The limitations of the Sarbanes-Oxley Act

According to AMR Research Inc., companies spent approximately $5,500,000,000 on compliance in 2004. Financial and system consultants, tracking software, and increased audit tees quickly can add up to millions of dollars. Yet, it is unlikely that these efforts will stop a management team determined to circumvent existing controls. Clearly, Congress believed the benefits of ensuring a strong control structure outweighed the cost borne by our public companies. Or it could be that they did not foresee how expensive Section 404 would be or the full impact its implementation could have on firms. Regardless, it is now law.

Choking small business

While the largest companies have the resources to comply, smaller businesses may have to make some hard choices between the costs of compliance and the need to access public markets. According to a survey by Foley & Lardner LLP, "the average cost of being a public company with revenue under $1 billion in the wake of corporate governance reform has increased 130%." Survey participants overwhelmingly cited Section 404 as having the most significant financial impact--and this is before the full costs of Section 404 have been tabulated. Companies are still preparing--and still spending.

The impact Section 404 will have on small firms and private entities wishing to go public should be monitored closely. If the regulatory environment has become too burdensome, then policymakers need to exempt small companies from Section 404. There already may be evidence that this is the case. The accounting firm Grant Thornton reports that the number of public companies going private is up 30% since passage of the Act. However, reversing such legislation will not be easy. It took more than 70 years to address the overly onerous sections of the Glass-Steagall Act despite widespread recognition that it was too broad a solution for the particular problem it was designed to address. That put the banking system at a disadvantage with foreign competitors. The reason for lack of action may have been the absence of competition in the wake of World War II, but the emergence of European banking powerhouses by the late 1990s had made the case for reform more acute.

One of the U.S.'s greatest competitive advantages lies in its small public companies. While heavily regulated European firms tend to be quite large before they can afford the costs associated with going public, the U.S. has been able to provide relatively low cost access to liquid markets for thousands of small and mid-cap public firms. Money to a business is like water to a plant. In good soil and climate, the plant may brow from rainwater alone, but add irrigation and fertilizer, and crop yields improve dramatically. Choke off access to capital, and you strangle the growth of small companies. Provide access to public markets for enterprises of this size and you not only get the opportunity for faster growth, but job creation, additional tax revenues, and better, less-expensive goods and services to consumers.