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A new study reveals that companies are paying a high price to stay public in the wake of a sweeping set of changes to federal securities law. Conducted by the law firm Foley & Lardner, the survey is the first to try to capture the cost of compliance with the Sarbanes-Oxley Act, which imposes numerous new regulations on the 14,000 companies that publicly trade their stock. The survey of mostly mid-cap companies found that since the law’s passage last summer, the average price of being public has close to doubled, from $1.3 million to almost $2.5 million. The study was based on responses from 32 companies and a review of 328 proxy statements, as well as interviews with accountants, insurers and public relations companies. By any account, the increase in costs is staggering, especially for many smaller companies struggling to stay afloat in a difficult economy. Yet lawyers who advise small and mid-cap companies said they were not at all surprised. “I don’t think any of the numbers are way off the mark,” said Michael Rennock, a partner in the New York office of San Francisco-based Morrison & Foerster. Sarbanes-Oxley was Congress’ reaction to mammoth accounting frauds at several of the nation’s biggest companies. It is aimed at restoring investor confidence by requiring companies to take specific actions to attain greater accountability and transparency. At first blush, this goal appears reasonable. Yet the law does not distinguish among public companies, the vast majority of which are small and mid-cap companies. And unlike their larger brethren who already have the infrastructure to handle new regulations, for the smaller firms, Sarbanes-Oxley is proving to be extremely burdensome. “The law was intended to address high-profile scandals at very large companies,” said Michael A. King, a partner at Weil Gotshal & Manges, “yet it is having the unintended consequence of hurting the small-cap and mid-cap companies.” Of the expenses associated with public status, almost two-thirds of the increase can be attributed to directors’ and officers’ liability insurance. Before Sarbanes-Oxley, when D&O insurance was an average of $329,000 a year, it was already the most expensive outlay for public firms. Now it is setting back companies a hefty $639,000 a year. Driving the upsurge is the increased legal exposure corporate executives are facing post-Sarbanes-Oxley. For instance, federal regulation now requires a company’s chief executive to personally sign off on its financial statements. And executives have also increasingly found themselves named as defendants in the shareholder suits that have mushroomed post-Enron and other corporate scandals. Somewhat surprisingly, given the dim view many shareholders take these days of the high-priced executive, the money devoted to directors fees has also doubled. This number reflects the increased time they are putting in, explained Lance Jon Kimmel, a partner in Foley & Lardner’s Los Angeles office. He said the directors surveyed expected the annual number of hours devoted to board work to double, from an average of 125 hours to more than 200. The supply of good directors has also shrunk. “Directors are resigning from boards, especially of smaller companies,” said Rennock of Morrison & Foerster. The survey found that smaller companies are being forced to pay search firms to find replacements, something they rarely had to resort to in the past. Accounting and legal costs respectively are the second- and third-priciest items related to public status. On average, both have basically doubled, from $243,000 to $499,000 for accounting fees, and from $210,000 to $404,000 for legal fees. The increase in audit costs is due largely to heightened sensitivity to liability concerns on the part of auditors, said CMS Energy Corp. Corporate Secretary Michael van Hemert, who spoke at a panel discussing the study last week. As might be expected, costs are even higher for companies under investigation. Van Hemert, whose company came under scrutiny two years ago because of questionable accounting and trading activities, said audit fees have increased three-fold. Legal fees too have skyrocketed. The survey found that fees directly associated with Sarbanes-Oxley compliance, such as revising committee charters and preparing codes of conduct, can easily range in the hundreds of thousands of dollars for even mid-cap companies. The law has also indirectly boosted legal costs for many companies, Weil Gotshal’s King said. For instance, audit and compensation committees are now hiring separate counsel to ensure their independence. In fact, the survey found that across the board, Sarbanes-Oxley has raised the cost of every item associated with public status. The increases range from a modest 12 percent for public relations (excluding investor relations) to a breathtaking 268 percent for compliance personnel. The price hikes are high enough to have many smaller companies thinking about going private, King said. “When you’re only making $5 million a year, $2.5 million is half your profits.” Rennock added that although a lot of companies have explored the idea, “surprisingly few” have actually taken the plunge, put off by the high cost of doing so. “It is an expensive process,” involving extensive filings with federal regulators and “almost inevitable” shareholders suits, he said. “Once you’re done, though, it saves you a lot of money,” he said. Sarbanes-Oxley is also having a significant impact on the decision whether to go public in the first place, King said. Because of that, it is reducing the availability of capital to finance new businesses, he said. Typically, venture capitalists look to hold the company for a few years, and then sell it or go public, he explained. “If businesses are less able to exist as public companies, it inhibits one of the two major exit strategies of the venture capitalists who finance them.” There is no relief on the horizon either; the survey noted that many of the increased costs are only just starting to be revealed, given companies’ different reporting cycles. King said that there is some talk of Congressional hearings to focus on changes that have occurred as a result of the statute, and the “small-cap company problem” might come up then, although he added that he did not foresee any legislation coming out on this issue any time soon. The Securities and Exchange Commission, which is charged with administering Sarbanes-Oxley, so far has declined to exempt small businesses from any of its requirements. But King said he felt that the issue is one that “will get attention from the SEC at some point.” “Investors want accurate accounting but more than that they want increased earnings,” he said, “and expenses are just so high.”

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