You Can Be Too Careful

How the government's new corporate accounting rules impede efficiency and stifle innovation.

Brian Doherty from the January 2006 issue

(Page 2 of 3)

Reason: How has Sarbanes-Oxley affected the day-to-day work of people who deal with corporate finance?

Bob Merritt: Section 404 deals with internal controls. That's the part of the law everyone is objecting to most. It says management must certify they have reasonable, cost-effective internal controls to ensure there's no misstatement. The Public Company Accounting Oversight Board has generated rules that require you to certify and test petty cash control--the whole "cost-effective" component gets thrown out. So auditors or people implementing the 404 requirements are requiring lots of duplication of effort.

Here's one great example: If you use an Excel spreadsheet to prepare some numbers for financial statements, auditors want you to prove that you have internal controls in place to guarantee that the Excel spreadsheet adds up. You have to give the spreadsheet numbers to someone and have them manually add them up.

It's hard to explain the frustration, because it's relentless. Every week they come out with new requirements and new regulations, and your day-to-day work becomes more absurd and mired in minutiae. SarbOx isn't the only reason I left Outback--there were a lot of things that happened, and I was at a point in my career where it made sense. But my life at Outback had become just dealing day to day with regulatory matters. I'm a business developer by mentality; I've always been a business person with a financial background. And suddenly I became a cop and a compliance guy. That's not my nature. I want to build things, make things better, and I no longer had time to do that.

I got so frustrated, it wasn't worth coming to work. I'd rather be the guy that holds the pole that the surveyor looks down than be CFO of a public company.

Karen De Coster: As a corporate finance person, this massive body of rules and regulations touches every aspect of my job, including that which seems irrelevant to the big picture, and barely stops short of making me keep Excel spreadsheets of my daily toilet paper use at the office and having the CFO sign off on the roll. Corporate finance people recognize that much of SarbOx is exactly what we strive to eliminate from our work day: non-value-added processes that encumber employees from doing more useful work aimed toward analyzing and maximizing financial position and providing management and shareholders with meaningful data.

Much of this value-added work all but gets lost in the rush to comply with mountains of SarbOx bureaucracy. SarbOx has caused top-end managers and corporate financial people to abandon value-added analysis and process improvement for the sake of day-to-day compliance. The network of planning and tasking involved in compliance with SarbOx is a monster to behold.

Stephen Stanton: Section 404 of Sarbanes-Oxley requires companies to document their internal controls over financial reporting. In layman's terms, they have to make sure the numbers they report are accurate and complete, that everything reported really exists, that all transactions really occurred, and that there is no fraud or material misstatement. They also have to prove how they know there was no fraud or material misstatements and that the reports are accurate and complete.

It's like when you take a test in high school. It's not just about getting the right answer, which is what the traditional financial statement was--the auditor makes sure that the final answers are right. This is more like a math test where you don't get credit if you don't show your work. Even if the numbers are right, if you don't show how you got there, you fail under Sarbanes-Oxley.

Almost all companies have gotten clean auditors' opinions for years, decades, only to discover now they have half a million dollars' worth of work ahead of them to get a clean opinion. Another frustration is that what they traditionally relied on to get to right numbers, there's no evidence that took place. If they have a conference call meeting, it's not enough; now we have to create a paper trail for everything they do. Companies that switched to a paperless system are now buying a heck of a lot of paper.

If you don't create a paper trail, it doesn't count. It's like trying to prove you love your wife: How many flowers did you buy her? What did you get her for Christmas? Lots of little things you wouldn't normally have a receipt for. Every journal entry must be printed out on paper, get two signatures, including either the assistant controller or controller, and be put in binders. Every month they produce stacks of binders that have to be archived. To my knowledge, my clients doing that haven't discovered anything materially misstated.

Reason: What are the costs of complying with Sarbanes-Oxley?

Merritt: We had to have a 4 percent increase in bodies, and incremental costs in year one of 404 certification were $3 to $4 million. But [Outback is] a simple company, not an international conglomerate. And that doesn't count the hidden cost of management time spent on regulatory stuff and not being spent on business development.

De Coster: I don't put a lot of stock in collective statistics. The monetary costs, business by business, have been heavily circulated, even by the mainstream media. Millions here, millions there. Since the costs will be forever ongoing, you can run the numbers any way
you want, and you'll come up with a heck of a lot of zeroes.

However, the bigger cost is in terms of the centralization of a regulatory system that can effectively stifle the free market via the imposition of arbitrary decree. When management makes a decision to implement controls, it's because they see a future benefit accruing to the company. When a bunch of empowered elites in Washington, D.C., implement controls, it's for the purposes of a power grab, face-time in the limelight, and the furtherance of total, central control. SarbOx, in a sense, is a form of central planning wherein D.C. can effectively rein in Wall Street and have complete control over corporate policing.