplication. Then there is the problem for initial public offerings for new companies. With Section 404 reports due every March, a fledgling company might delay an IPO slated for launch at the end of a calendar year to avoid the double whammy of IPO scrutiny and additional Section 404 controls testing and audits. Complying “requires a great deal more lead time,” said John W. White, a securities, IPO and corporate governance specialist with Cravath, Swaine & Moore in New York. A company planning an IPO in November won’t have the resources for both the IPO financial disclosures and the 404 process, White said. In future years, this will affect people’s timing of IPOs, he said. He recommended that companies should not have to do the first Section 404 report until they have been public a full year. A $54M price tag? And for a corporate behemoth like Deutsche Telekom A.G., with 400 subsidiaries in 65 countries, the estimated cost of Sarbanes-Oxley compliance in the first year runs a whopping $23 million to $54 million. Neil Belloff, the firm’s vice president and securities counsel in New York, urged the SEC to limit the management and audit reports to once every three years. Just two weeks ago, SEC Chairman William Donaldson told corporate America “we’ve been listening” in a Wall Street Journal editorial. But he also suggested that he’s not going to pull back. He said Section 404 reporting “is too important not to get right.” The SEC has received nearly 100 public responses from chief executive officers, lawyers, the largest accounting firms and consumer groups since it announced the April roundtable session two months ago. Most of them recognized that the implementation of Section 404 will benefit investors, but as one of the big four accounting firms, Ernst & Young, wrote, the first year has not been perfect but it is a “work in progress.” Griggs of Morgan Lewis said, “At the end of the day, is all this [even with modifications] going to preclude fraud? The answer is no. We have enormously clever people and if they want to commit fraud they will do it. Dummies won’t be able to do it . . . but there will still be fraud.” Turner pointed out that even with passage of Sarbanes-Oxley and its legal liability for executives, officials still falsified reports to the public. “I guess [there might be deterrence] if you take about 10 of these people down to Central Park, tie a rope around their necks, hang them from a tree and let people walk by for about a week; I don’t see how else you’re going to get people’s attention and get them to stop this,” he said.

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