Untangling the Sarbanes-Oxley tape

British accountants could soon be suffering the same regulatory headache dogging their US peers as they struggle to help trans-atlantic clients comply with new laws intended to crack down on corporate fraud.

Leading US accountants are warning that listed British companies trading in the US markets – typically as American Depository Receipts, or ADRs – are likely to be subject to the same set of rules as their US-based peers.

But with fewer than one-in-three US companies in compliance with the Sarbanes-Oxley provisions, widespread confusion about interpreting the rules and no precedents to follow, there are ominous signs of an expensive bureaucratic bottleneck, according to specialist accountants.

‘It is shaky, it is big, the goal line is undefined, rules are still evolving and no-one has been through this before, meaning there is not a lot of best practice as guidance,’ says Larry Baye, an accountant for Grant Thornton and head of a Sarbanes-Oxley taskforce.

Baye, who recently visited a varied range of 20 companies ranging in size from $5m to $3bn to discuss compliance, says they are grappling with what is a suitable level of documentation to meet the new standards for governance and internal controls.

And there could be worse to come as other regulators, ranging from the New York Stock Exchange to accounting regulators, pile on changes in a bid to prevent a repetition of the scandals that have defamed corporate America.

A survey by Parson Consulting found that it is already adding around 20% to finance budgets with the cost even higher where companies are spread over different locations with differing standards and procedures.

In the first round of US reforms, chief executives and chief financial officers of publicly traded companies have already had to start personally vouching for the accuracy of their numbers. Audit committee chiefs and heads of information technology departments, responsible for implementing the changes, are also liable.

Now begins the more complex task of documenting the reporting system behind those results and verifying that the processes are in good shape by developing financial disclosure controls, certifications, codes of ethics and committee charters.

Another batch of rules, covering loans to directors, external assessment of a company’s controls and certification requirements, are still being finalised by the Securities Exchange Commission, the chief securities regulator. ‘It is going to require a lot of procedural change,’ warns Kenneth Blackman, chairman of Fried Frank Harris Shriver & Jacobson, a New York legal firm.

There are also the new accounting procedures for disclosing off-balance sheet arrangements and their reconciliation with the generally accepted accounting principles, for earnings releases and other financial information prepared on a pro forma basis.

While most companies have implemented around two-thirds of the 66 sections of the rule changes, the remaining third are expected to be the most complicated.

A new accountancy regulatory board, affiliated to the SEC, is currently in battle with the accounting industry about the treatment of stock options. Incentives to comply are provided by fines of up to $5m and 20 years in jail for breaches. Will it work? ‘The jury is out on that one,’ says Michael Levitt, a partner at Fried Frank.

Just how big the remaining loopholes are was recently demonstrated by an attempt by the management of AMR, the parent of American Airlines, to fireproof their pension benefits from bankruptcy proceedings while leaving the rank-and-file in the lurch. The failed plan, which led to the stepping down of chief executive Donald Carty and another share price battering, was inadvertently leaked out.

Even SEC commissioner Cynthia Glassman warns: ‘Uncertainty caused by perpetual rulemaking can have a chilling effect on legitimate business decisions, including the decision to commit capital.’

Baye says there are a range of issues where accountants are struggling to determine the approach wanted by regulators, a problem exacerbated by some of the proposed rules not having been completed.

‘We are looking to figure out what are the requirements, both from governance and from internal controls,’ he says.

These include the level of documentation required, its formality, meeting the letter and spirit of core terms like ‘material and significant’ and dealing with companies spread over a range of sectors or countries.

According to the Parson survey of 1,000 companies, more than half have taken ‘some kind of change’ to comply. But only four in 10 anticipate any advantages in ‘removing conflicts of interest’ and even fewer believe it will improve the efficiency of their finance departments.

‘Many companies have incurred additional expenses and stress from Sarbanes-Oxley without realising any significant benefits,’ says Rick Fumo, senior vice-president at Parson Consulting.