Sarbanes Oxley: The Pain and the Promise

Companies around the world that are listed on U.S. stock exchanges are now trying to comply with the new regulations around reporting of internal financial controls. The big question is: do the benefits outweigh the costs?

Boardroom Minutes is pleased to present this two-part discussion around Sarbanes-Oxley (SOX). Part 1, a Q&A with SOX co-author and Sun board member Lynn Turner, focuses on the background, vision, and promise surrounding the legislation. Part 2 will focus on the experience of a corporate team working to comply.

Q: How did you become an expert on Sarbanes-Oxley?

During the course of my three years at the SEC, there was a fair amount of concern over the quality of financial reporting in the U.S. As a result, we did some work around financial reporting issues like revenue recognition. Chairman Levitt gave a speech called "The Numbers Game," which is now being used pretty regularly in the business schools.

We had success in some areas but got congressional pushback in others. Around mid-October, 2001, Enron began to implode. Within 30 days a conference in Washington D.C. reviewed the SEC's agenda and attendees made recommendations to then-Chairman Harvey Pitt. During the conference, some congressional staff asked if I would be willing to help draft some legislation if Enron continued to implode. Previously, while I was at the SEC, the staff had drafted legislation to create a new oversight board for the accounting profession with the assistance of the CEO of Ernst & Young. So using the results of that effort, a group of us reworked it into a piece of legislation. That draft legislation became the basis for what is now called Sarbanes-Oxley, as well as the new Public Company Accounting Oversight Board.

Q: What was Washington's reaction to the legislation?

A: It wasn't all smooth sailing. I had been in California speaking to the top 250 execs at a Fortune 25 company. I asked for a show of hands for those who had any training with respect to internal controls and the Foreign Corrupt Practices Act, and only one person in the audience raised their hand. That's when I knew that, despite opposition from the industry, we absolutely had to keep in the SOX Section 404 piece.

Truthfully though, until the WorldCom fiasco happened I don't think the legislation had any chance of getting passed. But when that happened, public opinion polls showed a significant impact on who the public was going to vote into office. And within seven days before the July 4th weekend, the people who'd been voting against the bill became like a bunch of lemmings going to the sea — they couldn't sign on fast enough. It was those public opinion polls that resulted in SOX being approved.

Q: What do you hope that Sarbanes-Oxley will do for businesses, consumers and the stock market?

A: From a consumer/investor perspective I'd like to see people becoming confident about putting their money into the marketplace and feeling like the information they're getting from executives can be trusted. One of the things that make capital markets work is the people's ability to allocate their capital to those companies who are the top performers and generate the highest return for investors. When investors are not getting accurate information, we have misallocation of capital.

In late '99 Chairman Levitt and I had dinner with the two leaders of the Business Roundtable (BRT). The BRT represents executives of the top 200 companies in corporate America. This was during the height of the tech boom. They were very concerned about the capital markets and urged us to do something. They felt that a lot of dot-com companies were draining capital away from legitimate businesses that would survive. They feared that many of these dot.com companies would fail. In turn, all the capital they had raised would be misallocated and not go to companies who would create jobs, production, and value for the economy. Quite frankly, they turned out to be absolutely right.

Q: So how would SOX prevent this from happening again?

A: We have an obligation to provide information to investors that allows them to distinguish between these types of situations. With SOX, the SEC passed rules that hopefully will provide much more transparent information so that investors get better information. They can then make better and more informed decisions, allocate capital to those companies who can most effectively employ it, and we have a more solid economy as a result.

My notion behind all of this is to create a mechanism for timely, accurate, transparent information for investors that will result in companies being more responsible to their owners. Executives need to ensure that this happens and hopefully some of the negative views of corporate America will dissipate. Unfortunately, the Conference Board Commission on Public Trust survey reported that 73% of Americans didn't think they could trust corporate executives of large companies.

Q: So despite all of the complaints, is Sarbanes-Oxley just the price of doing business today if you're going to do it the right way?

A: I think so. In November, BusinessWeek ran an article saying that companies are spending an average of $3 million and 30,000 hours to comply with Sarbanes-Oxley. It would be wrong to refute that. But there was also a much higher price to the corporate greed and the impact it had not only on investors, but on the economy and people in general. So if it costs the U.S. $10-20 billion to implement SOX, that's a drop in the bucket compared to the $7 trillion decline in the market cap that we had after Enron, WorldCom, and others. That is a phenomenal cost that is directly attributable to investors' trust in those corporate executives. And it's an unfortunate painting of the many corporate executives and employees who are honest, straightforward, and frank.

I sometimes hear people say, "It's just a few bad apples." That's just not true — if you look at the list of companies that have problems, it's pretty long. There are well over 1,000 companies who've had to restate their financial statements, so it's by no means anyone's imagination or just a few bad apples. But as we go through the next few months and finish this portion of the internal control work, where a lot of the costs are incurred, I think we're going to find the system does in fact work better. It does a better job of protecting investor's money and gives investors better information.

