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by Stephen Parezo

February 10, 2005—When it was signed into law in 2002, the Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act (SOX) sought to prevent such high-profile accounting disasters as Enron and WorldCom from ever happening again. Though SOX has become the benchmark against every company's financial and corporate governance practices will be measured, dealing largely with publicly traded companies, experts say some of its impacts are being felt by smaller businesses further down the line.

"People have said these things are starting to filter down to smaller, non-public companies," said Gerald Leporte, chief of the Office of Small Business Policy at the U.S. Securities and Exchange Commission. "Banks are requiring different standards for corporate governance which has increased as a direct result of Sarbanes-Oxley. People have started talking about spending more for internal controls, software, having to hire more auditors and higher D&O [directors and officers] insurance."

Implementing some of SOX's mandates is proving costly for some small businesses with their sights set on going public. Private corporations such as those who do government work could be liable for the products they sell under SOX.

Hurriedly passed

Industry watchers like Marc Morgenstern contend that SOX was hurriedly passed by a 99-0 vote with "inadequate foresight."

As managing partner of Kahn Kleinman in Cleveland and a nationally known expert on securities and corporate legal matters, Morgenstern says despite the rush to get SOX in place due to short-term political pressure that there are some bright spots.

"For instance, there's an emphasis on independent directors, improved accounting controls and an emphasis on independent audit committees that directly retain the auditors," he said.

The bad news, he says, is that "the increased sense of caution and risk aversion will ultimately affect everybody."

According to Morgenstern, many large accounting firms have been so overwhelmed by SOX that they have told clients of 50 years that they can no longer accommodate them. The overflow of clients is now going to regional accounting firms, making it harder for the truly smaller businesses to get serviced correctly.

There is also an element of risk in earnings that includes data and information controls which carry a heavy price tag.

"The owner of a $5 million company must trust their own judgment more than any system that they can afford to put into place," he said.

Morgenstern is heartened by the fact that in December the SEC announced they would form a committee to look at SOX's impact on smaller companies within a 12-13 month time frame.

"I think the SEC and regulatory agencies understand some of the unintended consequences of SOX and would like to make things better," he added. "Their hearts are in the right place. The question is how do you navigate through all the political stakeholders? Let's hope some good significant changes come out of it."

Speed bump

The U.S. Chamber of Commerce identifies accounting, auditing, corporate reporting and corporate governance as part of its policy priorities for 2005. The Chamber is promoting reasonable changes to current accounting standards and reporting regulations but opposes unjustified rules and regulations.

Giovanni Caratolo, director of small business policy with the Chamber, says the implementation of Section 410 of SOX presents some implementation hurdles for the nation's businesses.

"This requires that you have to actually set up procedures within your company to provide checks and balances," he said. "These types of things can be very costly especially if you have just one accountant."

Caratolo noted that one small business with 65 employees has spent over $1 million to ensure compliance with SOX. But that's a cost that many small companies with their sights set on higher brackets aren't always willing to pay.

"If you are a small company and your next step is to go public a lot of small companies are not making that transition," Caratolo said. "It [cost] becomes a huge speed bump in the road to growth."

Comeback trail

In recent years headline grabbing scandals have given a black eye to the accounting profession's previously above board reputation. For Fiducial's Tony Ambrosiano who serves as the company's district manager in Dumfries, VA, those standards have never wavered.

"We maintain our high standards," he said. "SOX does target the larger firms and I think it's almost sad that it's needed. Had the profession maintained the standards of ethics that were in place that were the norm SOX wouldn't have been necessary."

While college students shied away from studying accounting the last few years, the profession has been making a bit of a comeback as of late with a marked increase in the number of accounting majors. Accounting graduates are earning $50,000 or more leaving college which Ambrosiano says has driven up the salaries for more experienced CPAs.

"For the guy that's hiring that gets very expensive," he said. "That's why we're seeing a lot of bottom lines in CPA firms being squeezed out."

Higher costs are also being passed on to clients.

"Pricing is a natural reaction to costs but it's more expensive for a small business to get their accounting done than it was years ago," Ambrosiano said.

With the tax realm getting more complex every year, he says small businesses are bound to run into trouble if they try to tackle these areas on their own.

"There's no way that a small business can stay abreast of the tax laws and keep on top of it," Ambrosiano said. "That's not their job. It's our job to maintain our knowledge of tax laws. It's our job to maintain their books. You can't run a business effectively without good numbers."

Trickling down

Fiducial has been active on the acquisition front during the last several months, having acquired a CPA and financial services network along with some successful individual accounting offices. Bill Morice, Fiducial's director of field operations, spearheads the company's acquisition efforts while ensuring that the new additions to the network meet stringent guidelines.

"We do full due diligence rather than relying on a report from anyone," said Morice. "We send our own accounting and IT experts in to do a valuation of whatever assets are there. We do our own tests so we don't accept any statements they present to us because we're acquiring accounting firms and CPA firms. Part of our due diligence is to see if the work they do for their clients is in compliance with SOX and that there are no outstanding issues with the Public Company Accounting Oversight Board (PCAOB) and the state board of accountancy including looking at their prior peer review records."

David Moore, a Fiducial franchisee in Fort Lauderdale, FL, expects SOX accounting governance to trickle down to private corporations, especially those who do government work. For example, he said if a private company that's responsible for manufacturing specialized Kevlar vests experiences a malfunction with one of its products that the company's board of directors will be held accountable.

"Small businesses selling products could then become more liable under Sarbanes-Oxley," he said.

One of Moore's clients has a company of industrial divers who inspect cruise and freight ships for terrorist threats that come into the local port. They perform a lot of their work using underwater cameras and must have the right kinds of internal controls in place to avoid any serious consequences.

Positive step

Bob Signorelli operates a Fiducial franchise in Oakbrook Terrace, IL, and feels that small businesses like his won't see nearly the type of requirements or restrictions that have been imposed on large public companies due to SOX because his practice doesn't do any audits.

"We don't do SEC audits or private audits for a bank," said Signorelli who started his practice in 1981. "Pretty much we do 95% write-up work, business consultation and reviews."

In his 24th year as a CPA, Signorelli does believe that some fallout from SOX may start to hit small businesses as far as financial statements are concerned because banking, insurance and bonding businesses "may have different requirements." Overall, he expects these requirements to have a minimal effect on small companies.

He thinks Illinois will take a moderate stance on these issues but noted that in 2004 state regulators stipulated that professionals such as accountants, architects and engineers need to be registered and fully licensed there by 2006.

"They probably did it for consolidation and manpower reductions but it's a good thing," he said. "It was a positive step for Illinois to do that."

Before he and partner Fergal Woods started up their Fiducial business in Boston a few months ago, Michael Mulcahy was an internal auditor for a large bank where he did a lot of control work. But he doesn't foresee these regulations ever touching down on small companies.

"Mom and pop operations are already accountable for everything," said Mulcahy. "It will never filter down to that level."

Stephen Parezo is the Media Manager for Fiducial.

Whatever your small business needs, your Fiducial tax and financial professional can analyze your situation and recommend an appropriate action plan. To locate a Fiducial office nearest you on fiducial.com, see the Zip Code Locator located in the upper right hand corner of the page. Do you have a particular topic that we should be writing about that can help your business? Please send your suggestions to: stephen.parezo@fiducial.com.

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