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THE SARBANES-OXLEY ACT (SOX) : THE REAL COSTS AND VALUE

By Serge Ejzenberg
Posted Apr. 12, 2005

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Foreign companies listed in the USA, as well as those with more than 300 US shareholders[1], are bound by the requirements of the Sarbanes-Oxley Act. It introduces tough new regulations designed to prevent repeats of the Enron and Worldcom scandals. But it’s putting some European companies in bad mood.

Some large telecommunication providers have threatened to de-list or to buy back shares from American shareholders, arguing that their annual compliance bills (above 10 M$).

For many, pulling out of the US is not commercially viable. However resentful they are about knee-jerk legislation to a few corporate bad eggs, they are unwilling to turn their back on the world’s largest pool of market capital. What’s more, to make the excuse that SOX is too costly or difficult when peer companies are taking it on, may well raise investors’ eyebrows.

Around 305 European companies with equity or debt traded in the US are affected by SOX. The annual cost to European business is estimated to be in the region of $ 850 m. US companies had to comply by the end of Q1 2005; European firms have an extra year and a half grace to watch what’s going on across the pond.

Despite the extra time to prepare compliance will be “highly labour-intensive”. For most firms there have been considerable incremental costs in supplementing internal resources with appropriate professionals from outside.

Sarbanes-Oxley is an act of Congress written to address what were essentially US problems. The SEC can amend its own regulation but changing an Act of Congress means rewriting or amending the law.

And that’s why relaxing the requirements for European companies is not a quick fix. For now, at least, dual-listed companies and those that otherwise have to report to the SEC will have to comply.

US pulling power

A US listing has always cost more in terms of compliance than just staying put in the home market.

But that’s the price of access to the deepest pool of capital. Even before SOX’s arrival, the US market carried higher multiples than any others.

Investors notably in the media, biotech, gas and oil industries, have been prepared to pay more per share for well-governed companies with attractive equity stories.

There is also the broad perception that US-listed companies are required to provide a higher level of information to the market than counterparts in the other countries.

A company that de-lists needs to think seriously about the long term ROI and capital allocation implications. It needs to think about the message it sends to shareholders and remember that a U-turn at a later date…

Immoveable deadline

Sarbanes-Oxley demands that all companies get external auditors’ approval of their accounts and internal control procedures by the same date. This, on top of the cost, is also proving a strain.

Section 404 of SOX has got about 7 000 US-listed companies competing for certification from an accounting industry that’s already under heavy scrutiny.

Resources are strained and they are really four playersto choose from.

With memories of Enron, auditors are not going to be hurried into putting their reputation on the line for the sake of someone else’s.

Probably the biggest difference between US reporting and audit requirements and those in most of the rest the world is the fact that Section 404 requires auditors to give an opinion on internal controls as well as financial statements.

About turn?

The Chairman of the SEC, has indicated that the rules may be relaxed so that foreign companies can carve out an easier exit.

While would-be US listers may now think twice and emerging market companies may look to Europe for their dual-listing instead, SOX cannot guarantee better reporting and controls but it’s the closest they have got to a safety blanket right now.

And for that they are prepared to pay more.

The bottom line is that SOX signals that a company which is, in theory OK…

US RULES AT A GLANCE: WHAT EUROPEAN COMPANIES NEED TO KNOW…

SOX 302: Corporate Responsibility for Financial Reports

CEO’s and CFO’s of all US-listed companies must certified their annual and interim SEC filings. Each “principal officer” of the company must separately certify that the report is accurate, complete and fairly presented. This process affirms that fillings, relating to fraud and material weakness in internal controls, have been shown to independent auditors and to the “disclosure controls and procedures”. Finally, officers must indicate any significant changes to internal controls or factors that might change them.

SOX 401: Disclosures in Periodic Reports

Issuers must disclose any off-balance-sheet arrangements that have, or are likely to have, a material future impact on the business. This applies to foreign private issuers, except registered investment firms. It require a new section of the “management’s discussion and analysis” (MD&A) for off-balance-sheet information, plus a table of contractual obligations.

SOX 404: Management Assessment of Internal Controls

Management must report annually on (1) its responsibilities for internal controls and procedures for financial reporting and (2) their effectiveness. An external auditor must attest to and report on the management’s evaluation.

SOX 409: Real-Time Issuer Disclosure

Issuers must disclose information about material changes in their financial condition or condition or operations on “a rapid and current” basis. This must be written in plain English and supported by trend and qualitative information, plus graphic presentations.

Serge Ejzenberg

Président de l’Association Alexis de Tocqueville

[1] A company must report to the SEC (and therefore comply with SOX) if it has more than $10m in assets, more than 500 shareholders worldwide and more than 300 US shareholders of record. These are the rules whether you are listed or trade in the US or not. They also apply to US corporation.

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