Just recently, I was in Washington D.C., where I sit on an advisory group for the Public Company Accounting Oversight Board--the new board created out of Sarbanes-Oxley to oversee and regulate the accounting profession. The financial executives of four F500 companies were there, and I was very taken by their comments. They made it very clear that this has been a painful process and one that we need to continue to evaluate going forward.

But they all said that being forced to go through the internal control work has been a very positive experience in that it makes their companies better. Certain controls weren't in place that should have been. And the process forced them to put in controls that make the business better. My experience has been that you cannot have a well-run company if you don't have good controls. It has become clear that too many companies (over 300 this year) have already reported that they had material weaknesses on internal controls. And these are all companies whose CEOs and CFOs previously certified to their investors that their controls were fine. The good news is that these situations are surfacing and we're going to take care of them.

However, we probably won't know whether or not SOX in its entirety has been successful for about five years post-enactment of SOX.

Q: What do you say to companies that are overwhelmed with the task of complying?

A: I would start out by saying that you need to think of this as an opportunity to take a fresh look at what you're doing. See if there are ways you can improve your business. Then take the process systematically and methodically — you're not going to get it done overnight. There will be times when it will be difficult and frustrating, but for those companies who really embrace the opportunity, there is potential to score well with institutional investors who are always looking for those companies that are in the top 25% in terms of performance. That's when you really have a win-win situation where investors don't mind if you take home a nice compensation package because you've also rewarded them.

Q: What about the notion that Sarbanes-Oxley might cause more companies to stay private rather than go public? Do you think that's true?

A: To some degree, I hope so. There are a lot of companies that are public, that shouldn't be. There is an aura attached to being a public company in the U.S., that frankly doesn't exist in Europe. Some of these companies that go public will never have the ability to generate the type of returns that result in investors wanting to hold their stocks. There is something about these companies, either with the level of returns or otherwise, that make investors uninterested. I hear CEOs complain that they can't get analyst/press coverage, they can't get the institutional investors interested in them. That should tell you something. It tells you that the market is working and you shouldn't be a public company. If you listen to the Chairman of the NASDAQ, SOX is not having a negative impact. He wrote an op-ed piece in the Wall Street Journal stating that he wasn't having any trouble getting IPOs or attracting international companies into the US marketplace.

I'm neutral on whether companies go public or not. But my view is that if you take people's money, you have a certain obligation to them — to make sure you give them timely and accurate information and comply with all the rules and regulations. If you can't do that, then don't take their money.

Q: What is your perspective of all of this in light of being on Sun's board? What do you bring to it specifically?

A: I have personally gained a phenomenal amount from being on Sun's board. There are some amazing people in there. When I see the intellect and the discussion that goes on with people like Steve Bennett from Intuit and John Doerr from Kleiner Perkins, Naomi Seligman, Scott McNealy — just to name a few — these are unbelievably bright people.

What do I bring to it? I guess Sun benefits from my expertise on financial reporting issues like the Microsoft settlement and the accounting for that. I can help interface with the SEC if need be, or raise business questions about what Sun might be doing in the way of acquisitions, business plans, or strategies.

Any time you go onto the board of a company you take some risk that there might be unethical behaviors going on that you don't want your name attached to. I will tell you this about Sun — there is absolutely no question in my mind, whatsoever, about the integrity of Scott McNealy and Steve McGowan. You know, Scott's not a big fan of SOX. But when it comes to implementing it I've seen him tell people, with that steely look, to not even think about doing anything other than what is right. At the end of the day, that's what SOX is all about.

About Lynn Turner

Lynn Turner has the unique perspective of having been the Chief Accountant of the Securities and Exchange Commission, a professor of accounting, a corporate board member, a partner in one of the major international accounting firms, the managing director of a research firm and a chief financial officer and executive in industry.

Mr. Turner served as the Chief Accountant of the Securities and Exchange Commission (SEC) from his appointment by the SEC Chairman in July 1998 to August 2001. As Chief Accountant, Mr. Turner was the principal advisor to the SEC Chairman and Commission on financial reporting and disclosure by public companies in the U.S. capital markets as well as the related corporate governance matters.

Mr. Turner is currently the managing director of research at Glass Lewis & Co. Glass Lewis is an analytical proxy and financial research firm that uses proprietary research and extensive analysis to objectively evaluate the corporate integrity and financial transparency of public companies. Mr. Turner also serves as a senior advisor to Kroll Zolfo Cooper. Kroll Zolfo Cooper specializes in Corporate Advisory and Restructuring and Forensic and Litigation. Mr. Turner is also a member of the Board of Directors of Sun Microsystems and a member of the Standards Advisory Group of the Public Company Accounting Oversight Board.

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