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Two reports released last week claim that the burden of complying with the 2002 Sarbanes-Oxley Act, long a target of corporate complaints, grew still heavier in the past year, especially for smaller companies. Chicago-based law firm Foley & Lardner’s report on its third annual SOX compliance survey, released Thursday, and covering information from proxies gleaned from 700 companies in the Standard and Poor’s database and 147 respondents to a questionnaire sent by the law firm, said that the annual “cost of being public” since SOX was enacted had increased an average of 233 percent by last year for smaller companies, defined as those with annual revenue of less than $1 billion. The cost jumped 33 percent from 2003, it said. The report attributed the rise to a key SOX provision, known as �404, which mandates an assessment of a firm’s internal controls by management and external auditors. Those audit fees accounted for the largest increase in out-of-pocket expenses, the report said. Average audit fees for smaller companies revenue surged to $1 million in 2004, from $532,000 in 2003. The survey also found that lost-productivity costs for the smaller companies soared to $1.1 million in 2004, from $160,000 in 2003. “As predicted, Section 404 dominated corporate-governance concerns for public companies in 2004,” wrote Tom Hartman, study director and partner with Foley & Lardner, in the report. “The magnitude of the average audit-fee increases, coupled with the reported lost productivity number, confirms that the economic costs of the Sarbanes-Oxley are not trivial or immaterial, particularly for smaller public companies.” In an interview, however, Hartman noted that the survey does not pass judgment on the law or its intent. “It’s clear this is an appropriate regulation,” he said, “but when you take an act that was intended for large companies and apply the prescription to all companies no matter what the size, than you start having problems.” A second report, by the Nasdaq Stock Market Inc., also suggests that the burden of SOX compliance falls more heavily on smaller companies. A recent survey of Nasdaq-listed companies showed that while 74 percent of respondents believe SOX is necessary, they think its failure to account for size puts smaller companies under a greater burden, especially as regards complying with �404. “The burdens of 404 implementation are not always commensurate to its benefits, especially with regard to smaller public companies,” Ed Knight, executive vice president and general counsel for the Nasdaq, testified at a New York hearing held by the SEC Advisory Committee on Smaller Public Companies on June 17. “Based upon a survey of our companies, as a percent of revenue, smaller issuers appear to have spent approximately 11 times more than larger companies on 404 compliance.” The Nasdaq report, based on two surveys sent to 3,053 Nasdaq-listed concerns with a total of 775 respondents, said the compliance costs per company now average $1 million, though some companies report costs as high as $15 million. Knight “conservatively” estimated the total annual cost of �404 compliance at $3.5 billion. He said smaller companies are also finding it difficult to meet filing deadlines. “Since auditor resources are stretched thin, the set of smaller companies that do retain national auditors often receive less attention and are put on a lower priority track than larger companies,” he said. “This makes it more difficult for smaller companies to get back on track within a reasonable time period after they have had a late filing.” He added that Nasdaq this year has issued 60 delisting letters to issuers that failed to file on time, up from 14 last year. The Foley & Lardner survey also suggests that the relationship between companies and their auditors has become increasingly adversarial as a result of tighter accounting rules. Confidential responses from the 147 companies that responded on that particular issue expressed anger and suspicion toward outside auditors charged with inspecting their books. Among the quotes cited in the Foley & Lardner report, one company said: “The relationships have become almost unusable. This is probably the largest unintended consequence of Sarbanes-Oxley. Companies can no longer consider the Big Four [accounting firms] their ‘trusted business advisers.’” Said another: “Public company auditors are now privatized regulators for the Securities and Exchange Commission.” Hartman says he believes that the accounting profession is generally sympathetic to the companies but that �404 has changed the dynamics between client and company. Auditors “now have to answer to the [Public Company Accounting Oversight Board]” and are “ charged with doing something they’ve never done before — with a large liability attached if they get it wrong.” Smaller companies are also finding it difficult to compete with their larger counterparts for qualified financial staff. These issues and others have caused some companies to conclude that the public markets are not for them. In the first quarter of this year, 22 Nasdaq issuers voluntarily delisted because of SOX, compared with only seven in the year-earlier period. “In each of these cases, the companies explained their decisions by citing the increasing regulatory costs associated with being public,” said Knight, adding that if “small businesses forgo the lower-cost capital-raising opportunities afforded by the public markets, it will, in the long term, have adverse effects on the economy.” The Foley & Lardner survey showed that 20 percent of the respondents were also considering delisting because of the regulatory overload. Not everyone is sympathetic to complaints about SOX and to small-company demands for regulatory relief. Lynn E. Turner, a managing director at research firm Glass Lewis & Co. LLC and a former SEC chief accountant, says small companies are 2 to 3 times more likely to have errors in their financial statements than larger companies. “Why would you cut a break to the group of companies that have the most problems?” he said. Turner noted that the error rate in financial statements for companies traded on the Nasdaq or over the counter is much higher than for those listed on the New York Stock Exchange. “What you’re hearing from is the group of companies that are certainly impacted [by the higher SOX fees], but they’re also the ones that have the biggest problem getting the truth to investors,” he said. Turner says easing the requirements could result in another crisis in the market. “We’ve gone through this already about half-a-dozen times,” he said. “There’s a major crisis, a major meltdown, a major impact on economy, and then a few years later it ebbs and people come in and roll back the reforms. As a result we repeat the same problem.” Copyright �2005 TDD, LLC. All rights reserved.

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